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Chapter 4

Chapter 4 Elasticity.docx

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Economics (Arts)
ECON 208
Mayssun El- Attar Vilalta

Chapter 4 Elasticity 4.1 Price Elasticity of Demand  Demand elastic when quantity demanded is quite responsive to changes in price  When quantity demanded is relatively unresponsive to changes in price, demand is inelastic  The more responsive the quantity demanded is to changes in price, the less the change in equilibrium price and the > the change in equilibrium quantity resulting from any given shift in the supply curve The Measurement of Price Elasticity  Able to compare two demand curves b/c o both drawn on same scale and initial equilibrium prices (Slope of demand curve tells us the amount by which price must change to cause a unit change in quantity demanded) o quantities were the same in both parts (if initial prices and quantities the same in both cases, the larger absolute change is also the larger %age change)  Price elasticity of demand (Ƞ): a measure of the responsiveness of quantity demanded to a change in the commodity’s own price  Ƞ = %age change in quantity demanded %age change in price The Use of Avg Price and Quantity in Computing Elasticity  Demand elasticities computed using changes in price and quantity measured in terms of avg values of each to avoid the ambiguity caused by the fact that when a price or quantity changes, the change is a different %age of the original value than it is of the new value  Using avg values for price+demand = measured elasticity of demand on demand curve between A and B is independent of whether the movement is from A –B or B-A  Ƞ p p (no units) Interpreting Numerical Elasticities  Negative slope of demand curve = ^price = decrease in quantity demanded  Since %age changes in price+quantity have opposite signs, demand elasticity –ve  More responsive quantity demanded to a change in price = greater elasticity, larger Ƞ  Demand curve vertical when elasticity 0, change in price = no change in quantity demanded, consumers don’t alter consumption at all when price changes  Demand curve horizontal when elasticity infinite, even a very small change in price leads to an enormous change in quantity demanded  Inelastic demand: following a given %age change in price, there is a smaller %age change in quantity demanded; elasticity<1  Elastic demand: following a given %age change in price, there is a greater %age change in quantity demanded; elasticity>1  Demand is unit elastic – when%age change in quantity demanded is = to %age change in price, elasticity = 1  Moving down a linear demand curve, price elasticity falls continuously, even tho the slope is constant; the same absolute changes in price+quantity occur over the intervals CD and EF, but elasticity differs b/c these absolute changes represent diff %ages  Elasticity approaches infinite as we get closer to where the demand curve intersects the vertical axis; elasticity approaches 0 as we get closer to where the demand curve intersects the horizontal axis  Demand curve doesn’t have the same elasticity over its whole length  Linear demand curve has constant elasticity only when it is vertical or horizontal; non-linear demand curve w/ constant elasticity when unit elasticity (Ƞ=1) –hyperbola for which price times quantity demanded is constant What Determines Elasticity of Demand? Availability of Substitutes  A change in the price of products, with the price of the substitutes remaining constant, can be expected to cause much substitution  Product defined more broadly, such as all foods or all clothing, have many fewer satisfactory substitutes than do products defined much more narrowly. Rise in prices of broadly defined products expected to cause a smaller fall in quantities demanded than if close substitutes availa  Demand elasticity higher for diet pepsi than beverages overall  Products with close substitutes tend to have elastic demands; products with no close substitutes tend to have inelastic demands. Narrowly defined products have more elastic demands than do more broadly defined products Short Run and Long Run  Takes time to develop satisfactory substitutes – demand that is inelastic in the short run may prove to be elastic in the long run  The response to a price change, and thus the measured price elasticity of demand, will tend to be greater the longer the time span  Cornflakes and sweaters – full response to price change happens fast – little reason to make distinction between short and long run effects; change in price of electricity may not have its major effect til the stock of appliances that use the products has been adjusted  Short-run demand curve shows immediate response of quantity demanded to a change in price given the current stock of durable goods o Supply increase leads to movement down the relatively inelastic curve – causes large fall in price but only small ^ in quantity  Long-run demand curve shows the response of quantity demanded to a change in price after enough time has passed to change the stock of durable goods o Supply increase, Demand is more elastic – long-run equilibrium has price and quantity above those that prevailed in short-run equilibrium  The long-run demand for a product is more elastic than the short-run demand Elasticity and Total Expenditure  Total expenditure depends on the price elasticity of demand  At any point on the demand curve: Total Expenditure = Price x Quantity  Change in TE depends on the relative changes in the price and quantity o Price decline of 10% o Elastic demand: Quantity demanded changes by >10% - Q change dominates and TE ^ o Inelastic Demand: Q demanded changes by <10% - P change dominates and TE falls o Unit Elastic Demand: Q demanded increases by 10%, then Q and P %age changes offset each other and TE remains unchanged  TE maximum when price elasticity is =1 4.2 Price Elasticity of Suppy  Price elasticity of supply (Ƞs): a measure of the responsiveness of quantity supplied to a change in the product’s own price  Ƞs = %age change in quantity supplied %age change in price  +ve slope: ^price causes ^ quantity supplied: +ve elasticity since both change in same direction  Ƞs p p  Supply curve may have constant slope but the elasticity may be different at diff places on the curve: when Ƞs>1, elastic supply; when Ƞs<1, inelastic supply  Vertical supply curve – quantity supplied doesn’t change as price changes – then elasticity of supply is 0; hori
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