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ECN104 Notes - Chapter 5, 6, 7, 8, 9

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ECN 104
Tsogbadral Galaabaatar

ECN104 Week 3 Notes Chapter 5 Questions o What is elasticity? What kinds of issues can elastic help us understand? o What is the price elasticity of demand? How is it related to the demand curve? How is it related to revenue and expenditure? o What o What are the income and cross-price elasticities of demand? Elasticity o Basic idea: elasticity measures how much one variable responds to changes in another variable One type of elasticity measures how much demand for your websites will fail if you raise your price. o Definition: Elasticity is a numerical measure of the responsiveness of Q(demand) and Q(supply) to one of its determinants Price Elasticity of Demand o Price elasticity of demand measures how much of Q(demand) responds to change in P(price) o Price elasticity of demand = Percentage change in Q(demand) / Percentage change in P(price) o Loosely speaking, it measures the price-sensitivity of buyers demand o Along a D curve, P and Q move in opposite directions, which would make price elasticity negative We will drop the minus sign and report all price elasticities as positive numbers Calculating Percentage changes o Standard method of computer percentage change: end value start value / start value * 100% o Midpoint Method: is the number halfway between the start and end values, the average of those values o it doesnt matter which value you use as the start and which as the end, you get the same answer either way o Midpoint Method = end value start value / midpoint * 100% What determines price elasticity? o Example 1: Breakfast Cereal versus Sunscreen Price of both goods rise by 20%, for which good does Qd drop the most? Breakfast cereal has close substitutes (e.g., pancakes, waffles, leftover pizza) Sunscreen has no close substitutes so consumers wont buy less if price rises Price elasticity is higher when close substitutes are available o Example 2 Blue Jeans vs Clothing Price of both goods rise by 20%, for which good does Qd drop the most? For a narrowly defined good such as blue jeans, there are many substitutes (e.g., khakis, shorts, speedos) There are fewer substitutes for a broadly defined good Price elasticity is higher for narrowly defined goods than broadly defined ones o Example 3 Insulin vs Caribbean Cruises prices of both goods rise by 20%, for which good does Qd drop the most? To millions of diabetics, insulin is a necessity. Rise in price wont affect demand so much Cruise is a luxury. If price increases, demand will definitely decrease Price elasticity is higher for luxuries than for necessities o Example 4 Gasoline in the short run vs Gasoline in the long run Prices of both goods rise by 20%, does Qd drop more in the short run or long run? Theres not much people can do in the short run, other than ride the bus and carpool In the long run, people can buy smaller cars or live closer to where they work Price elasticity is higher in the long run than short run Variety of Demand Curves o Price elasticity of demand is closely related to slope of the demand curve o Rule of thumb Flatter the curve, the bigger the elasticity Steeper the curve, the smaller the elasticity o Five different classifications of Demand Curves Perfectly inelastic demand (one extreme case) % change in Q / % change in P = 0%/10% = 0 Demand Curve: Vertical Consumers Price Sensitivity: None Elasticity: 0 Inelastic demand % change in Q / % change in P = <10%/10% = <1 Demand Curve: Relatively steep Consumers Price Sensitivity: Relatively low Elasticity: <1 Unit elastic demand % change in Q / % change in P = 10%/10% = 1 Demand Curve: Intermediate Slope Consumers Price Sensitivity: Intermediate Elasticity: 1 Elastic Demand % change in Q / % change in P = >10%/10% = >1 Demand Curve: Relatively Flat Consumers Price Sensitivity: Relatively High Elasticity: >1 Perfectly Elastic Demand (the other extreme) % change in Q / % change in P = any % / 0% = infinity Demand Curve: Horizontal Consumers price Sensitivity: Extreme Elasticity: Infinity Price Elasticity and Total Revenue o Revenue = Price x Quantity o Price increase has two effects on revenue Higher P means more revenue on each unit you sell But you sell fewer units (lower Q) due to law of demand
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