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Chapter 5

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McMaster University

Economics

ECON 1B03

Hannah Holmes

Fall

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Chapter Five: Elasticity and Its Application
Basic Idea:
Elasticity measures how much one variable responds to changes in another variable
One type of elasticity measures how much demand for your website will fall if you raise your
price
Elasticity: is a numerical measure of the responsiveness of Qd or Qs to one of its determinants
Price Elasticity of Demand
Price Elasticity of Demand: measures how much Qd responds to a change in P
Loosely speaking, it measures the price-sensitivity of buyers’ demand
Along a D curve, P and Q move in opposite directions, which would make price elasticity
negative
Drop the minus sign and report all price elasticities as positive numbers!!!!
Calculating Percentage Changes
Standard method of computing the percentage (%) change: So, Instead we use the Midpoint Method:
The midpoint is the number halfway between the start and end values, the average of those
values
It doesn’t matter which value you use as the “start” and which as the “end”
The Determinants of Price Elasticity:
The price elasticity of demand depends on:
The extent to which close substitutes are available
Whether the good is a necessity or a luxury
How broadly or narrowly the good is defined
The time horizon – elasticity is higher in the long run than the short run
The Variety of Demand Curves
the price elasticity of demand is closely related to the slope of the demand curve Rule of Thumb:
the flatter the curve, the bigger the elasticity
the steeper the curve, the smaller the elasticity
Five Different Classifications of D curves:
1)
2)
3)
4) 5)
Price Elasticity and Total Revenue
If you raise your price from $200 to $250, would your revenue rise or fall?
Revenue = P x Q
A price increase has two effects on revenue:
Higher P means more revenue on each unit you sell
But you sell fewer units (lower Q) due to Law of Demand
Which of these two effects is bigger? It depends on the price elasticity of demand
Price Elasticity and Total Revenue
If demand is elastic, then price e

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