ECN 104 Chapter Notes - Chapter 5: Ice Cream Cone, Demand Curve, Midpoint Method

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23 Jul 2016
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Chapter 5- Elasticity and Its Application
Elasticity and Its Application
-Elasticity is a measure of how much buyers and sellers respond to changes in market
conditions
-When studying how some event or policy affects a market, we can discuss not only the
direction of the effects but their magnitude as well
-Elasticity is useful in many application, will be seen towards the end of the chapter
The Elasticity of Demand
Elasticity: A measure of the responsiveness of quantity demanded or quantity supplied
to one of its determinants
-How the change in price impacts the quantity demeaned
The Price Elasticity of Demand and Its Determinants
Price Elasticity of Demand: A measure of how much the quantity demanded of a good
responds to a change in the price of that good, computed as the percentage change in
the quantity demeaned divided by the percentage change in price
-Demand for a good is said to be elastic if the quantity demanded responds
substantially to changes in the price
-Demand is said to be inelastic if the quantity responds only slightly to changes in the
price
1.Availability of Close Substitutes
2.Necessities versus Luxuries
3.Definition of the Market
4.Time horizon
Computing the Price Elasticity of Demand
Price elasticity of demand= Percentage change in quantity demanded
______________________________________
Percentage change in price
Example: Suppose that a 10 percent increase in the price of an ice cream cone causes
the amount of ice cream you buy to fall by 20 percent. It is calculated as:
20 Percent
Price of elasticity=_____________ = 2
10 Percent
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-The price elasticity is 2
The Midpoint Method: A Better Way to Calculate Percentage Changes ad
Elasticities
(Q2-Q1)/((Q2+Q1)/2)
Price Elasticity of demand= ___________________
(P2-P1)/ ((P2 +P1)/2)
The Variety of Demand Curves
-Economists classify demand curves according to their elasticity
-Demand is elastic when the elasticity is greater than 1, so that quantity moves
proportionately more than price
-Demand is inelastic when the elasticity is less than 1, so that quantity moves
proportionately less than price
-If the elasticity is exactly 1, so the quantity moves the same amount proportionately
as price, demand is said to have unit elasticity
Total Revenue and The Price of Elasticity
Total Revenue (in a market): The amount paid by buyers and received by sellers of a
good, computed as the price of the good times the quantity sold
TR= P X Q
-How does total revenue change?
-The answer depends on the price of elasticity of demand
General Rules
1.When demand is inelastic (a price elasticity less than 1) price and total revenue move
in the same direction
2.When demand is elastic (a price elasticity greater than 1), price and total revenue
move in opposite directions
3.If demand is unit elastic (a price elasticity exactly equal to 1), total revenue remains
constant when the price changes
Elasticity and Total Revenue along a Linear Demand Curve
-A straight line has a constant slope
-Even though the slope of a linear demand curve is constant, the elasticity is not
-The reason is that the slope is the ratio of changes in two variables, whereas the
elasticity is the ratio of percentage changes in the two variables
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Other Demand Elasticities
-In addition to the price elasticity of demand economists also use other elasticities to
describe the behaviour of buyers in a market
Income Elasticity of Demand: A measure of how much the quantity demanded of a
good responds to a change in consumers income, computed as the percentage change
in quantity deadness divided by the percentage change in income
Percentage change in quantity demanded
Income elasticity of demand= ___________________________________
Percentage change in income
-Higher income raises quitting demanded for normal goods ,because quantity
demanded and income move in the same direction, normal goods have positive income
elasticity
-Higher income lowers the quantity demanded for inferior goods, because quantity
demanded and income move in opposite directions, inferior goods have negative
income elastics
Cross-Price Elasticity of Demand: A measure of how much the quantity demanded of
one good responds to a change in the price of another good, computed as the
percentage change in quantity demanded of the first good divided by the percentage
change in the price of the second good
Percentage change in quantity demanded of good 1
Cross-Price Elasticity of Demand= ________________________________________
Percentage change in price of good 2
Substitutes: Positive cross elasticity
Compliments: Negative cross elasticity
Unrelated Products: You will have a zero cross elasticity
The Elasticity of Supply
-To turn from qualitative to quantitative statements about quantity supplied, we use the
concept of elasticity
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