# Week 4 study guide

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School
UTSC
Department
Economics for Management Studies
Course
MGEA02H3 Chapter 4 Elasticity Notes
4.1 Price Elasticity of Demand
x demand is said to be elastic when quantity demanded is quite responsive to changes in price
x when quantity demanded is relatively unresponsive to changes in price, demand is said to be inelastic
x the more responsive the quantity demanded is to changes in price, the less the change in equilibrium price and the greater the
change in equilibrium quantity resulting from any given shift in the supply curve
The Measurement of Price Elasticity
x price elasticity of demand () : measure of the responsiveness of quantity demanded to a change in the commodity’s own price
x = (percentage change in quantity demanded) / (percentage change in price)
x this measure is called the price elasticity of demand, or simply demand elasticity because the variable causing the change in
quantity demanded is the product’s own price, the term own-price elasticity of demand is also used
x the formula for price elasticity is then
= (ûQ / Q) / (û p / p) = ((Q1Q0) / Q) / ((p1 – p0) / p)
x inelastic demand : following a given percentage change in price, there is a smaller percentage change in quantity demanded;
elasticity less than 1
x elastic demand : following a given percentage change in price, there is a greater percentage change in quantity demanded;
elasticity greater than 1
What Determines Elasticity of Demand?
x products with close substitutes tend to have elastic demands; products with no close substitutes tend to have inelastic demands
x any one of a group of related products will have a more elastic demand than the group as a whole
x the response to a price change, and thus the measured price elasticity of demand, will tend to be greater the longer the time span
x the long-run demand for a product is more elastic than the short-run demand
Elasticity and Total Expenditure
x total expenditure = price × quantity
x the change in total expenditure depends on the relative percentage change in the price and quantity
x if the percentage change in price exceeds the percentage change in quantity (elasticity less than 1), the price change will
dominate, and total expenditure will change in the same direction as price changes
x if the percentage change in price is less than the percentage change in quantity demanded (elasticity greater than 1), the quantity
change will dominate, and total expenditure will change in the same direction as quantity changes
x if the two percentage changes are equal, total expenditure is unchanged—this is the case of unit elasticity
4.2 Price Elasticity of Supply
x price elasticity of supply (s) : a measure of the responsiveness of quantity supplied to a change in the product’s own price
x s = (percentage change in quantity supplied) / (percentage change in price)
x s = (ûQ / Q) / (û p / p)
Determinants of Supply Elasticity
x much of the treatment of demand elasticity carries over to supply elasticity
x the long-run supply for a product is more elastic than the short-run supply
x size of the changes in the equilibrium price and quantity following a shift in demand depends on the time frame of the analysis
4.3 An Important Example Where Elasticity Matters
x excise tax : a tax on the sale of a particular commodity
x tax incidence : the location of the burden of a tax; that is, the identity of the ultimate bearer of the tax
x burden of excise tax is distributed b/n consumers & sellers in manner that depends on relative elasticities of supply & demand
x after the imposition of an excise tax, the difference between the consumer and the seller prices is equal to the tax
x in the new equilibrium, the quantity exchanged is less than that exchanged prior to the imposition of the tax
x when demand is inelastic relative to supply, consumers bear most of the burden of excise taxes
x when supply is inelastic relative to demand, producers bear most of the burden
4.4 Other Demand Elasticities
Income Elasticity of Demand
x income elasticity of demand (y) : a measure of the responsiveness of quantity demanded is a change in income
x y = (percentage change in quantity demanded) / (percentage change in income)
x normal good : a good for which quantity demanded rises as income rises—its income elasticity is positive
x inferior good : a good for which quantity demanded falls as income rises—its income elasticity is negative
x the more necessary is an item in the consumption pattern of consumers, the lower is its income elasticity
Cross Elasticity of Demand
x cross elasticity of demand (xy) : a measure of the responsiveness of the quantity of one commodity demanded to changes in
the price of another commodity
x xy = (percentage change in quantity demanded of good X) / (percentage change in price of good Y)
x the positive or negative signs of cross elasticities tell us whether goods are substitutes or complements
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