MacroeconomicsScience and Technology
Introduction to Elasticity
Imagine going to your favorite coffee shop and having the waiter inform you the pricing has changed. Instead of $3 for a cup of coffee, you will now be charged $2 for coffee, $1 for creamer, and $1 for your choice of sweetener. If you pay your usual $3 for a cup of coffee, you must choose between creamer and sweetener. If you want both, you now face an extra charge of $1. Sound absurd? Well, that is the situation Netflix customers found themselves in—a 60% price hike to retain the same service.
In early 2011, Netflix consumers paid about $10 a month for a package consisting of streaming video and DVD rentals. In July 2011, the company announced a packaging change. Customers wishing to retain both streaming video and DVD rental would be charged $15.98 per month, a price increase of about 60%.
How would customers of the 14-year-old firm react? Would they abandon Netflix? Would the ease of access to other venues make a difference in how consumers responded to the Netflix price change? The answers to those questions will be explored in this chapter: the change in quantity with respect to a change in price, a concept economists call elasticity.
In this chapter, you will learn about:
- Price Elasticity of Demand and Price Elasticity of Supply
- Polar Cases of Elasticity and Constant Elasticity
- Elasticity and Pricing
- Elasticity in Areas Other Than Price
Anyone who has studied economics knows the law of demand: a higher price will lead to a lower quantity demanded. What you may not know is how much lower the quantity demanded will be. Similarly, the law of supply shows that a higher price will lead to a higher quantity supplied. The question is: How much higher? This chapter will explain how to answer these questions and why they are critically important in the real world.
To find answers to these questions, we need to understand the concept of elasticity. Elasticity is an economics concept that measures responsiveness of one variable to changes in another variable. Suppose you drop two items from a second-floor balcony. The first item is a tennis ball. The second item is a brick. Which will bounce higher? Obviously, the tennis ball. We would say that the tennis ball has greater elasticity.
Consider an economic example. Cigarette taxes are an example of a “sin tax,” a tax on something that is bad for you, like alcohol. Cigarettes are taxed at the state and national levels. State taxes range from a low of 17 cents per pack in Missouri to $4.35 per pack in New York. The average state cigarette tax is $1.51 per pack. The current federal tax rate on cigarettes is $1.01 per pack, but in April 2013 the Obama Administration proposed raising the federal tax nearly a dollar to $1.95 per pack. The key question is: How much would cigarette purchases decline?
Taxes on cigarettes serve two purposes: to raise tax revenue for government and to discourage consumption of cigarettes. However, if a higher cigarette tax discourages consumption by quite a lot, meaning a greatly reduced quantity of cigarettes is sold, then the cigarette tax on each pack will not raise much revenue for the government. Alternatively, a higher cigarette tax that does not discourage consumption by much will actually raise more tax revenue for the government. Thus, when a government agency tries to calculate the effects of altering its cigarette tax, it must analyze how much the tax affects the quantity of cigarettes consumed. This issue reaches beyond governments and taxes; every firm faces a similar issue. Every time a firm considers raising the price that it charges, it must consider how much a price increase will reduce the quantity demanded of what it sells. Conversely, when a firm puts its products on sale, it must expect (or hope) that the lower price will lead to a significantly higher quantity demanded.
- Welcome to Economics!
- Choice in a World of Scarcity
- Demand and Supply
- Labor and Financial Markets
- The Macroeconomic Perspective
- Economic Growth
- The International Trade and Capital Flows
- Introduction to the International Trade and Capital Flows
- Measuring Trade Balances
- Trade Balances in Historical and International Context
- Trade Balances and Flows of Financial Capital
- The National Saving and Investment Identity
- The Pros and Cons of Trade Deficits and Surpluses
- The Difference between Level of Trade and the Trade Balance
- The Aggregate Demand/Aggregate Supply Model
- Introduction to the Aggregate Demand/Aggregate Supply Model
- Macroeconomic Perspectives on Demand and Supply
- Building a Model of Aggregate Demand and Aggregate Supply
- Shifts in Aggregate Supply
- Shifts in Aggregate Demand
- How the AD/AS Model Incorporates Growth, Unemployment, and Inflation
- Keynes’ Law and Say’s Law in the AD/AS Model
- The Keynesian Perspective
- The Neoclassical Perspective
- Money and Banking
- Monetary Policy and Bank Regulation
- Exchange Rates and International Capital Flows
- Government Budgets and Fiscal Policy
- The Impacts of Government Borrowing
- Macroeconomic Policy Around the World
- International Trade
- Globalization and Protectionism
- Introduction to Globalization and Protectionism
- Protectionism: An Indirect Subsidy from Consumers to Producers
- International Trade and Its Effects on Jobs, Wages, and Working Conditions
- Arguments in Support of Restricting Imports
- How Trade Policy Is Enacted: Globally, Regionally, and Nationally
- The Tradeoffs of Trade Policy
- The Use of Mathematics in Principles of Economics
- The Expenditure-Output Model