ECON528 – Module2

Elasticity of Demand

a measure of quantity demanded change with a change in price.

Elasticity of Demand = % change in quantity / % change in price

Very Elastic = Given % change in Price, large % change in Quantity

Very Inelastic = Given % change in Price, small % change in Quantity

 

Absolute value of Elasticity of Demand = |Ed|

When |Ed| > 1, we have elasticity. For 1% drop in price, the change in quantity is more than 1%. Total Revenue will go up.

When |Ed| = 1, we have unit elasticity. For 1% drop in price, the change in quantity is also equal to 1%. Approximately no change in Total Revenue.

When |Ed| < 1, we have inelasticity. For 1% drop in price, the change in quantity is less than 1%. Total Revenue will go down.

 

Cross Elasticity of Demand (CED): how price change of one good affects the other.

CED = % change in quantity of one good / % change in price of the other good

In case of nearly perfect substitute goods, CED approaches infinity (CED -> ∞)

Substitute products will have +ve CED, means P1↑ then Q2↑, P1↓ then Q2↓

Complement products will have -ve CED, means P1↑ then Q2↓, P1↓ then Q2↑

Unrelated products will have zero CED means, change in P1 will have no effect on Q2

Elasticity of Supply

Elasticity of Supply = % change in quantity / % change in price

 

Government Intervention

  1. Direct Government Price Controls
    1. Price Floor
    2. Price Ceiling
  2. Taxes or Subsidies on a Market (The price and quantity outcomes are subject to change)

Excise Taxes: how does it change the supply curve

The supply curve shifts up by the amount of tax

Incidence of taxation