Unit 3 Additional Reading Adapted from: Government of Ontario. (2013, November 7"). EsLearning Ontario. Retrieved September 1?. 2020, from httpwwwedu.gov.on.cafelearningi C|A4UAnalysing Current Economic Issues, lGrade 12, University Preparation. [n.d.). Retrieved Elasticity When you think of an elastic band, what features come to mind? You might think exible or stretchy. But not all elastics are equally flexible. In other words, not all elastics are equally exible. Think about a broccoli elastic, for example. It can stretch, but not like a typical elastic band. The same is true of demand and supply for products and services. Elasticity is the responsiveness of quantities demanded and supplied to changes in price. Economists have developed a formula to determine the actual change in quantity demanded for a product whose price has changed. Price Elasticity of Demand (Arc Formula) Economists have developed a formula to determine the actual change in quantity demanded for a product whose price has changed. The elasticity of demand or Ed is calculated as follows: Ft 5":- ('hdngci in Qd 'Q'fAQu' J = = _ '2? t'hrrngr' in P VIA}? If we break it down: sod {7 AC 1 = ( 2f s'lf't'ir't' Q Elasticity and Total Revenue: For a producer, the elasticity of demand for a product is very important for them to know when they are trying to decide on a price. If a product has an inelastic demand, like gasoline, then the higher the price, the more money will be made, as people will continue to buy it. For some products, a higher price may mean less money if the drop in demand results in more money lost than is gained by the price increase. Definitions: lnclasticity; if a price increase causes total revenue (money being made by the seller) to rise, then demand is inelastic. iasticity; if a price increase causes total revenue to drop, then demand is elastic. Unitary Elasticity: if a price increase results in no change in total revenue, then demand as unitary elasticity. When using these definitions it is important to note that the elasticity of demand may change at different price ranges. For example, the demand for the latest video game may be inelastic up to a certain price that most consumers can afford or feel is not unreasonable. It is a popular product and most consumers are willing to pay a high price for it. However, not many people would pay $15,000 for a new video game system. There will be a price threshold past which the demand will become elastic again. This would be a very useful price for the seller to know. The following example illustrates how the elasticity of a product can change over different price ranges. Example Here is the data representing the demand for tuna. Price per Quantity Total Revenue Elasticity of Can Demanded in {$10003} Demand 1000's $1.80 60 108 Elastic from $1.60 to $1.80 $1.60 T0 112 Unitary elasticity from $1 .40 to $1.00 $1.40 80 11 J lnelastic from $1.20 to $1.40 $1.20 00 108 Inelastic from $1.00 to $1.20 $1.00 100 The above chart shows that from $1.00 to $1.40 the total revenue goes up. Therefore demand is inelastic. From $1.40 to $1.60 the total revenue stays the same. The drop in demand has offset the increase in price exactly. Above $1.60 total revenue drops. Therefore demand is elastic. Big businesses have marketing departments that may do research to determine the elasticity of demand for their product. For small businesses trial and error and using small price changes may be the approach used. Elasticity of demand can apply to labour as well. Highly skilled workers are able to demand higher wages because there is no easy substitute for their skills. Elasticity of demand is an important consideration for the government when deciding excise taxes. The government taxes products with inelastic demand, e.g. gasoline. because the consumer is willing to pay the higher price. The government also taxes items like alcohol and tobacco. where they are not concerned with a drop in demand. Other Types of Elasticity Cross-Elasticity of Demand Explores how the price of a related good (complement or substitute} affects the quantity demanded of a good or service. Elasticity of Supply Measures a Seller's responsiveness to a change in price. Affected by: 5. Table 5.8 gives data for Fez Imports. Price Quantity Total Elasticity ($) demanded revenue coefficient 10 100 120 140 160 180 2000 Time u the longer the time it takes for a producer to respond to a change in price, the less elastic a product will be. The longer the time period, in general, the more elastic every product will become 0 Storage cost - Items that cost more to store will generally be less elastic :- Production Complements and substitutes 0 Easy substitutes in production (eg. corn vs wheat} tend to be more elastic o byproducts of primary production items (eg. hide for leather as a byproduct of a beef processor} tend to be less elastic. Tax Price m :1 Quantity by Economics Oniine You will note that the supply curve shifts left. Find the new equilibrium price {P1}. Draw a straight line down to the x-axis. Where the line meets the original supply curve, draw a line to the y axis. The area beneath the original price line is the burden on the producer and the area above is the burden on the consumer burden. The level of burden of a tax on the producer or consumer depends on elasticity of demand. and AP AP = Average P To determine the average, add up the numbers and divide by 2: Average Q = 21+ Q2 2 Average P = P1+ P2 2 Calculate the % change by dividing the change by the average: AQd = - AQd Average Q and AP AP = Average P The final step is divide the % change in Qd by the % change in P. AQd Ed = AP Interpretation of the Elasticity Coefficient Ed 1 means elastic demand (there are substitutes) - shallow curve Ed = 1 means Unit or unitary elasticity Ed = 0 means perfectly inelastic - vertical demand curve Ed = 0o means perfectly elastic - horizontal demand curve