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Chapter 4

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Economics (Arts)
ECON 208
Sebastien Forte

Chapter 4: Elasticity  Excise tax is the tax on top of the producer’s price  Demand is said to be elastic when quantity demanded is very responsive to a change in the product’s own price.  Demand is inelastic when quantity demanded is very unresponsive to changes in its price (ex. Insulin, gasoline in the short run, cigarettes in the short run)  If the percentage change in quantity demanded is less than the percentage change in price, it is inelastic  Elasticity is related to the slope of the demand curve (but is not the same)  Elasticity can be calculated at each point along the demand curve. The slope will be the same at every point but the elasticity will not be the same at every point  If the price increases by a small amount, the quantity demanded decreased by a fairly large amount  Steeper demand curve is less elastic (because there is less of a change in quantity demanded when the price changes) Elasticity (the Greek letter eta: η) is defined as: η = percentage change in quantity demand Percentage change in price η = ΔQd/Qd Δ p/p  Price elasticity of demand elasticity is always negative, but economists usually emphasize the absolute value  It is always negative because: Quantity demanded is always positive (there is not opposite of consumption) And the price cannot be negative The final quantity demanded is going to be lower than the initial quantity, so the change will be negative  Elasticity usually measures the change in P and Q relative to some base values of p and Q Ex) demand elasticity between point 0 and point 1 on some demand curve is η = ΔQd/Qd Δ p/p η = (Q1 – Q0)/Q (p1 – p0)/ p where p and Q are the average price and average quantity, respectively. Thus p = (p1 + p0)/2 and Q= (Q1 + Q0)/2 η = (Q1 – Q0)/(Q1+Q0) (p1 – p0)/ (P1 + P0)  Elasticity falls as you move down a linear demand curve  Higher on the line a small change in price can lead to a very large change in quantity  Unit elasticity- there is one point on the line where a once percent change in price will lead to a one percent change in quantity demanded  Firms try to use the unit elasticity point as the point of profit maximization, but it doesn’t always happen at the equilibrium price. But it does have the property of maximizing.  Demand elasticity tends to be high when there are many close substitutes (ex. Between coffee and tea, because people can easier switch)  The availability of substitutes in determined by: o The length of the time interval considered (ex. Gasoline is inelastic in the short run because most can’t change their behaviour if they need to drive to work. But in the long run, it could be elastic because they could get a more fuel efficient car, move closer to work, etc.) o Whether the good is a necessity or a luxury o How specifically the product is defined (ex. T-shirt vs. clothing as a whole vs. the entire consumer market). It is easier to find a substitute for a t- shirt than it is to find a substitute for your clothing as a whole).  Three special cases of demand curves with constant elasticity: 1. A vertical line: because quantity demanded does not change regardless of the change in price. This is perfectly elastic 2. A horizontal line because there is only one price that consumers are willing to bear. If the price is lower, they will want an infinite quantity, but if the price is higher, they will want zero. It is perfectly elastic (elasticity is equal to infinity) 3. A positive curve- it is a unit elastic curve Elasticity is equal to 1.  Short run and long run changes following an increase in supply:  The change depends on the time that consumers have to respond (ex. Short run vs. long run gasoline consumption example)  In the long run, demand is more elastic (there are new things like advancement in technology, more resources, etc).  E) You have a supply for MP3 players and there is a new technology that makes it easier to produce Mp3 players, and supply increased in the short run. The size of the market (quantity sold) increases in that particular market, and a firm will see an opportunity to produce a substitute good, like the iPod. The alternative is a result of it becoming less costly to produce that good. In the long run, there will be a larger price elasticity of demand.  TE= total expenditure  TE = price * quantity  When demand is elastic (elasticity is greater than 1), TE increases when price falls. This happens because Q goes up fast than price decreases.  When demand is inelastic, TE decreases when price falls. Percentage change in quantity will be smaller than the percentage change in price.  TE reaches a maximum when demand is unit elastic  Price elasticity of supply measures responsiveness of the quanti
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