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Chapter 4

# Microeconomics - Chapter 4.docx

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University of Guelph

Economics

ECON 1050

Eveline Adomait

Fall

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Microeconomics - Chapter 4
Price Elasticity of a Demand – is a units-free measure of the responsiveness of the
quantity demanded of a good to change in its price
when all other influences on buying plans remain the
same
Perfectly Inelastic Demand - if the quantity demanded remains constant when the
price changes, then the price elasticity of demand is
zero
Unit Elastic Demand – if the percentage change in the quantity demanded equals the
percentage change in the price, then the price elasticity equals
1
Inelastic Demand – price elasticity of demand is between 0 and 1
Perfectly Inelastic Demand – if the quantity changes by an infinitely large percentage
in response to a tiny price change, then the price
elasticity of demand is infinity
(the demand for a good that has a perfect substitute is
perfectly elastic)
Elastic Demand – the price of elasticity demand is greater than 1
Total Revenue – the value of a firm’s sales. It is calculated as the price of the good,
multiplied by the quantity sold.
Demand is elastic:
1% price cut increases quantity sold by more than 1% and total revenue increases.
Demand is inelastic:
1% price cut increases quantity sold by less than 1% and total revenue decreases.
Demand unit is elastic:
1% price cut increases quantity sold by 1% and total revenue does not change.
Price cut in elastic range brings an increase in total revenue- percentage increase in
the quantity demanded is greater than the percentage decrease in price.
Price cut in inelastic range brings a decrease in total revenue- percentage increase
in the quantity demanded is less than the percentage decrease in price.
Unit elasticity- total revenue is at maximum.
Total Revenue Test – method of estimating the price elasticity of demand by observing the change in the price, when all other influences on
the quantity sold remain the same.
Price cut increases total revenue: Demand is Elastic
Price cut decreases total revenue: Demand is Inelastic
Price cut leave total revenue unchanged: Demand is Unit Elastic
Demand is Elastic:
1% price cut increases quantity you buy by more than 1% and expenditure on item
increases.
Demand is Inelastic:
1% price cut increases quantity you buy by less than 1% and expenditure on the
item decreases.
Demand is Unit Elastic:
1% price cut increases quantity you buy by 1% and expenditure on item does not
change.
Factors the Influence Elasticity of Demand:
1. Closeness of Substitutes
A necessity has less substitutes = inelastic demand
A luxury has many substitutes = elastic demand
2. Proportion of Income Spent on Good
Greater proportion of income spent = elastic

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