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Chapter 5

ECN 104 Chapter Notes - Chapter 5: Breakfast Cereal, Demand Curve, Sunscreen


Department
Economics
Course Code
ECN 104
Professor
Tsogbadral Galaabaatar
Chapter
5

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Economics Chapter 5
Basic idea: Elasticity measures how much one variable responds to changes in another variable.
One type of elasticity measures how much demand for your websites will fall if you raise
your price.
Elasticity is a numerical measure of the responsiveness of Qd (quantity demand) or Qs(quantity supply)
to one of its determinants.
Price elasticity of demand measures how much Qd
responds to a change in P. Loosely speaking, it
measures the price-sensitivity of buyers’ demand.
Calculating Percentage changes
Exercise 1
Use the following information to calculate
the price elasticity of demand for hotel rooms:
if P = $70, Qd = 5000
if P = $90, Qd = 3000

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What determines price elasticity?
To learn the determinants of price elasticity, we look at a series of examples. Each compares two
common goods.
In each example: Suppose the prices of both goods rise by 20%. The good for which Qd falls the most (in
percent) has the highest price elasticity of demand. Which good is it? Why? What lesson does the
example teach us about the determinants of the price elasticity of demand?
Example 1) Breakfast Cereal vs. Sunscreen
The prices of both of these goods rise by 20%. For which good does Qd drop the most? Why?
Breakfast cereal has close substitutes (e.g., pancakes, Eggo waffles, leftover pizza), so buyers can
easily switch if the price rises.
Sunscreen has no close substitutes, so consumers would probably not buy much less if its price rises.
Lesson: Price elasticity is higher when close substitutes are available.
Example 2) Blue Jeans vs. Clothing
The prices of both goods rise by 20%. For which good does Qd drop the most? Why?
For a narrowly defined good such as blue jeans, there are many substitutes (khakis, shorts, Speedos).
There are fewer substitutes available for broadly defined goods.
Lesson: Price elasticity is higher for narrowly defined goods than broadly defined ones.
Example 3) Insulin vs. Caribbean Cruises
The prices of both of these goods rise by 20%. For which good does Qd drop the most? Why?
To millions of diabetics, insulin is a necessity. A rise in its price would cause little or no decrease in
demand.
A cruise is a luxury. If the price rises, some people will forego it.
Lesson: Price elasticity is higher for luxuries than for necessities.
Example 4) Gasoline in the Short Run vs. Gasoline in the Long Run
The price of gasoline rises 20%. Does Qd drop more in the short run or the long run? Why?
There’s not much people can do in the short run, other than ride the bus or carpool.
In the long run, people can buy smaller cars or live closer to where they work.
Lesson: Price elasticity is higher in the long run than the short run.
The Determinants of Price Elasticity: A Summary
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
Total revenue (in a market): the amount paid by buyer & received by sellers of a good. Computed as the
price of the good times the quantity sold
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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. Perfectly inelastic demand (one extreme case) 2. Inelastic Demand
3. Unit elastic demand 4. Elastic Demand
5. Perfectly Elastic Demand
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