DEMAND AND SUPPLY ELASTICITY
I. Price Elasticity of Demand
A. Concept of Price Elasticity
The responsiveness or sensitivity of quantity
demanded to a change in price.
B. General Formula for Price Elasticity
Percentage change in quantity demanded
Percentage change in price
C. Mid-Points Formula
D. Interpreting the Elasticity Coefficient
A coefficient higher than 1 is elastic
" " lower " 1 is inelastic
" " exactly 1 is unitary
A negative coefficient implies that a lower
price results is lower quantities sold.
E. Extreme Elasticities
Perfectly Elastic Perfectly Inelastic
Demand or Supply Demand or Supply
II. Total Revenue Test
If Demand is Elastic If Demand is Inelastic
P TR P TR
P TR P TR
III. What Determines Price Elasticity
A. The number and quality of substitute goods.
B. The proportion of income the purchase makes up.
C. The size of the expenditure.
D. The time available for adjustments.
E. Luxuries tend to be elastic.
F. Necessities tend to be inelastic.
G. Durable goods tend to be elastic. H. Promotion.
IV. Cross Elasticity of Demand
Shows whether two goods are substitutes or
Cross Elasticity Percentage Change in Q
Formula Percentage Change in P
If two goods are substitutes, the coefficient will be
If two goods are complements, the coefficient will be
V. Income Elasticity of Demand
Shows the responsiveness of certain goods to changes
in real consumer income.
Income Elasticity % Change in Q Demanded
Formula % Change in Real Income
Income-sensitive products have a coefficient higher
The coefficient will vary according to income level.
VI. Elasticity of Supply
Shows the responsiveness of quantity supplied to a
change in price.
General Percentage Change in Q Supplied
Formula Percentage Change in Price
Determinants of Supply Elasticity
A. Short-Run Period (inelastic supply)
B. Long-Run Period (more elastic supply)
C. Market Period (short= inelastic; long= elastic)
VII. Applications of Price Elasticity of S and D
A. Wage bargaining (wage give-backs may save jobs if
the product is income-sensitive/ elastic)
B. Bumper crop in agriculture (will reduce the total
revenue of farmers, since products are inelastic.)
C. Automation (if the product is elastic, workers
displaced by automation, may be rehired)
D. Deregulation (works well on elastic goods)
E. Excise taxes, sin taxes (should be applied to
inelastic goods in order to enhance tax revenue)
THE FINANCIAL ENVIRONMENT OF BUSINESS
I. The Legal Organization of Firms
A. Single Proprietorships (over 13 million, 74.3%)
1. Easy to organize
2. The owner is his own boss
3. All profits go to the owner
1. Unlimited liability
2. Limited financial resources
3. Owner is responsible for all decisions
B. Partnerships (1.7 million, 7.1%)
1. Easy to organize.
2. Easier to raise capital.
3. More specialization in management.
1. Unlimited liability
2. Each partner is responsible for the actions
of all other partners.
3. Division of authority leads to discord
4. The withdrawal of one partner ends the
C. Corporations (over 3 million, 18.6%)
Definition: An artificial person, invisible,
intangible, and existing only in the eyes of the law.
1. Limited liability of stockholders.
2. The ability to raise capital by selling stock.
3. Larger size permits specialization, efficiency
4. Continuity of life ensured.
5. Separation of ownership and control.
1. Legally more complex.
2. Principal-agent problem.
3. Double taxation of corporate profits.
II. Methods of Corporate Financing
A. Share of Stock (ownership)
Legal claim to a share of...