1 elasticity
TRANSCRIPT
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Elasticity
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Why Economists Use ElasticityAn elasticity is a unit-free measure.
By comparing markets using elasticitiesit does not matter how we measure theprice or the quantity in the twomarkets.
Elasticities allow economists to quantifythe differences among markets withoutstandardizing the units of
measurement.
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What is an Elasticity? Measurement of the percentage change
in one variable that results from a 1%
change in another variable.
Can come up with many elasticities.
We will introduce four.
three from the demand function
one from the supply function
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2 VIP Elasticities Price elasticity of demand: how
sensitive is the quantity demanded to a
change in the price of the good.
Price elasticity of supply: how sensitiveis the quantity supplied to a change in
the price of the good. Often referred to as own price
elasticities.
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Examples of Own Price
Demand Elasticities When the price of gasoline rises by 1% the
quantity demanded falls by 0.2%, so gasoline
demand is not very price sensitive. Price elasticity of demand is -0.2 .
When the price of gold jewelry rises by 1%the quantity demanded falls by 2.6%, so
jewelry demand is very price sensitive.
Price elasticity of demand is -2.6 .
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ElasticityA measure of the responsiveness of one
variable (usually quantity demanded or
supplied) to a change in anothervariable
Most commonly used elasticity: price
elasticity of demand, defined as:
Price elasticity of demand =
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Price elasticity of demand Demand is said to be:
elastic when Ed > 1,
unit elastic when Ed = 1, and
inelastic when Ed < 1.
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Perfectly elastic demand
This meansthat at thesame price forthe item, theconsumer is
willing to buymore andmore even atthat sameprice.
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Perfectly inelastic demand
If quantitydemanded iscompletelyunaffectedby a price
change
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Elasticity & slope a price increase from $1 to $2 represents a 100%
increase in price,
a price increase from $2 to $3 represents a 50%increase in price,
a price increase from $3 to $4 represents a 33%increase in price, and
a price increase from $10 to $11 represents a 10%increase in price.
Notice that, even though the price increases by $1 ineach case, the percentage change in price becomessmaller when the starting value is larger.
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Elasticity along a linear demand
curve
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Arc elasticity measure
where:
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Example Suppose that quantity demanded falls from
60 to 40 when the price rises from $3 to $5.
The arc elasticity measure is given by:
In this interval, demand is inelastic (since elasticity < 1).
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Elasticity and total revenue Total revenue = price x quantity
What happens to total revenue if the
price rises?
Price elasticity of demand =
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Elasticity and TR (cont.)
A reduction in price will lead to:
an increase in TR when demand is elastic. a decrease in TR when demand is inelastic.
an unchanged level of total revenue when
demand is unit elastic.
Price elasticity of demand =
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Elasticity and TR (cont.)
In a similar manner, an increase in price will
lead to: a decrease in TR when demand is elastic.
an increase in TR when demand is inelastic.
an unchanged level of total revenue when demand
is unit elastic.
Price elasticity of demand =
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Elasticity and TR (cont.)
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Price discrimination different customers are charged
different prices for the same product,
due to differences in price elasticity ofdemand
higher prices for those customers whohave the most inelastic demand
lower prices for those customers whohave a more elastic demand.
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Price discrimination (cont.) customers who are willing to pay the
highest prices are charged a high price,
and customers who are more sensitive to
price differentials are charged a low
price.
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Determinants of price
elasticityPrice elasticity is relatively high when:
close substitutes are available,
the good or service is a large share ofthe consumer's budget, and
a longer time period is considered.
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Cross-price elasticity of
demand The cross-price elasticity of demand
between two goodsjand kis defined
as:
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Cross-price elasticity (cont.)
cross-price elasticity is positive if and
only if the goods are substitutes cross-price elasticity is negative if and
only if the goods are complements.
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Income elasticity of demand
A good is a normal good if incomeelasticity > 0.
A good is an inferior good if incomeelasticity < 0.
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Income elasticity of demand
A good is a luxury good if incomeelasticity > 1.
A good is a necessity good if incomeelasticity < 1.
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Price elasticity of supply
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Perfectly inelastic supply
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Perfectly elastic supply
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Determinants of supply
elasticity short run - period of time in which
capital is fixed
all inputs are variable in the long run
supply will be more elastic in the longrun than in the short run since firms
can expand or contract their capital inthe long run.
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Tax incidence distribution of the burden of a tax
depends on the elasticities of demand
and supply. When supply is more elastic than
demand, consumers bear a larger share
of the tax burden. Producers bear a larger share of the
burden of a tax when demand is more
elastic than supply.
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Estimating Demand for Medical Care
Quantity demanded = f( ) out-of-pocket price
real income
time costs prices of substitutes and complements
tastes and preferences
profile state of health
quality of care
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Income Elasticity of Demand: Normal Good demand rises as
income rises and vice versa
Inferior Good demand falls asincome rises and vice versa
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Elasticity Cross Elasticity:
The responsiveness of demand
of one good to changes in the price of arelated good eithera substitute or a complement
Xed =% Qd of good t
__________________
% Price of good y
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Elasticity Goods which are complements:
Cross Elasticity will have negative sign
(inverse relationship between the two)
Goods which are substitutes:
Cross Elasticity will have a positive sign
(positive relationship between the two)
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Elasticity Price Elasticity of Supply:
The responsiveness of supply to changesin price
If Pes is inelastic - it will be difficult for suppliersto react swiftly to changes in price
If Pes is elastic supply can react quickly tochanges in price
Pes =% Quantity Supplied____________________
% Price
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Determinants of Elasticity Time period the longer the time under
consideration the more elastic a good is likely to be
Number and closeness of substitutes
the greater the number of substitutes,the more elastic
The proportion of income taken up by theproduct the smaller the proportion the moreinelastic
Luxury or Necessity - for example,addictive drugs
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Importance of Elasticity Relationship between changes
in price and total revenue
Importance in determiningwhat goods to tax (tax revenue)
Importance in analysing time lags in
production Influences the behaviour of a firm
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market failureDefinition A condition in which a market does not efficiently
allocate resources to achieve the greatest possibleconsumer satisfaction. The four main market failures
(1) public good,
(2) market control,
(3) externality, and
(4) imperfect information.In each case, a market acting without any government
imposed direction, does not direct an efficientamount of our resources into the production,distribution, or consumption of the good.
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Whay health market fails? Information asymmetry Healthcare is difficult and expensive to commodify
Excess capacity is needed for market choice to work(waiting list)
Exit from the market is very difficult-interdendent
Market entry is prohibitively expensive
Problems with private insurance systems (poor get
lowest and rich get the best) Price signals don't work (risk pooling is needed)
Medical professionalism is anti-market
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Why Health Market Fails? Patients want local services
Markets provide for wants rather than needs
Need for specialty clusters, high volumeworkload and regional and national planning
First duty of investor owned firms is to theirshareholders, not patients
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Summary
Health care characterized by info. asymmetrysuppliers better informed than consumers
Suppliers (professionals) therefore act as patientsagent, making decisions for them
Creates potential for supplier-induced demand(demand in excess of what patient would chose)
Extent SID depends on structure of healthsystem, especially financial incentives
SID not always a bad thing may increase
ff