Elasticity is a measure of the sensitivity of one variable to a change in another, or a number that shows the percentage change in one variable resulting from a change in another variable.

Types of elasticity:

tote elasticity;
arc elasticity;

Arc elasticity called the elasticity between two points on the supply or demand line.

Point elasticity characterizes the relative change in the volume of demand with an infinitesimal change in price.

Price Elasticity of Demand

Elasticity of demand relative to price(E D P) shows the relative change in the volume of demand under the influence of a 1% change in price: E D P = (ΔQ/Qd)/(ΔP/P) where ΔQ/Qd is the relative change in demand;

or E D P = %Qd/%P %Qd - change in demand as a percentage, %P - change in price as a percentage.

The meaning and essence of elasticity of demand: by what percentage will demand change if the price changes by 1%.

The elasticity coefficient is considered modulo, i.e. its absolute value |E D P |.

Example. What is the price elasticity of demand if, when the price of a product decreases by 10%, revenue increases by 10%.
Solution. E D P = %Qd/%P = |10%/(-10%)| = |-1| = 1

Types of demand by elasticity.

E D P = 0. Completely inelastic demand - essential goods (salt, matches);
E D P< 1. Неэластичный спрос - при изменении цены на 1% спрос изменяется менее, чем на 1%. Падение цены приведет к снижению выручки;
E D P = 1. Unit elasticity. Maximum revenue. When price changes by 1%, demand also changes by 1%. Maximum revenue;
E D P > 1. Elastic demand. When price changes by 1%, demand changes by more than 1%. A fall in price will lead to an increase in revenue;
E D P = ∞. Perfectly elastic demand - luxury goods;

Example. Test. Demand is price inelastic:
A) the response of demand to a price change is small;
B) the demand response to price changes is high;
B) the reaction of demand to a price change is neutral;

Factors influencing price elasticity of demand

the presence of substitutes (the more goods - substitutes, the more elastic the demand for this product;
specific gravity goods in the consumer’s budget (the higher the share, the higher the price elasticity);
amount of income;
quality of the product (the better the quality of the product, the less elastic the demand for it);
degree of necessity of the product, versatility of the product;
the size of the stock (the larger the stock, the more elastic the demand);
buyer psychology.

Example. Test. Which of the following will cause the demand curve to shift to the right?
a) growth in the number of consumers;
b) reducing the price of substitute goods;
c) an increase in the cost of producing goods;
d) reduction in the price of a given product.

Price elasticity of demand at the equilibrium point

Price elasticity of demand at the equilibrium point. E = - α x P / Q α - coefficient of slope of the demand line;
P - equilibrium price,
Q is the equilibrium volume.

Coefficient of direct price elasticity of demand

The calculation of the coefficient of direct price elasticity of demand can be done using the first derivative: Ed = dQ/dP · P/Q For example, Qd = 50 - 9P. First derivative dQ/dP = -9.

Elasticity of supply

Elasticity of supply(E S P) shows the relative change in supply volume under the influence of a 1% change in price: E S P = (ΔQ/Qs)/(ΔP/P) where ΔQ/Qs is the relative change in supply;
ΔP/P is the relative price change.

or E S P = %Qs/%P %Qs - change in supply as a percentage, %P - change in price as a percentage.

The meaning and essence of elasticity of supply: by what percentage will supply change if the price changes by 1%.

The supply elasticity coefficient is always positive, because For most of the goods under consideration, the supply curve is upward sloping.

Types of elasticity proposal.

E S P = 0. Absolutely inelastic supply - raw materials (oil, gas, ore);
E S P = 1. Unit elasticity. When price changes by 1%, supply also changes by 1%;
E S P > 1. Elastic supply. When price changes by 1%, supply changes by more than 1%. Normal goods;
E S P = ∞. Perfectly elastic supply - factors of production (labor, capital);

Price elasticity of supply at the equilibrium point

Price elasticity of supply at the equilibrium point. E = β x P / Q β - coefficient of slope of the supply line;
P - equilibrium price,
Q is the equilibrium volume.

Coefficient of direct price elasticity of supply

The calculation of the coefficient of direct price elasticity of supply can be done using the first derivative: Es = dQ/dP · P/Q For example, Qs = 50 + P. The first derivative dQ/dP = 1.

Factors influencing elasticity of supply

ability to long-term storage and the cost of storage (for a product that cannot be stored for a long time, the elasticity of supply will be low);
peculiarities production process(if the producer of a good can either expand its production when the price rises, or switch to producing other products when its price decreases, then the supply of this good is elastic;
time factor (the manufacturer is not able to instantly respond to price changes, since it takes a certain time to hire additional workers, purchase equipment, raw materials, etc.)

Cross Elasticity

Cross Elasticity characterizes the relative change in the volume of demand for one product when the price of another product changes. E D xy = (ΔQ/Qd)/(ΔPy/Py) where ΔQ/Qd is the relative change in demand for the product X;
ΔPy/Py - relative change in the price of the product Y.

or E D xy = %Qdx/%Py %Qdx - change in demand for the product X in percent, %Рy - change in the price of the product Y in percentages.

Meaning and essence cross elasticity : by what percentage will the demand for product X change if the price of product Y changes by 1%. Cross elasticity is widely used in antitrust policy: evidence that a company is not a monopolist of a particular product is the fact that the product produced by this company has a positive cross elasticity of demand with the product of another company.

Types of goods by elasticity.

E D xy = 0. Completely inelastic demand - essential goods (salt, matches);
E D xy< 1. Взаимодополняющие товары (кофе - сливки, шашлык - соус);
E D xy = 1. Unit elasticity. Maximum revenue. When price changes by 1%, demand also changes by 1%. Maximum revenue;
E D xy > 1. Substitute goods (competitors' products);
E D xy = ∞. Perfectly elastic demand - luxury goods;

Coefficient of cross price elasticity of demand

The calculation of the coefficient of cross price elasticity of demand can be done using the first derivative: E = dQ x /dP y · P y /Q a For example, Q x = 50 + 3P y. The first derivative dQ x /dP y = 3.

Income Elasticity of Demand

Elasticity of demand relative to income(E P I) shows the relative change in the volume of demand under the influence of a 1% change in income: E P I = (ΔQ/Qd)/(ΔI/I) where ΔQ/Qd is the relative change in demand;
ΔI/I is the relative change in income.

or E P I = %Q/%I %Q - change in demand as a percentage, %I - change in income as a percentage.

The meaning and essence of income elasticity of demand: By what percentage will demand change if income changes by 1%. The more vital a product is, the lower the income elasticity of demand.

Types of income elasticity.

E P I = 0. Completely inelastic demand - essential goods (salt, matches);
E P I< 0. Товары низкого качества;
0 < E P I < 1. Товары неэластичные по доходу. Продукты питания, топливо, сырье;
E P I = 1. Unit elasticity. Essential goods. Unitary demand. Reducing the price does not lead to a commercial effect;
E P I > 0. Products High Quality(normal, standard goods);
E P I > 1. Goods are income elastic. Quality products. Prestigious goods;
E P I = ∞. Perfectly elastic demand - luxury goods;

If the economy is booming and the average household income increases, then industries producing goods with E P I > 1 will expand, and industries with E P I

Factors influencing income elasticity of demand

the importance of a particular product for the family budget (the more the product is needed by the family, the less elastic it is);
whether the product is a luxury item or a necessity (for the former it is higher than for the latter);
conservatism of demand (as income increases, the consumer does not immediately switch to consuming more expensive goods).

Example. The elasticity of the population's demand for a product in terms of price is (-1.6), and in terms of income it is 0.8. If the price of a good decreases by 4% and income increases by 5%, how will the demand for the good change?
Solution. Price elasticity of demand: E P D = %Q D /%P. If the price decreases by 4%: -1.6 = %Q D /(-4%) . Where does %Q D = -4*(-1.6) = 6.4%. If the price decreases by 4%, the quantity demanded will increase by 6.4%.
Income elasticity of demand: E P I = %Q I /%I. With an increase in income by 5%: 0.8 = %Q I /5%, from which %Q I = 0.8*5% = 4%. Thus, with an increase in income by 5%, the demand for a product will increase by 4%.
Total demand will increase by 10.4% (6.4% + 4%).

Section 1. Basic principles of microeconomics

Topic 2. Elasticity of supply and demand

Practical work 2

Problems for calculating elasticity coefficients

Problem 1

Formulation of the problem: Look at the drawing. Determine the coefficient price elasticity on segment AB of the demand curve d 1. What product are we talking about?

Technology for solving the problem: To solve the problem, you need to remember how to determine arc price elasticity coefficient. We denote the elasticity coefficient as E d/p, then

Answer: the elasticity coefficient is –2.3. The product is elastic.

Problem 2

Formulation of the problem: Three products are given. Changes in demand volumes depending on price changes are shown in the table. Determine the price elasticity coefficients for each product.

Technology for solving the problem: it is necessary to determine the coefficients of arc elasticity of demand for price for each product. The elasticity coefficient of product A (E d/p A) is determined by the formula

Putting the values into the formula, we get:

This coefficient characterizes an elastic product.

Similarly, we calculate the elasticity coefficient for product B:

And finally, E d/p C:

Answer: E d/p A = –1.25; E d/p B = –1; E d/p C = –0.6.

Problem 3

Formulation of the problem: As a result of the price increase from 4 to 7 dollars, the quantity demanded for product X fell from 1000 to 800 units. Determine the price elasticity of demand.

Technology for solving the problem: We denote the elasticity coefficient as Ed/р, then

Putting the values into the formula, we get:

This coefficient characterizes a low-elastic product.

Answer: the elasticity coefficient is –0.4; This is a low-elastic product.

Problem 4

Formulation of the problem: The price of product A increased from 100 to 200 den. units Demand for this product fell from 3,000 to 1,000 units. The demand for product B increased from 500 to 1000. Determine the elasticity coefficients of product A and B. What coefficients are we talking about?

Technology for solving the problem: Since the price of product A has increased, and the demand for this product has fallen, we can determine the price elasticity coefficient of product A:

Putting the values into the formula, we get:

The response of demand for product B to a change in the price of product A is shown by the cross-elasticity coefficient, which is determined by the formula

Let's substitute the values and get:

Answer: the price elasticity coefficient of product A is (–1.5), the cross elasticity coefficient is +1.

Problem 5

Formulation of the problem: The price of product A increased from 10 to 15 deniers. units Demand for product B increased from 1000 to 2000 units, and demand for product C fell from 50 to 40 kg. Determine the cross elasticity coefficients.

Technology for solving the problem:

First, we calculate the cross-elasticity coefficient of product B using the formula

Let's substitute the values and get:

Since the coefficient is positive, then we're talking about about goods that are interchangeable with each other.

Then we determine the cross-elasticity coefficient of product C using the same formula:

Let's substitute the values and get:

Answer: E B/A = 1.675; E C/A = –0.56.

Problem 6

Formulation of the problem: The price of product A increased from 1 to 4 deniers. units Demand for product B fell from 3,000 to 1,000 units. The demand for product C increased from 500 to 1000, while the demand for product D did not change. Determine the cross elasticity coefficients.

Technology for solving the problem:

First we calculate the cross elasticity coefficient product C according to the formula

Let's substitute the values and get:

Since the coefficient is positive, we are talking about goods that replace each other.

Then we determine the cross-elasticity coefficient of product B using the same formula:

Let's substitute the values and get:

Since the coefficient is negative, we are talking about goods that complement each other.

Since the demand for good D has not changed, the cross-elasticity coefficient is 0, i.e. the goods are neutral.

Answer: E B/A =–0.83; E C/A = 0.558; E D/A = 0.

Problem 7

Formulation of the problem: In the market for product A, the volume of demand is determined by the formula. Determine the elasticity of demand at the point corresponding to Q = 10.

Technology for solving the problem:

, where B is a coefficient showing the slope of the demand curve. First you need to find the price: therefore, P = 4. Hence .

Answer: the elasticity coefficient is 0.8.

Problem 8

Formulation of the problem: The demand for product X is determined by the formula . Determine the elasticity coefficient at a price equal to 30 USD. e.

Technology for solving the problem: To solve the problem it is necessary to apply the formula for calculating the coefficient point elasticity:

, where B is a coefficient showing the slope of the demand curve. Let's find the quantity demanded at a given price:

30 = 60 – 2 Qd, hence Qd = 15. Substituting the values in the formula, we get:

Answer: Ed = 1.

Problem 9

Formulation of the problem: There are two groups of consumers in the product market, whose demand functions are written by the following formulas: , . Determine what the price elasticity of demand will be at the point corresponding to Qd equal to 12.

Technology for solving the problem: First, the formula for market demand for a product is determined: Q d1 + Q d2 = 12 – P + 12 – 3P = 24 – 4P. We find the price of the product when the volume of demand on the market is equal to 12 units: 12 = 24 – 4Р; P = 3. Then, using the point elasticity formula, we find the elasticity coefficient:

, where B is a coefficient showing the slope of the demand curve.

Answer: 1.

Problem 10

Formulation of the problem: The demand function for a product has the form Qd = 50 – 2Р. Determine the arc price elasticity of demand when the price decreases from 10 to 9 euros.

Technology for solving the problem: We determine the volume of demand at a price of 10 euros: and then at a price of 9 euros:

. After this, we calculate the elasticity coefficient:

Answer:–0,61.

Problems involving the use of elasticity coefficients

Problem 11

Formulation of the problem: The price elasticity of household demand for a product is (–0.8), and the income elasticity of demand is 1.3. If the price of a good decreases by 2% and income increases by 5%, what happens to the demand for that good?

Technology for solving the problem: The volume of demand will increase under the influence of a decrease in the price of the product and an increase in income, taking into account elasticity coefficients. This is calculated as follows:

Where Inc is the consumer's income. Substituting the values, we get:

Answer: The volume of demand will increase by 8.1%.

Problem 12

Formulation of the problem: Cross elasticity coefficient Ex/y = (–2). The price of product Y is 100 USD. e. Determine the demand for product X if the price of product Y increases by 10%, and the initial demand for product X is 80 tons.

Technology for solving the problem: To solve the problem, you need to use the formula for calculating the cross-elasticity coefficient of product X using the formula

Consequently, the change in the volume of demand for product X is determined by multiplying the cross-elasticity coefficient by the change in the price of product Y: . Therefore, the volume of demand will be equal to: Qdх = 80 * 0.95 = 76 tons.

Answer: 76 t.

Problem 13

Formulation of the problem: At a price of 10 USD e. the volume of demand for product A is 1000 units. The entrepreneur decides to change the price. He determined that when the price increases by 10%, the elasticity of the product becomes equal to (–1.2), and when the price decreases by 10%, the elasticity coefficient is equal to (–0.8). What price will the entrepreneur settle on?

Technology for solving the problem: To solve the problem, you need to determine what demand will be at the new price, and then calculate the revenue from the sale of the product. At a price of 10 USD e. the entrepreneur receives 10,000 USD. If the price decreases by 10%, it will become equal to 9 cu. that is, the demand for the product will increase by , i.e. it will become 1000 * 1.08 = 1080 pieces. The entrepreneur will receive from the sale of these goods:

u. e. Revenue decreased by 10,000 – 9720 = 280 USD. That is, therefore, the price cannot be reduced.

If the price increases by 10%, i.e. it becomes 11 USD. that is, the demand for the product will fall by 12% (1.2 * 10%), i.e. it will become equal to . Selling them for 11 USD. That is, the entrepreneur will gain 9680 USD. e. Revenue has decreased again, which means that it is also impossible to increase the price by 10%. Therefore, the entrepreneur should maintain the old price.

Answer: 10 USD e.

print version

The average per capita income for the year was 1200 den. units and increased to 1400 den. units, and the sale of garments from 80 den. units up to 110 den. units Determine the indicator (coefficient) of demand elasticity. Comment on this indicator.

Solution:

Elasticity of demand characterizes the degree of response of demand to the action of any factor. Depending on the type of factor influencing demand, they distinguish between price elasticity of demand, income elasticity of demand and cross elasticity of demand.

The elasticity of demand depending on income can be determined by the following formula:

Ke=(Δx/Δy)×(x/y),

where Ke is the coefficient of elasticity of demand by income;

x is the average per capita demand;

y is the average per capita income;

Δх - increase in demand;

Δу - increase in income.

Ke=(110-80)/(1400-1200)=2.25.

The obtained value of the elasticity coefficient indicates that 1% increase in income accounts for 2.25% increase in demand.

Cross Elasticity Problem

The cross elasticity between the demand for kvass and the price of lemonade is 0.75. What products are we talking about? If the price of lemonade increases by 20%, then how will the demand for kvass change?

Solution:

Kvass and lemonade are interchangeable goods, since the coefficient of cross elasticity of demand (Ksper) has a positive value (0.75).

Using the formula for the coefficient of cross elasticity (Ksper), we determine how the demand for kvass will change when the price of lemonade increases by 20%.

Ksper = % change in demand for kvass (x) / % change in price for lemonade (y) = 0.75.

If we take the change in demand for kvass as x, and the change in the price of lemonade as y, then we can write the equation Kper = x/y; whence x=Kper×y or x=0.75×y=0.75×20%=15%.

Thus, if the price of lemonade increases by 20%, the demand for kvass will increase by 15%.

Task. Calculation of price elasticity coefficients

The table shows the scale of demand for eggs during the month.

Price, den. units	Volume of demand, thousand units

Calculate total income (expenses) in dollars. units and coefficients of price elasticity of demand by filling in the appropriate columns. Draw a conclusion about the nature of the relationship between revenue and price elasticity of demand.

Solution:

In the table, the first column shows prices, the second column shows demand volumes at the corresponding prices. Therefore, in order to obtain the total (total) income, it is necessary to multiply the indicated prices by the indicated values of demand volumes. The total income is presented in the third column of the table.

Price, den. units	Volume of demand, thousand units	Total income, thousand den. units	Price elasticity of demand coefficient

To determine the price elasticity of demand, the formula is used: KS=ΔQ/ΔC, KS – price elasticity coefficient; ΔП – price change (in%); ΔQ – change in demand (in %).

However, this coefficient has a drawback - its value is different depending on whether we are talking about an increase or decrease in price, since the initial basis for the calculation will be different. Therefore, to calculate the demand elasticity coefficient, a more objective indicator is used - the arc elasticity coefficient:

Kds=(ΔQ/Qsr)/(ΔTs/Tssr), where Qsr is the average volume of demand between the initial and final volumes; Tsr – the average price between the initial and final prices.

As an example, let's calculate the Kds for the first case: the price decreased from 12 den. units up to 10 days units; the volume of demand as a result of this price reduction increased from 20 thousand units. up to 40 thousand units In our task, the price change (ΔP) was 2 days. units (12 - 10), change in quantity of demand (ΔQ) – 20 units. (40 - 20). The average price is 11 den. units ((12+10)/2), and the average volume is 30 units. ((20+40)/2). Substituting these values into Kds, we get:

Kds=(ΔQ/Qsr)/(ΔC/Tsr)=(20/30)÷(2/11)=3.7.

Similarly, we calculate the remaining coefficients of price elasticity of demand. They are presented in the fourth column of the table.

To identify segments of elastic and inelastic demand on the constructed demand curve, you need to know that the criterion for elastic demand is Kds>1, and the criterion for inelastic demand is Kds<1. Поэтому единичная эластичность выступает в качестве разграничителя этих двух отрезков кривой спроса. В нашем примере единичная эластичность соответствует цене в размере 7 ден. ед. и объему спроса в размере 70 тыс. ед.

As long as demand is elastic, total income increases, while in the area of inelastic demand it decreases.

Task

Three buyers submit bids for product A. The first agrees to pay for 1 copy of the product – 10 dollars, the second – 7 dollars, the third – 5 dollars. Offer manufacturer is 1 copy of the product And with the cost of its production being $7. The question is, at what price will the manufacturer sell his product?

At what price can the manufacturer sell his product if he increases production to 3 units at the same cost per unit of product? Will it reduce the supply of goods and to what extent?

The solution of the problem:

If the manufacturer’s supply is 1 copy of product A with production costs of $7, then this manufacturer, maximizing profit, sells 1 copy of the product to the first buyer. The profit will be 10-7=3 dollars.

If the manufacturer increases production to 3 units at the same cost per unit of goods, then, using a flexible pricing policy, he will be able to sell these 3 units to the first buyer for $10, the second for $7, and the third for $5. Average price sales will be: (10+7+5)/3=$7.33.

The manufacturer’s profit will be: (7.33-7)×3=0.99≈1 dollar.

In order to say to what extent the manufacturer will reduce the level of production, we calculate his profit when selling two units of production and compare the results obtained.

Having produced two units of products, the manufacturer, using a flexible pricing policy, sells them to the first buyer at a price of $10, and to the second buyer at $7. The average selling price will be: (10+7)/2=$8.5.

The profit will be: (8.5-7)×2=3 dollars.

Let's compare the results:

Thus, the manufacturer has three production alternatives, two of which give the maximum profit for this manufacturer - $3.

Purchased goods; - I - consumer income. To calculate, determine the change in consumers for a given type of product, provided that the price for it is the same. Suppose that in one month the store purchased mobile phones worth 200 thousand rubles, in the next month - for 210 thousand rubles. Prices remained the same.

Calculate the percentage change in customer income. The dynamics of income can be determined by the statistical data of your. Let’s say that over the course of a month the average salary of the population changed from 21,000 rubles. up to 22,000 rub. Calculate the percentage change in income for the period: (22,000-21,000)/21,000*100%=4.8%, that is, the population’s income increased by an average of 4.8%.

Calculate the percentage change in the average price of phones sold: (8,300-8,000)/8,000*100%=3.8%. Consequently, the average price of a phone sold over the month increased by 3.8%.

Calculate the elasticity of demand for mobile phones using the formula given in paragraph 5. The coefficient of elasticity of demand for mobile phones by price will be equal to: E = 5%/3.8% = 1.32. This figure means that if the price of mobile phones changes by 1%, the demand for this product category will change by 1.32%.

note

If the calculated coefficient of price elasticity of demand for a given type of product is less than one, then such goods are considered inelastic (for example, essential items). If the elasticity coefficient is greater than one, then such goods are classified as elastic (furniture, household appliances).

Sources:

Economic theory: elasticity of supply and demand
calculate the demand elasticity coefficient
Elasticity coefficient depending on

The sensitivity of the market to changes in prices for goods, consumer incomes and other factors of market conditions is reflected in the indicator elasticity, which is characterized by special coefficient. Coefficient elasticity demand shows how much the volume has changed in quantitative terms demand when the market factor changes by 1%.

Instructions

You must take into account that there are several indicators elasticity demand. Coefficient elasticity demand by price degree of quantitative change demand or a price reduction of 1%. There are three options elasticity. Inelastic occurs when the quantity purchased increases at a rate less than the decrease in price. Demand is considered elastic when a 1% decrease in price leads to an increase demand by more than 1%. If the quantity of goods purchased is at the same rate as the price falls, then unit demand occurs. elasticity.

When analyzing elasticity you can coefficient elasticity demand by income. It is determined by analogy with elasticity demand at price as the degree of quantitative change in consumer income by 1%. Due to the fact that as income increases, the possibility of purchasing goods increases, this coefficient has a positive trend. If the coefficient elasticity demand income is extremely low, then we are talking about essential goods; if, on the contrary, it is very large, then about luxury goods.

Imagine that you are a wheat farmer. Since your entire income comes from the sale of wheat, you make every effort to increase the productivity of the land you own. You monitor the weather and soil conditions, check fields for pests and diseases, and study the latest advances in agriculture. You know that the more wheat you grow, the more grain you will sell, and, accordingly, the higher your income and standard of living will be.

One day you heard about an important discovery. Researchers from the agronomy department of a local university have developed a new variety of wheat that can increase grain harvest by 20%. How will you react to this news? Should you use a new variety? Will this improve your standard of living? In this chapter, using the basic tools of economics - supply and demand - we will get amazing answers to seemingly simple questions.

In the wheat market, the upward sloping supply curve represents the behavior of suppliers, and the downward sloping demand curve represents the behavior of consumers. The price of a product changes until the volumes of demand and supply for the product are balanced. Using supply and demand analysis as a tool to assess the impact of seed scientists' discoveries on the wheat market involves an important addition - the concept of elasticity. The introduction of the concept of elasticity, a measure of the reaction of buyers and sellers to changes in market conditions, allows us to increase the accuracy of the analysis of supply and demand.

Elasticity of demand

When we looked at the determinants of demand, we noted that when consumer incomes increase, when the prices of substitute goods increase or the prices of complementary goods decrease, consumers would want more of the product at a lower price. We looked at demand primarily from a qualitative, rather than quantitative, side; we analyzed the direction of change in the volume of demand, and not its magnitude. When measuring the response of demand to changes in the factors that determine it, economists use the concept elasticity.

Price elasticity of demand and its determinants

The law of demand states that a decrease in the price of a good causes an increase in the quantity demanded. Price Elasticity of Demand determines the response of the volume of demand to changes in the price of a product. The demand for a product is called elastic, if a change in price changes the quantity demanded significantly. Demand is called inelastic, if when the price changes, the quantity demanded changes only slightly.

What determines the elasticity or inelasticity of demand for a product? Since the demand for any product depends on consumer preferences, the price elasticity of a product is determined by many economic, social and psychological factors that shape human desires. However, based on practice, we are able to name some general rules that determine the price elasticity of demand.

Essential goods and luxury goods. The demand for essential goods is characterized by low price elasticity of demand, while the demand for luxury goods is characterized by high price elasticity. It is unlikely that patients will significantly reduce the number of visits to the doctor, even if the price of medical services is constantly rising. On the contrary, an increase in the price of yachts will lead to a significant decrease in the volume of demand. The reason is that most individuals view visiting a doctor as a necessity and owning a yacht as a luxury. Of course, when a product should be classified as essential goods or luxury goods, this is determined not by its internal qualities, but by consumer preferences. For an avid sailor with excellent health, a sailboat is a necessity with inelastic demand, and a visit to the doctor is a luxury characterized by high price elasticity.

Availability of close substitute products. Products that have close substitutes have more elastic demand because consumers can easily use one product instead of another. For example, butter and margarine are easily interchangeable. A slight increase in the price of butter, while the cost of margarine remains unchanged, will lead to a significant decrease in the volume of butter sales. In contrast, given the fact that chicken eggs are a product for which there is no close substitute, the demand for eggs is likely to be less elastic than the demand for butter.

Market Definition. The elasticity of demand depends on our definition of the boundaries of any market. A more narrowly defined market is also characterized by more elastic demand compared to a broadly defined market, in which it is much easier to find substitute goods. For example, food products, as a broad product category, have virtually inelastic demand because they have no substitutes. Ice cream, a narrower product category, also has more elastic demand, since it is easier to replace with other desserts. Vanilla ice cream is already a very narrow category, characterized by very elastic demand, since other types of ice cream are almost perfect substitutes.

Time horizon. Over long periods of time, the value of the elasticity of demand for the price of goods increases. When the price of gasoline rises, the volume of demand for it decreases slightly in the first few months, but over time the person buys a more economical car, uses public transport more often, or moves closer to his place of work. Considering the dynamics of demand for gasoline over several years, we will come to the conclusion that its consumption will decrease significantly.

Calculation of price elasticity of demand

Economists calculate the price elasticity of demand as the ratio of the percentage change in quantity demanded to the percentage change in price.

Let's say the price of a cone of ice cream went up from $2.00 to $2.20, and you now buy 8 instead of 10 cones a month. We calculate the percentage change in price as

In a similar way, we calculate the change in the volume of demand, expressed as a percentage, as

In this case, the price elasticity of demand will be:

In this example, a price elasticity of demand of 2 means that the change in quantity demanded is twice as large as the change in price.

Since the volume of demand for a product is inversely proportional to its price, the sign of the change in quantity demanded, expressed as a percentage, is always opposite to the sign of the change in price, expressed as a percentage. In our example, the percentage change in price is plus 10% (price increase) and the percentage change in quantity demanded is minus 20 % (decrease in demand). For this reason, the price elasticity of demand is sometimes considered a negative number. In this book we will follow common practice and treat price elasticity as a positive number (mathematicians would call it absolute value). Under this condition, a larger price elasticity of demand means a proportionally larger change in the quantity demanded compared to the change in price.

Types of demand curves

Typically, economists classify demand curves according to their elasticity. Demand is estimated as elastic, when the elasticity is greater than 1. That is, the change in quantity, expressed as a percentage, is relatively higher than the change in price, expressed as a percentage. Demand is estimated as inelastic, when the elasticity is less than 1. That is, the change in quantity of a good is relatively lower than the change in price. If the elasticity is 1, when the relative quantity of a good changes exactly as the price changes, demand is characterized by unit elasticity.

Knot for memory

CALCULATION OF ELASTICITY USING THE MIDPOINT METHOD

If you try to calculate the price elasticity of demand between two points on the demand curve, you will quickly notice an annoying problem: the value of the elasticity calculated from point A to point B is not the same as the value of the elasticity calculated from point B to point A. Consider, for example, the following data.

Point A: Price = $4, Quantity = 120. Point B: Price = $6, Quantity = 80.

When moving along a curve from point A to point B, the price increases by 50%, the quantity of goods decreases by 33%, which means: the price elasticity of demand is 33/50 or 0.66. On the contrary, when moving from point B to point A, the price decreases by 33 %, and the quantity increases by 50%, which means: the price elasticity of demand is 50/33 or 1.5.

One way to get around this problem is to use midpoint method. This method involves defining elasticity as the ratio of the change in price value at the starting and ending points (in percentage) to the value of the midpoint of the curve. For example, a price of $5 is the midpoint between $4 and $6. Therefore, when moving from point $4 to point $6, the price increases by 40%. (Why? Yes, because (6 - 4) / 5 x 100 = 40). Likewise, when moving from $6 to $4, the price decreases by 40%.

Because the midpoint method produces a value of change that is independent of the direction of movement along the curve, it is very often used to calculate the price elasticity of demand between two points. In our example, the midpoint between points A and B is:

Midpoint: price = $5, quantity = 100.

According to the midpoint method, when moving from point A to point B, price increases by 40% and quantity decreases by 40%. Similarly, when moving from point B to point A, price decreases by 40% and quantity increases by 40%. In both directions the price elasticity of demand is 1.

If you need to calculate elasticity, remember the midpoint method. We will not use this method as often in this book. For our purposes, the essence of elasticity—the response of quantity demanded to a change in price—is more important than its calculation.

Price elasticity of demand shows the dependence of the quantity demanded of a product on changes in price, therefore, it is closely related to the value of the slope of the curve (see the discussion of the slope of the curve and elasticity in the appendix to Chapter 2). It is very useful to follow the rule of thumb: the flatter the demand curve passing through a given point, the higher the elasticity of demand; The steeper the demand curve passing through a given point, the lower the price elasticity of demand.

Figure 5.1 shows five types of demand curve. In the extreme case of zero elasticity, demand is completely inelastic and the demand curve is vertical. In this case, at each possible price the quantity supplied does not change. As elasticity increases, the demand curve becomes flatter. In the extreme case of perfectly elastic demand, the price elasticity of demand tends to infinity. In this case, the demand curve is horizontal to the x-axis, reflecting the fact that small changes in price lead to large changes in quantity demanded.

Total revenue and price elasticity of demand

When analyzing changes in market demand or supply, we need to consider the impact of a variable such as total revenue- the amount of money paid by buyers and received by sellers of goods. In any market, total revenue is equal to P x Q: the price of the product multiplied by the quantity of the product sold. Graphically, total revenue (Fig. 5.2) is represented by a rectangle under the demand curve, the height of which is R, and the length is Q. Area of the rectangle, calculated as P x Q, equal to the total revenue generated in that market. If P = $4,a Q= 100, total revenue is $4 x 100, or $400.

Rice. 5.1. Price Elasticity of Demand

How does total revenue change as you move along the demand curve? The answer depends on the price elasticity of demand. If demand is inelastic (see Figure 5.3), an increase in price will lead to an increase in total revenue. An increase in price from $1 to $3 leads to a decrease in quantity demanded from 100 to 80 units, and total revenue increases from $100 to $240. An increase in price leads to an increase in the product P And Q, since the decrease Q relatively less than the increase R.

If demand is elastic, we get the opposite result: an increase in price leads to a decrease in total revenue. For example, if the price of a good increases from $4 to $5, quantity demanded decreases from 50 to 20 units, and total revenue decreases from $200 to $100. Since demand is elastic, the decrease in quantity demanded is large enough to offset the increase in price. That is, an increase in price leads to a decrease in product R And Q, because decrease Q relatively greater than the increase R.

Although the examples shown in Fig. 5.3 and 5.4 are rather extreme cases, they illustrate the general rule:

Rice. 5.4. Change in total revenue when price changes: elastic demand

When the price elasticity of demand is less than 1, an increase in price leads to an increase in total revenue, and a decrease in price leads to a decrease in total revenue;

When the price elasticity of demand is greater than 1, an increase in price leads to a decrease in
decrease in total revenue, and a decrease in price leads to an increase in total
revenue.

In special cases, when the price elasticity of demand is 1, the price change
does not affect total revenue.

Income Elasticity of Demand

In addition to the price elasticity of demand, economists use other types of elasticity indicators. One of the most interesting - income elasticity of demand, that is, the dependence of the volume of demand on changes in consumer income. Income elasticity is calculated as

As we noted earlier, most products fall into the category normal goods: An increase in consumer income leads to an increase in the volume of demand for them. Since quantity demanded and income move in the same direction, normal goods have a positive income elasticity. Some products, such as bus travel, are classified as inferior goods: An increase in consumer income leads to a decrease in the volume of demand for such goods. Because quantity demanded and income move in different directions, inferior goods have a negative income elasticity.

The income elasticities of different normal goods vary considerably. Essential goods, such as clothing and food, have low income elasticity because consumers, regardless of income, are forced to purchase at least some of them. Luxury goods, such as caviar and furs, are characterized by high income elasticity because the decline in consumers' incomes leads them to believe that they can do without the disproportionately expensive goods.

Elasticity of supply

When looking at the factors that determine supply, we noted that supply increases when the price of a product rises, the price of inputs falls, or technology improves. To move from qualitative to quantitative analysis of supply, we will use the concept of elasticity.

Price elasticity of supply and its determining factors

The law of supply states that a higher price for a good leads to an increase in the quantity supplied. Price elasticity of supply displays the degree of change in the volume of supply when the price changes. The offer of a product is called elastic, if a change in price leads to a significant change in the quantity supplied. The sentence is called inelastic, if the price change has little effect on the quantity supplied.

Price elasticity of supply depends on the ability of sellers to flexibly vary the volume of products produced. For example, a coastal strip of land is characterized by inelastic supply because it is practically impossible to expand it. In contrast, goods such as books, cars, and televisions have elastic supply because manufacturing firms are able to expand production when product prices rise.

The key determinant that determines the price elasticity of supply in most markets is the time period considered. Supply is usually more elastic in the long run than in the short run. Companies need some time to expand or reduce production capacity. Thus, in the short term, the volume of supply reacts poorly to price changes. On the contrary, a sufficiently long period of time allows companies to commission new production facilities or close old ones, which means that in the long run the volume of supply responds significantly to price changes.

Knot for memory

ELASTICITY, TOTAL REVENUE AND THE DEMAND CURVE

Demand curves are not always characterized by constant elasticity throughout their entire length. An example of a demand curve with variable elasticity is the straight line in Figure 5.5. A linear demand curve has a constant slope. Recall that the slope of a curve is defined as the ratio of the change in price to the change in quantity. In this case, the slope of the demand curve is constant, since each increase in price by one dollar leads to a decrease in quantity demanded by 2 units.

Rice. 5.5 Linear demand curve

But a constant slope of the demand curve does not mean that its elasticity will also be constant. The reason is that slope is a ratio changes two variables, while elasticity is the ratio change in variables expressed as a percentage. Consider the demand schedule presented in Table 5.1, the corresponding demand curve in Figure 5.5 and calculations of the price elasticity of demand. At points of low prices and high quantity demanded, the demand curve is inelastic. At points of high prices and low quantity demanded, the demand curve is elastic.

Table 5.1 also shows total revenue at each point on the demand curve, which illustrates the relationship between total revenue and elasticity: when price is $1, for example, demand is inelastic, and an increase in price to $2 causes total revenue to increase. When the price of a good is $5, demand is elastic, and an increase in price to $6 results in a decrease in total revenue. At prices between $3 and $4, the elasticity of demand is 1 and total revenue is the same at each price.

Table 5.1. Calculation of the elasticity of a linear demand curve

PRICE, IN $	QUANTITY	TOTAL REVENUE (PRICE x QUANTITY)	PRICE CHANGE, IN %	CHANGE IN THE VOLUME OF DEMAND, IN %	ELASTICITY	DEMAND CHARACTERISTICS
						Inelastic
						Inelastic
						Inelastic
						Unit elasticity
						Elastic
						Elastic
					13,0	Elastic

Calculation of price elasticity of supply

Now that we have some idea of what price elasticity of supply is, let's try to be more precise. Economists calculate the price elasticity of supply as the ratio of the percentage change in quantity supplied to the percentage change in price. That is

Let's assume that the price of 1 liter of milk increased from $3.00 to $3.30, and the monthly production volume increased from 10 thousand liters to 11.5 thousand liters. We calculate the price change, expressed as a percentage, as

Similarly, we calculate the change in supply volume, expressed as a percentage

In this case, the price elasticity of supply is:

The price elasticity of supply was 1.5, that is, it is greater than 1; therefore, the quantity supplied has changed in a greater proportion than the price of the product.

Types of supply curves

Price elasticity of supply determines the change in the volume of supply when the price changes, which is reflected in a variety of curves (Fig. 5.6). Elasticity equal to zero (the product is completely inelastic in price) corresponds to a vertical supply curve, when the quantity supplied does not depend on the price level of the product. As elasticity increases, the supply curve becomes flatter and quantity supplied changes by a greater proportion than prices. Perfectly elastic supply occurs when the price elasticity of supply tends to infinity. In this case, the supply curve is horizontal; A small change in price results in a very large change in quantity supplied.

Rice. 5.6. Price elasticity of supply

In some markets, the elasticity of supply changes as you move along the supply curve. Figure 5.7 shows a typical case for an industry with limited production capacity. For lower levels of supply, the price elasticity of supply is high, and firms' response to price changes is significant. In this region, firms have excess production capacity that is idle for part or all of the day. A small increase in price allows you to increase the utilization rate of equipment and the profits of companies. As supply increases, firms approach full capacity utilization. Once enterprise capacity is fully utilized, further increase in production requires new investments. In order for companies to decide on the advisability of additional expenses, the price must rise significantly, and supply therefore becomes less elastic.

Rice. 5.7. Possible change in the price elasticity of the supply curve

Let's look at Figure 5.7. When the price of a good increases from $3 to $4 (+33%), quantity supplied increases from 100 to 200 units (+100%). Quantity supplied increases by a much greater proportion than price, the price elasticity of the supply curve is greater than 1. In contrast, when price increases from $12 to $15 (+25%), quantity supplied increases from 500 to 525 units (+5%). In this case, quantity supplied increases less than price, so the elasticity is less than 1.

Three examples of practical applications of demand and elasticity

Could news of increased yields make farmers anxious? Why the Organization of Petroleum Exporting Countries (OPEC) failed to maintain high oil prices? Will the drug ban increase or decrease the number of crimes committed on this basis? It may seem to you that these questions have nothing in common. But each of them refers to markets in which supply and demand interact. We use flexible demand, supply and elasticity tools to answer these questions.

Could news of increased yields make farmers anxious?

Let's return to the question posed at the beginning of the chapter. How will the emergence of a new high-yielding variety affect wheat farmers and the wheat market itself? Remember that there are three steps involved in finding the answer to these types of questions. First, we look at shifts in the demand curve or supply curve. Secondly, we answer the question about the direction of the curve shift. Third, we use supply and demand graphs to visualize changes in market equilibrium.

First, we conclude that the introduction of a new variety of wheat affects the supply curve. As the volume of wheat produced per hectare of land increases, farmers will supply larger volumes of wheat at every possible price. In other words, the supply curve shifts to the right. The position of the demand curve does not change because this event has no effect on consumers' desire to buy wheat products at each possible price. So the supply curve shifts from position S l to position S 2, the quantity of wheat sold increases from 100 to 110, and the price of wheat decreases from $3 to $2 (Figure 5.8).

How does the introduction of new technology affect the situation of farmers? Let's consider what happens to the total revenue of farmers, which is equal to P x Q, the product of the price of wheat and sales volume. The emergence of a new variety allows the production of wheat to increase (Q increases), but the price of each kilogram of it decreases (P decreases).

The increase or decrease in total revenue is determined by the elasticity of demand. In real life, the demand for staple foods such as wheat is usually inelastic because these goods are relatively inexpensive and have many substitutes. The inelasticity of the demand curve (Figure 5.8) means that an increase in the price of a product leads to a decrease in total revenue: the price of wheat decreases to a much greater extent than the quantity of wheat sold. Total revenue decreases from $300 to $220.

Rice. 5.8. Increase in supply on the wheat market

If the introduction of a new technology leads to a deterioration in the economic performance of farmers, why do they adopt it? The answer to this question lies in the fundamentals of how a competitive market works. Since each farmer owns a small share of the wheat market, he accepts the price as it comes. The farmer believes that at any price for the product it is profitable for him to use a new variety and sell more wheat. And since his way of thinking is no different from the conclusions that most farmers come to, the supply of wheat increases, the price of the product decreases and the standard of living of each producer decreases.

You may think of this example as hypothetical, but it helps explain the major changes that occurred in the American economy in the 20th century. A hundred years ago, most Americans lived on farms. Scientific knowledge about agricultural methods was low, so most Americans worked on the land, providing food for themselves and their fellow citizens. Over time, improvements in agricultural production technology have led to an increase in the volume of produce produced by each farmer. The increase in food supply coupled with inelastic demand for food has led to a decrease in farmers' income, which in turn has encouraged farmers to move to cities.

The following statistics illustrate this process. In 1948, the number of farmers and members of their families in the United States was 24 million people, or 17 % population of the country. In 1993, the number of farm dwellers dropped to 5 million people (2 % population). This change is associated with a significant increase in agricultural productivity: despite the reduction in the number of farmers by 80 %, in 1993, the growth of grain and meat production was twice the level of 1948.

Analysis of the market for agricultural products allows us to explain the apparent paradox of social policy: agricultural programs aimed at helping farmers stimulate a reduction in land used for production. What's the matter? The purpose of such programs is to reduce the supply of agricultural products and, therefore, increase their prices. Since demand for food is inelastic, farmers as a group receive more total revenue if they offer less grain to the market. Not a single farmer will agree to destroy grain on his own, since everyone accepts the market price as it is. But if all farmers reduced their food supply, everyone's standard of living would improve.

When analyzing the consequences of agricultural technology or agricultural policy, it is important to remember the fact that what is good for farmers is not necessarily good for society as a whole. New technologies have a negative impact on farmers, whose labor needs are continually decreasing, but new technologies are certainly beneficial to the population, whose food costs are decreasing. Similarly, policies aimed at reducing the supply of agricultural products can increase farmers' incomes, but only at the expense of consumers.

Why has OPEC failed to keep oil prices high?

Perhaps the most tumultuous developments in the global economy have occurred in the last few decades in the oil market. In the 1970s. Organization of Petroleum Exporting Countries ( OPEC) decided to increase world oil prices, which sharply increased the income of producing countries. The main method of raising prices was through a coordinated, joint reduction in the amount of oil supplied. From 1973 to 1974, the price of oil (adjusted for inflation) rose by more than 50 %. After few years OPEC repeated its trick: in 1979, the price of oil increased by 14%, in 1980 - by 34% and in 1981 - by 34 %.

However OPEC I discovered that keeping prices high is much more difficult than raising them. From 1982 to 1985, oil prices fell steadily by 10% per year. In the once close ranks of member countries OPEC confusion and vacillation arose. In 1986, coordination of their actions was completely stopped and the price of oil fell by 45 %. In 1990, the price of oil (adjusted for general inflation) returned to 1970 levels and remained there for most of the 1990s.

This example is an excellent illustration of the dynamics of supply and demand in the short and long term. In the short term, both the demand and supply of oil are relatively inelastic. Supply is inelastic because there is no possibility of rapid changes in the amount of proven oil reserves and its production capacity. Demand is inelastic because consumers react slowly to price changes. Many drivers of older gas-guzzling cars, for example, will simply pay large sums for fuel. Thus, as graph (a) in Figure 5.9 shows, the short-run supply and demand curves are quite steep. Change in oil supply from S l before S l 2 leads to a significant increase in price from P 1 before R 2.

In the long term, the situation changes radically. Reaction to price increases by non-member oil producers OPEC, is to intensify oil exploration efforts and build new production capacities. Consumers respond to rising prices by saving more, for example by replacing old, inefficient cars with new, efficient ones. Thus, as graph (b) in Figure 5.9 shows, the demand and supply curves are more elastic in the long run. In the long run, a shift in the supply curve from S l to position S l 2 results in a slight increase in price.

Rice. 5.9. Reduced supply on the global oil market

Our analysis shows why OPEC managed to maintain high oil prices only in the short term. Reduction in oil production by member countries OPEC caused the supply curve to shift to the left. Although each member cut back on oil sales, the price rose so much in the short run that their incomes increased significantly. In contrast, in the long run, when supply and demand are more elastic, the same reduction in supply, as measured by the horizontal shift in the supply curve, resulted in a slight increase in price. Thus, the OPEC price reductions turned out to be less profitable in the long run.

OPEC exists today, but the coordination of the actions of its members is disrupted, in particular, due to the organization’s inability to maintain high oil prices.

Will banning drugs reduce drug-related crime?

One of the most pressing problems of modern society is the illegal use of drugs. One of the consequences of their use is the threat to the lives of drug addicts and the destruction of their families. Another is that drug addicts, in an effort to get the money needed to purchase the potion, commit violent crimes. To reduce illegal drug use, the US government spends billions of dollars every year. Let's analyze drug prohibition policies using the tools of supply and demand.

Suppose the government increases the number of federal agents assigned to combat drugs. What's happening to the illegal drug market? As usual, there are three steps to answer this question. First, consider a shift in the demand curve or supply curve. Secondly, we determine the direction of the shift. Third, let's look at how the shift affects the equilibrium price and equilibrium quantity.

Although the goal of drug prohibition is to reduce drug use, its direct impact on sellers is different from its impact on buyers. When the government cuts off the flow of some drugs into the country and increases the capture of smugglers, the cost of drugs increases and, therefore, the supply of drugs at each possible price decreases. The demand for drugs - the number of buyers who are willing to purchase the potion at each possible price - does not change. As graph (a) in Figure 5.10 shows, restricting the supply of drugs shifts the supply curve to the left from S l, to position S 2 and does not change the demand curve. The equilibrium price of drugs increases with P 1 before R 2, and the equilibrium volume decreases from Q 1 to Q 2, since restricting the import of drugs reduces their use.

How do these changes affect the number of drug-related crimes? To answer this question, consider the total number of addicts who buy drugs. Since a limited number of drug addicts will give up their destructive habit when prices rise, it is obvious that the demand for drugs is inelastic (Figure 5.10).

Rice. 5.10. Programs to reduce illegal drug use

If demand is inelastic, then an increase in price leads to an increase in total revenue, that is, the amount of money that drug addicts have to pay for drugs increases. Drug addicts who made money by committing crimes need even more money. Thus, the prohibition of drugs may lead to an increase in the number of crimes committed to obtain them.

Because drug interdiction programs often backfire, some analysts advocate alternative approaches to solving the problem. Instead of limiting the supply of drugs, policymakers can try to reduce demand, including through educational programs about the dangers of drugs. If such programs are successful, the demand curve shifts to the left from position D 1 to position D 2(graph (b) Fig. 5.10). As a result, the equilibrium volume decreases with Q l before Q2, and the equilibrium price decreases from P 1 before R 2. Total revenue (the product of drug price and quantity supplied) also decreases. Thus, unlike drug prohibition efforts, education programs can reduce both drug use and drug-related crime.

Proponents of drug prohibition may argue that the impact of these policies is different in the short and long run because the elasticity of demand may change. The demand for drugs is likely to be inelastic in the short run, as price increases do not have a significant effect on drug use by addicts. But demand may be more elastic over a longer period of time because higher prices will reduce drug experimentation among young people and lead to fewer drug addicts over time. In this case, drug prohibition will lead to an increase in the number of drug crimes in the short term, and a decrease in them in the long term.

Conclusion

According to the old saying, even a parrot can become an economist if he learns the words “supply and demand.” The last two chapters should have convinced you that there is a lot of truth in this statement. Supply and demand tools allow you to analyze many of the most important events and government programs that have a significant impact on the economy. After some time, you will have the right to call yourself a good economist (or at least a well-educated parrot).