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Chapter 5

ECN104- CHAPTER 5 Review

10 Pages

Course Code
ECN 104
Helene Moore

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ECN104 ­ CHAPTER 5 ELASTICITY  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.  Definition: Elasticity is a numerical measure of the responsiveness of Q or Q to one of its determinants. PRICE ELASTICITY OF DEMAND  Price elasticity of demand measures how much Q responds to a change in P.  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  We drop the minus sign and report all price elasticises as positive numbers CALCULATING PERCENTAGE CHANGES SO, WE INSTEAD USE THE MIDPOINT METHOD  It doesn't matter which value you use as the “start” and which as the “end” – you get the same answer either way! 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.  More substitute – more elasticity  Less substitute – less elasticity Example #2 Blue Jeans vs. Clothing  The prices of both goods rise by 20%. For which good does Q 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. (There aren’t too many substitutes for clothing, other than living in a nudist colony.)  Lesson: Price elasticity is higher for narrowly defined goods than broadly defined ones. Example #3: Insulin vs. Caribbean Cruises  The prices of both of tdese goods rise by 20%. For which good does Q 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.  Necessity – lower elasticity  Luxury – more elasticity  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 Q 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: 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 More substitute – higher Less substitute – lower Luxury – higher Necessity – lower Narrowly defined – higher Broadly defined – lower Long time horizon – higher Short run – lower THE VARIETY OF DEMAND CURVE  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.  If the demand is perfectly inelastic demand, you will get zero because people are insensitive to the change of price  Responsive  Ex: You need banana for your potassium, doesn’t matter if the price goes up, you’re still going to buy it  Price goes down, quantity demand goes up by very little amount – less than 10%  Inelastic demand emerges when number is less than 1  Ex: gas, price goes up or down, it matters but not that much  An example: Student demand for textbooks that their professors have required for their courses.  Here, it’s a little more clear that elasticity would be small, but not zero. At a high enough price, some students will not buy their books, but instead will share with a friend, or try to find them in the
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