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Chapter 5

Econ 1B03 - Chapter 5 Part 2.docx

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Hannah Holmes

Richard Damra Monday, January 28, 2013 Econ 1B03 – Chapter 5 – Elasticity Part 2 Generalities About Elasticities and Their Determinants  1. Goods that are necessities tend to have inelastic demand. o E.g demand for insulin – perfectly inelastic o E.g demand for dentist visits – inelastic  2. Goods that are luxuries tend to have elastic demand o E.g plasma TV or vacations – elastic  3. Goods that have close substitutes tend to have elastic demand. o E.g Coke and Pepsi (if Price of Coke increase, switch to Pepsi fairly quickly) o E.g eggs have no close substitutes – inelastic  4. Goods tend to have more elastic demand over longer time horizons o You can find substitutes in the long run where you can’t today  5. How you define the market makes a difference o E.g market for food – perfectly inelastic. o Market for vegetables – more elastic o Market for broccoli – even more substitutes so even more elastic o The more narrowly defined the market, the more elastic the demand.  6. How much of your budget you spend on a good determines elasticity. o If you spend a large proportion of your budget on a good, demand for that good will tend to be elastic. o If you only spend a small proportion, demand will tend to be inelastic.  Elasticity is not constant along a linear demand curve  Elasticity is not the same as slope.  Slope measures rates of change.  Elasticity measures percentage changes.  We can illustrate different elasticities along the demand curve o o Midpoint = unit elastic Richard Damra Monday, January 28, 2013  Why does elasticity change along the curve the way it does?  Recall that our point elasticity formula for a demand curve specified as Q = f(p) is Ep = dQ/dP * P/Q  Slope dQ/dP is constant for a linear demand curve  But P and Q are different combinations at different points on the demand curve, so elasticity changes along the demand curve.  Since dQ/dP is the slope of the demand curve, that’s why we can see elasticity by the steepness (slope) of the curve. Price Elasticity and Total Revenue  A firm wants to maximize its profit. Other things being equal, it will want to maximize its total revenue.  The firm would like to sell as much as it could at the highest price it could get. But, it wouldn’t want to charge a price so high that it loses costumers and revenue drops.  Here’s where knowing the price elasticity of demand for its good is hand for a firm.  Total revenue, TR, is defined as TR = PQ (Price times the quantity traded)  Diagramatically o  With an inelastic demand curve, an inc
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