QIISS4LONG EXAM I REVIEWERFerdinand B. Sta. Ana Jr. (IV – Electron)

Elasticity

Elasticity (η) Responsiveness of quantity to changes

in certain factors Demand

1. Price Elasticity of Demand (PεD)2. Income Elasticity of Demand (I εD)3. Cross-price Elasticity of Demand (CP εD)

Supply1. Price Elasticity of Supply (PεS)

Degrees of Elasticity Unit elastic

Change in a certain factor is equal to change in price of g00d ↑1% Price -> =↓1% Quantity demanded (for PεD) Elasticity = 1

Elastic Quantity demanded/supplied of a good reacts substantially to

change in factor ↑1% Price -> >↓1% Quantity demanded (for PεD) 1 < Elasticity < +∞

Inelastic Quantity demanded/supplied of a good only responds slightly to

change in factor ↑1% Price -> <↓1% Quantity demanded (for PεD) 0 < Elasticity < 1

Price Elasticity of Demand (PεD)

Responsiveness of QDx to ΔPDx = Always negative so take the absolute

value

Elasticity ≠ Slope

However……There are cases when slope = elasticity

Perfectly Elastic: PεDx = ∞ m = ∞ (in math

terms, it is undefined)

Perfectly Inelastic: PεDx = 0 m = 0

Income Elasticity of Demand (I εD)

Responsiveness of Dx to ΔI = = Interpreting the Income Elasticity of

Demand: I εD < 0 (negative) – good is an inferior good I εD > 0 (positive) – good is a normal good

If > 1 – good is a superior good If between 0 and 1, good is a

necessity/relatively inelastic

Cross Price Elasticity of Demand (CPεD)

Responsiveness of Dx to ΔPy = = Interpreting the Cross Price Elasticity of

Demand: If CPεD > 0 x and y are substitute goods If CPεD < 0 x and y are complements If CPεD = 0 x and y are independent

goods

Price Elasticity of Supply (Pεs) Responsiveness of Qsx to ΔPx = = Interpretation of Price Elasticity of

Supply: If PεS = 0 supply is perfectly inelastic If 0 < PεS < 1 supply is relatively inelastic If PεS = 1 supply is unit elastic If 1 < PεS < +∞ supply is relatively

elastic If PεS = ∞ supply is perfectly elastic

Determinants of Elasticity Type of good:

Necessity – relatively inelastic (needed) Luxury – relatively elastic (not needed; luxury ≠ prestige)

Availability of substitutes ↑substitutes ↑elasticity (elastic) ↓substitutes ↓elasticity (inelastic)

Price as a percentage of income/Amount of disposable income on a good The lower the share of the price on the income, the more price-

insensitive (inelastic) the buyer is. (e.g. candies) The higher the share of the price on the income, the more price-sensitive

(elastic) the buyers is. (e.g. airfare, house and lot or automobile)

Determinants of Elasticity Time frame

Longer time frame – elastic Shorter time frame – inelastic Has something to do with the response of buyer

given a period of time. The more time the buyer has, the more time the buyer can think/look for better deals. (e.g. transportation)

Unique value Loyalty, sentimental value buyers tend to be

price-insensitive (inelastic) By virtue of branding

Tax Incidence

Tax mainly used by the government to raise

revenues (not limited to this) Affects the cost of production of goods

taxes directly affect the supply In graphical terms, causes a shift of the

supply curve to the left It can also discourage market activity. (When

a good is taxed, quantity of good sold is smaller in the new equilibrium)

The buyer and seller share the burden of tax

Who has the heavier burden? This is where elasticity comes in. Analyze

the ff. graphs:

Demand and Supply have equal elasticity

Compare and contrastElasticity: Supply > Demand

Elasticity: Supply < Demand

Remember: taxes cause a shift of the supply curve, not movement. Forgive me because the graphs I found didn’t have a new supply curve. Just imagine a line passing through the point on the demand curve (blue line) and is parallel to the supply curve (red line)

Red bracket: per unit producer tax burdenBlue bracket: per unit consumer tax burden

Compare and contrast

Burden is solely shouldered by consumers

Burden is solely shouldered by producers

Perfectly Elastic Supply Perfectly Elastic Demand

Conclusion If demand is relatively inelastic, heavier

tax burden for consumers If demand is relatively elastic, heavier

tax burden for producers

Other notes Remember that the government will profit

more from taxing inelastic goods But, inelastic goods are usually necessities,

and taxing inelastic goods will contradict the equity function of the government

So, the gov’t taxes the elastic goods that it wants to lower transactions of. Sin taxes – taxes on generally socially unwanted

goods. Taxes on imports – taxes levied on imports to

promote local products

References Samuelson, P. A. & Nordhaus, W. D.

(2004). Economics, 18th ed. USA: Mc-Graw Hill, Inc.

Mankiw, N. G. (2009). Principle of microeconomics, 5th ed. Mason, OH: South-Western Cengage Learning

Depken, C. A. (2006). Microeconomics demystified. USA: Mc-Graw Hill, Inc.

Notes from the lecture of Vladimir S. Lopez

END OF REVIEWER-fbsaj2011