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| | *income elasticity of demand | | *income elasticity of demand |
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| − | It is important to keep these different types of elasticity separate. Your own teacher made the mistake of confusing them in the question 4 of the homework for Lecture 3, as explained below. He won't make that mistake again!
| + | Keep these different types of elasticity separate: price elasticity is the change in demand due to a change in the price of the good, while income elasticity is the change in demand due to a change in the income of the buyer. Your own teacher made the mistake of confusing these different concepts in the question 4 of the homework for Lecture 3, as explained below. Once he realized his error, he won't make that mistake again! |
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| − | ''''Price''''' elasticity of demand is the change in the quantity demanded by the public for a particular good due to a change in its '''''price'''''. For example, if the price of gasoline increases, how does the demand for gasoline change? It decreases due to the Law of Demand, but the '''''price elasticity'''' tells us '''''how much''''' it decreases due to a price increase. Specifically, price elasticity is the percentage change in quantity demanded, divided by the percentage change in the price of the good. If the percent change in quantity demanded is more than the percent change in price, then the good is considered "elastic". If the percent change in quantity demanded is less than the percent change in price, then the good is considered "inelastic". | + | === Price Elasticity === |
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| | + | ''''Price''''' elasticity of demand is the change in the quantity demanded by the public for a particular good due to a change in its '''''price'''''. Its symbol is "Ped", for "Price elasticity of demand." This term answers this question: if the price of gasoline increases, how does the demand for gasoline change? It decreases due to the Law of Demand, but the '''''price elasticity'''' tells us '''''how much''''' it decreases due to a price increase. Specifically, price elasticity is the percentage change in quantity demanded, divided by the percentage change in the price of the good. If the percent change in quantity demanded is more than the percent change in price, then the good is considered "elastic". If the percent change in quantity demanded is less than the percent change in price, then the good is considered "inelastic". The Law of Demand means that price elasticity is always negative, but for convenience everyone uses the absolute value (positive value) without the minus sign. |
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| | Price elasticity of demand is important because it tells us whether the owner's | | Price elasticity of demand is important because it tells us whether the owner's |
| | overall revenue goes up or down due to a price change. Revenue is price times quantity, and when price goes up then quantity goes down, and we need to know the price elasticity to know what happens to the overall price times quantity. | | overall revenue goes up or down due to a price change. Revenue is price times quantity, and when price goes up then quantity goes down, and we need to know the price elasticity to know what happens to the overall price times quantity. |
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| − | <income elasticity next> | + | === Income Elasticity === |
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| | + | ''''Income''''' elasticity of demand is the change in the quantity demanded by the public for a particular good due to a change in '''''income'''''. Stated another way, income elasticity is the responsiveness in demand for a good due to a change in the buyers' income. Its symbol is "Yed", because "Y" is a symbol for income, and "ed" refers to "elasticity of demand." |
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| | + | In calculating elasticity, the numerator is the same for both price and income elasticity: it is the percent change in quantity demanded for the good. But the denominator is different for these two elasticities: the denominator for price elasticity is the percent change in price of the good, while the denominator for income elasticity is the percent change in income for the buyers. |
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| | + | Unlike price elasticity, income elasticity can be either positive or negative, depending on the good. For a "normal" good, income elasticity is positive; for an "inferior" good, it is negative. Inferior goods are rare: they see a decrease in demand when income by the public increases. Usually demand for goods increase as income by the public increases, hence the name "normal good" for them. |
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| | + | The mistake on Lecture Three question 4 by your teacher was when he described "necessary" and "luxury" goods in terms of '''''price''''' elasticity rather than '''''income''''' elasticity. A "necessary" good is one <more> |
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| | + | The same cutoff of unit 1 separates "elastic" from "inelastic" goods with respect to income elasticity: |
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| | + | {|wikitable |
| | + | |Yed |
| | + | |Normal or Inferior? |
| | + | |Elastic or Inelastic? |
| | + | |Necessity or Luxury? |
| | + | |- |
| | + | |-0.5 |
| | + | |inferior |
| | + | |inelastic |
| | + | | |
| | + | |- |
| | + | |+0.6 |
| | + | |normal |
| | + | |inelastic |
| | + | | |
| | + | |- |
| | + | |-1.9 |
| | + | |inferior |
| | + | |elastic |
| | + | | |
| | + | |- |
| | + | |+3.5 |
| | + | |normal |
| | + | |elastic |
| | + | | |
| | + | |- |
| | + | |} |
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| | + | Yed = - 0.6: Good is an inferior good but inelastic – a rise in income of 3% would lead to demand falling �by 1.8% |
| | + | Yed = + 0.4: Good is a normal good but inelastic – �a rise in incomes of 3% would lead to demand rising �by 1.2% |
| | + | Yed = + 1.6: Good is a normal good and elastic – �a rise in incomes of 3% would lead to demand rising �by 4.8% |
| | + | Yed = - 2.1: Good is an inferior good and elastic – �a rise in incomes of 3% would lead to a fall in demand of 6.3% |
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| | + | === Cross Elasticity === |
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| | + | Once you fully understand price elasticity of demand, then it is easy to understand the concept of "cross elasticity of demand. Cross elasticity of demand is the percent change in demand �of '''''one good''''' due to a change in the price of a '''''different good'''''. The two goods are either substitutes or complements for each other, which makes their cross elasticity interesting and useful. The symbol for cross elasticity of demand is "Xed", with "X" representing theh "cross" and "ed" representing the "elasticity of demand." |
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| | + | mathematically expressed |
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| − | Most questions about elasticity concern elasticity ''of demand''. Explain income elasticity (luxury, necessity, and inferior goods) and mistake on question 4 from the homework for Week three.
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| − | normal and inferior goods
| + | === Supply Elasticity === |
| − | necessities and luxuries
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| − | <cross elasticity>
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| | == Introduction to Short and Long Run == | | == Introduction to Short and Long Run == |