Transcript Elasticity2
Elasticity 2 Why are something are elastic and some inelastic? Elasticity Review • Perfectly elastic – quantity responds enormously to price changes (E = ). • Elastic – the percentage change in quantity exceeds the percentage change in price (E >1). Elasticity Review • Unit elastic – the percentage change in quantity is the same as the percentage change in price (E = 1). Elasticity Review • Inelastic – the percentage change in quantity is less than the percentage change in price (E <1). • Perfectly inelastic – quantity does not respond at all to price changes (E = 0). Substitution and Elasticity • As a general rule, the more substitutes a good has, the more elastic is its supply and demand. Substitution and Demand • The larger the time interval considered, or the longer the run, the more elastic is the good’s demand curve. – There are more substitutes in the long run than in the short run. – The long run provides more options for change. Substitution and Demand • The less a good is a necessity, the more elastic its demand curve. • Necessities tend to have fewer substitutes than do luxuries. Substitution and Demand • Demand becomes more elastic as the definition of a good becomes more specific. – A broadly defined good like transportation does not have many substitutes so that demand will be inelastic. – A more narrowly defined good like bus transportation will have more substitutes. Substitution and Demand • Demand for goods that represent a large proportion of one's budget are more elastic than demand for goods that represent a small proportion of one's budget. Substitution and Demand • Goods that cost very little relative to your total expenditures are not worth spending a lot of time figuring out if there is a good substitute. • It is worth spending a lot of time looking for substitutes for goods that take a large portion of one’s income. Substitution and Supply • The longer the time period considered, the more elastic the supply. • The reasoning is the same as for demand. – In the long run there are more options for change so it is easier (less costly) for suppliers to change into the production of another good. Substitution and Supply • Economists distinguish three time periods relevant to supply: – The instantaneous period. – The short run. – The long run. Substitution and Supply • In the instantaneous period, quantity supplied is fixed – the elasticity of supply is perfectly inelastic. • This supply is sometimes called the momentary supply. Substitution and Supply • In the short run, some substitution is possible – the short-run supply curve is somewhat elastic. • In the long run, significant substitution is possible – the supply curve becomes very elastic. How Substitution Factors Affect Specific Decisions • Suppose you’ve been asked to evaluate the potential impact of a 10¢ gas tax increase in Washington, D.C. and in the entire nation. Evaluating the 10¢ Gas Tax Increase • We’d expect the short run the demand curve for gasoline to be less elastic than in the long run. • In the long run, motorists would switch to fuel efficient cars. Evaluating the 10¢ Gas Tax Increase • Demand is probably inelastic for the entire U.S. – Gasoline is considered a necessity – It is only a small part of what it costs to drive. Evaluating the 10¢ Gas Tax Increase • Demand for gasoline is very elastic in Washington, D.C. – Some may switch to an alternative form of transportation. – Others would go to neighboring states to buy gasoline. Empirical Estimates of Elasticities • The following table provides short- and long-term estimates of elasticities for a number of goods. Short-Run and Long-Run Elasticities of Demand Product Tobacco products Electicity (household) Health Services Nodurable toys Movies/motion pictures Beer Wine University tuition Price elasticity Short Run Long Run 0.46 1.89 0.13 1.89 0.20 0.92 0.30 1.02 0.87 3.67 0.56 1.39 0.68 0.84 0.52 —