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# 2nd Quarter | A.Y.

2018 - 2019
Economics Reviewer

ELASTICITY
Microeconomics
→ the detailed study of individual firms, consumers and markets.

💬 What is elasticity?
Elasticity​ (ε) refers to the ​degree​ to which individuals, consumers or producers ​change​ their
demand or the amount supplied ​in response to price or income changes​.

💬 What are the different degrees of elasticity?
At the very least, there are three.
● Elastic​: ​If the ​elasticity ≥ 1​, the good is considered to be elastic.
● Unit-Elastic​: ​If the ​elasticity = 1​, the good is considered to be unit-elastic.
● Inelastic​: ​If the ​elasticity ≤ 1​, the good is considered to be inelastic.

But you also have some polar extremes.
● Perfectly Elastic​: In which ​elasticity = ∞​, because even if price doesn’t change, the
quantity demanded or supplied is always shifting
● Perfectly Inelastic​: In which ​elasticity = 0​, because even if price keeps shifting, the
quantity stays the same all throughout

​Perfectly Inelastic Perfectly Elastic Unit-Elastic

Price-Elastic Price-Inelastic

Figure 1. ​The different degrees of elasticity. Note that these are all SUPPLY curves, which
explains why they’re ​upward-sloping​. Demand curves would be ​downward-sloping​, but still
follow the same principle: ↑ Elasticity = Flatter curve.
2nd Quarter | A.Y. 2018 - 2019
Economics Reviewer
💬 What are the different kinds of elasticities?
Four Types:
1. Price Elasticity of Demand (PεD)
2. Income Elasticity of Demand (IεD)
3. Cross-Price Elasticity of Demand (CPε​D​)
4. Price Elasticity of Demand (PεS)

💬 How do we solve for different elasticities and what are its applications?
Price Elasticity of Demand (Pε εD​​x​​)
calculated by:
% change in quantity​X​ demanded /
% change in price​x

REVIEW: ​Percentage Change ​= ΔX / initial​x​ · 100% = [ final​x​ - initial​x​ ] / initial​x​ · 100%
● However, economists want to be as accurate as possible in their calculations, so they
don’t wanna divide ΔX by just one of the X values.
● Instead, they use the AVERAGE of the final and initial values to compute for the
percentage change.
● That means the exact formula for calculating PεD​x​ would be:

ΔQ ΔQ
Q1+Q2 ÷ Q1+Q2
2 2

the simplified equation:
ΔQ ∑Q
ΔP ∑P
·
● PεD​x​ is ​always positive​.

Determinants of PεD​x
A good is more likely to be elastic (↑PεD​x​) if…
● It has substitutes
● It is a ​luxury good​ → a good for which demand increases when ave. income increases
○ Ex. high-end automobiles, jewelry, watches
○ As people become richer, more luxury goods will be bought
● It takes up a higher percentage of your income/budget
○ If the price of ​Chocnut ​were to increase, you wouldn’t really mind buying it
anyway since it takes up so little of your income. Chocnut, then, is inelastic.
○ But if you were considering buying a ​condominium unit​ and the price suddenly
2nd Quarter | A.Y. 2018 - 2019
Economics Reviewer
○ That’s why ​salespeople​ are so important for goods that take up a high fraction
of income. They coax you into thinking the good is inelastic.
○ This is also the concept behind the goods placed near cashiers in groceries!!
They take up a smaller fraction of your income, so you wouldn’t think twice
○ If you have a lot of time before you upgrade your operating system, you can still
search around for the best price; hence, elasticity is high.

Think of it this way—if the price of a certain good went up and you wouldn’t really mind buying
it anyway, it’s inelastic to you.

A good is more likely to be inelastic (↓PεD​x​) if…
● It has unique value to you → This is related to the presence of substitutes determinant.
When a good is unique in your eyes, nothing can replace it. ​It has no substitutes.
● It is a ​necessity​ → products and services that consumers will buy regardless of the
changes in their income levels, therefore making these products less sensitive to price
change
○ Ex. tobacco products, haircuts, drinking water, electricity
○ If you’re panicking to get to the airport ASAP, you’d still get a taxi ride no matter
how expensive the price offered by the driver is.

Relating PεD​x​ To Revenue
When given options for a good’s price, to maximize revenue...
● Choose the LOWER price if a good is elastic.
○ A price increase would reduce the total revenue.
● Choose the HIGHER price if a good is inelastic. Consumers wouldn’t mind.
● It doesn’t really matter which one you choose if the good is unit-elastic.
○ A price decrease leads to no change in total revenue.

Income Elasticity of Demand (Iε εD​​x​)

calculated by:
% change in quantity​X​ demanded /
% change in income

the simplified equation:
ΔQ ∑I
ΔI
· ∑P

This time, IεD​x​ can be either positive or negative.
2nd Quarter | A.Y. 2018 - 2019
Economics Reviewer
You can tell if a good represents a normal good, a luxury or a necessity based on IεD​x : ​

Normal Good
Inferior Good
Necessity  Luxury Good

## As income grows,   As income grows,  As income grows,

consumers turn to more  proportionally less is spent  proportionally more is spent
costly substitutes  on necessities  on luxuries

Ex. Instant noodles, canned  Ex. Tobacco products,  Ex. Branded goods,
goods, McDonald’s coffee  haircuts, staple groceries,  expensive holiday trips,
(compared to Starbucks)  water, electricity  high-end automobiles

REVIEW:
💬 What are independent goods, substitute goods, luxury goods*...?
● Independent Goods​: Two or more goods whose consumption have absolutely ​no effect
on each other; meaning, CPε​Dx​ = 0.
● Substitute Goods​: Two or more goods sharing the ​same function​. This means a good's
demand is increased when the price of another good is increased; meaning CPε​Dx​ > 0.
● Normal Goods​: Goods for which ​demand increases when income increases
● Superior Goods​: Goods that typically make up a greater percentage of a person's
spending as their income rises
○ Synonymous with luxury goods according to most sources
● Inferior Goods​: Goods for which ​demand decreases when income increases

*See section on PεD​x​ for the definition of luxury and necessity goods.

## Cross-Price Elasticity of Demand (CPε ε​Dx​)

calculated by:
% change in quantity​X​ demanded /
% change in price​y

the simplified equation:
ΔQ ∑Q y
ΔP y
· ∑P

Complementary goods—goods used in adjunct with each other, ​Ex. coffee and
coffeemate​—have a negative CPε​Dx​. See the review section above for the case with substitute
goods and independent goods.
2nd Quarter | A.Y. 2018 - 2019
Economics Reviewer

TAX INCIDENCE
→ refers to the ultimate economic effect of a tax on both producers and consumers

💬 How does elasticity affect the incidence of tax?
The tax incidence depends on the relative price elasticity of supply and demand. The presence
of a tax will increase production costs for the producers, ​shifting the supply curve to the left​.
The table below shows the different cases depending on PεD.

Curve  Degree of Elasticity  Who pays the tax?

Perfectly Inelastic  ● The burden is shifted entirely forward to the
PεD​x =​ 0  consumers ALONE.

Relatively Inelastic  ● The burden is shifted towards the consumers.
0 < PεD​x <​ 1  ● The producers’ revenues are also affected by
the tax, though not so much as what the
consumers. experience.

Unit-Elastic  ● The consumers and producers share the
PεD​x =​ 1   burden of the tax equally.

Relatively Elastic  ● The burden is shifted towards the producers.
PεD​x >​ 1  ● The consumers are also affected by the tax,
though not so much as what the producers.
experience.

Relatively Elastic  ● The burden is shifted entirely backward to the
PεD​x =​ ∞  producers ALONE.

2nd Quarter | A.Y. 2018 - 2019
Economics Reviewer

Figure 2. ​A graph illustrating the incidence of  Figure 3. ​A graph illustrating the incidence
a tax on producers. A unit-elastic curve is  of a tax on consumers. A unit-elastic curve
assumed for both demand and supply.  is assumed for both demand and supply.

● The revenue shown in the graph above goes to the government. Some of it comes from
the consumers (upper box), others from producers (lower box). These rectangles show
the ​total tax burdens​ of both parties.
● DWL stands for ​Deadweight Loss​. It’s the fall in total surplus cause by the tax, and a loss
of economic efficiency. No one gets any revenue from that.
○ Being in the government is hard because you have to choose between social
equity and economic efficiency. ​Equity is the opportunity cost of efficiency.
Sure, you can raise taxes to increase revenue, but people will complain that it’s
too high. At the same time, you can tax citizens lower but they’ll also complain
because you won’t have enough funds for government programs. Hayst.
● The ​per unit tax burden​ can be calculated by taking the vertical distance between the
original equilibrium point and the new one caused by the tax. In the context of Fig. 2,
that’s ​Ptax​
​ - P​E​.
● Consumer Surplus​: Refers to the difference
between what consumers are willing to pay
and what they actually pay.
● Producer Surplus​: Refers to the difference
between what producers are willing to
produce and what they actually produce.

Figure 4. ​A graph illustrating ​consumer
and ​producer​​ surplus.  F

2nd Quarter | A.Y. 2018 - 2019
Economics Reviewer

REMINDERS
● Do not memorize, understand.
● Go back to first quarter topics.
● You ace tests and recitations by overlearning, and looking beyond the material in front
of you. Learn about current issues, watch Crash Course, and study with Khan Academy.
● Do practice exercises. Here are some—
○ https://www.sparknotes.com/economics/micro/elasticity/problems/