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

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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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