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Chapter

ECON 208 - Notes, week of Sep 22


Department
Economics
Course Code
ECON 208
Professor
Lee Ohanian

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Adrienne Pacini ECON 208 WEEK: September 22, 2009
ELASTICITY
- Elasticity: the sensitivity of quantity demanded to change in price
Price Elasticity of Demand
- Elasticity is related to the slope of the demand curve
o The steeper the line, the less sensitive or elastic the demand
As a curve shifts outward with the same slope, elasticity at each price falls
o The slope only gives absolute changes
Measuring Price Elasticity: η = elasticity
- η = %ΔP ÷ %ΔQ
- Demand elasticity is negative but we focus on absolute values
- Measures the change in price and quantity relative to some base values of price and
quantity
- To get point elasticity at a given price where P = Paverage: η = (P/Q) ÷ (ΔP/ΔQ)
o Can also be seen as: (slope of ray) ÷ (slope of curve)
- If the slope of the ray is greater than the slope of the curve, %ΔQ is greater than %ΔP
o Demand is elastic
- Elasticity falls as you move down a straight line demand curve
- When η = ∞ (perfectly elastic, horizontal line); when η = 0 (perfectly inelastic, vertical line)
- Parabola curve: concave upward; unit elastic (η = 1)
- When demand is elastic, total expenditure increases as price falls (and vice-versa)
- Total expenditure reaches a maximum when demand is unitary
Calculating Elasticity of Demand
- For any price you can find the quantity demanded and get the slope of the ray
- The equation tells you the slope of the curve: 1/b
- Elasticity of a straight line demand curve: η = (P) ÷ (a/b – P)
- QD = a bP or P = (a/b) (1/b)QD
Interpreting Numerical Elasticities
- Inelastic demand: following a given percentage change in price, there is a smaller
percentage change in quantity demanded (elasticity is less than 1)
- Elastic demand: following a given percentage change in price, there is a greater percentage
change in quantity demanded (elasticity is greater than 1)
What determines elasticity of demand?
- Availability of substitutes: one of the main determinants of elasticity of demand
o Products with close substitutes tend to have more elastic demands
- Definition of the product: any one of a group of related products will have a more elastic
demand than the group as a whole (e.g. a certain type of cereal vs. all cereal)
- Is the good a necessity or a luxury?
- Short run and 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
Elasticity and Total Expenditure
- Total expenditure depends on the price elasticity of demand
o Total expenditure = price × quantity
- If the %ΔP is greater than %ΔQ, price change will dominate and total expenditure will
change in the same direction as price (and vice-versa)
- Unit elasticity: total expenditure remains unchanged
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