AP Economics
Mr. Bernstein
Module 48:
Other Elasticities
October 20, 2014
AP Economics
Mr. Bernstein
Elasticity can measure responsiveness of other
consumer and producer activities
• Cross-price elasticity of demand
• Income elasticity of demand
• Price elasticity of supply
2
AP Economics
Mr. Bernstein
Who is interested in these elasticities?
•
•
•
•
Economists
Governments
Firms
Example of cross-price elasticity: How do changes in the
price of gas affect car sales? GM and Ford care.
• Example of income elasticity: In a recession, how do
declining incomes affect hotel occupancy? Holiday Inn and
Priceline care.
3
AP Economics
Mr. Bernstein
Cross-Price Elasticity of Demand
•
•
•
•
Measures the responsiveness of the demand for good “X” to
changes in the price of good “Y”
Aka %rDx / %rPy
Demand curve for X shifts due to a change in Py
Substitutes have positive cross-elasticity
•
•
Compliments have negative cross-elasticity
•
•
A 2% rise in the price of Nikes causes a 4% increase in demand for Adidas;
EAdidas, Nikes = 4% / 2% = 2
A 20% rise in the price of gasoline causes a 5% fall in demand for SUVs; E
SUVs, gasoline = 20% / -5% = -4
Independent products have zero cross-elasticity
•
A 10% rise in the price of peanut butter has no effect on demand for SUVs
4
AP Economics
Mr. Bernstein
Income Elasticity of Demand
•
•
•
•
Measures the responsiveness of demand for a good to
changes in income
Aka %r Dx / %rI
Demand curve shifts due to change in income; elasticity
measures the responsiveness or how much the curve shifts
Normal goods have positive income elasticity
•
•
American income declines 2% and purchases of airline tickets to Italy
decline 8%; Ei= 8% / 2% = 4 (a high income elasticity typical of luxury
items)
American income increases 4% and purchases of fresh vegetables
increase 1%; Ei = 1% / 4% = .25 (an income-inelastic response typical of
necessity items)
5
AP Economics
Mr. Bernstein
Income Elasticity of Demand, cont.
•
Inferior goods have negative income elasticity
•
American income declines 5% and purchases of SPAM increase 4%;
Ei= 4% / -5% = -.8
6
AP Economics
Mr. Bernstein
Price Elasticity of Supply
•
Law of Supply: When price increases, firms increase quantity
supplied
• Price Elasticity of Supply follows same formula as Price
Elasticity of Demand: Es = %rQs / %rP
• Elastic and Inelastic definitions are the same also:
• If Es >1, supply is considered elastic
• If Es <1, supply is considered inelastic
• If Es = 1, supply is considered unit elastic
• Elastic is flatter and perfectly elastic is horizontal
• Inelastic is steeper and perfectly inelastic is vertical
7
AP Economics
Mr. Bernstein
Price Elasticity of Supply
•
What might cause a perfectly inelastic supply curve?
•
•
Even at absurdly high prices, firms will not increase supply
Limits to production, perhaps due to technology limits, resource
constraints or in the case of farming, seasonal impossibilities
8
AP Economics
Mr. Bernstein
Factors Influencing Elasticity of Supply
•
Availability of inputs
•
•
Example: If coal shipments only arrive monthly, a factory cannot
quickly increase production when prices increase
Time
•
•
•
•
“Market period” is so short that supply is perfectly inelastic
Short-run elasticity of supply is greater than zero
Long-run elasticity of supply is greater than short-run elasticity
Example: Farmers cannot react to rising soybean prices until the next
growing season.
9