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Chapter 5

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Ryerson University
ECN 104
Frank Trimnell

ECN – Chapter 5 Elasticity and its Application The Elasticity of Demand  Elasticity: a measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants The Price Elasticity of Demand and its Determinants  Price elasticity of demand: measures how much the quantity demanded responds to a change in price o Demand for a good is elastic if the quantity demanded responds substantially to changes in price o Demand is inelastic if the quantity demanded responds only slightly to changes in price Computing the Price Elasticity of Demand  Price elasticity of demand = … Percentage change in quantity demand / Percent change in price o A larger price elasticity implies greater responsiveness of quantity demanded to price  Calculating percentage of change: (end – start value / start value) x 100%  Midpoint method: o (End value – start value / midpoint) x 100% OR o = (Q2 – Q1)/[(Q2 + Q1)/2] / (P2 – P1)/[(P2 + P1)/2]  The Determinants of Price Elasticity: A Summary o Price elasticity of demand depends on:  The extent to which close substitute are available  Whether the good is a necessity/luxury  How broadly/narrowly the good is defined  The time horizon – elasticity is higher in the long run than short run The Variety of Demand Curve  Demand is elastic when elasticity is greater than 1  Inelastic when elasticity is less than 1  If the elasticity is exactly 1 (quantity moves the same amount proportionately as price), demand is said to have unit elasticity  Price elasticity of demand is closely related to slope of the demand curve  *The flatter the demand curve that passes through a given point, the greater the price elasticity of demand  *The steeper the demand curve that passes through a given point, the smaller the price elasticity of demand  Tip: Inelastic curves look like the letter I and Elastic curves look like the letter E Total Revenue and the Price Elasticity of Demand  Total revenue (in a market): the amount paid by buyers and received by sellers of a good o Revenue = Price x Quantity  If demand is inelastic, then an increase in price causes an increase in total revenue
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