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Chapter 5

Microeconomics - Chapter 5.docx

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Rita Cossa

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Microeconomics – Chapter 5 (Elasticity and Applications) Elasticity – Numerical measure of responsiveness of Q or Q to one of its determinates Price Elasticity of Demand – Measures how much Q responds to change in P - Measures the price-sensitivity of buyer demands - All elasticities are reported as positive numbers Calculating Percentage Change: - A problem with this method is that different answers are received depending on where you start from - The midpoint method is more accurate: Determinants of Price Elasticity: - Price elasticity is higher when there are close substitutes available - Price elasticity is higher for narrowly defined goods (jeans) than broadly defined goods (shirts) - Price elasticity is higher for luxury goods than for necessities - Price elasticity is higher in the long run than in the short term Price elasticity of demand is closely related to the slope of the demand curve: - Flatter the curve, bigger the elasticity - Steeper the curve, smaller the elasticity Variety of Demand curves: Calculating Total Revenue: Revenue = P * Q - Higher P means more revenue per unit sold - However, less units are sold due to Law of Demand - Which effect is bigger? If demand is elastic, price elasticity of demand > 1; % change in Q > % change in P - Fall in revenue from lower quantity outweighs the increase in revenue from increased prices - Revenue decreases with higher prices If demand is inelastic, price elasticity of demand
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