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Chapter 4 – Elasticity

Price Elasticity of Demand

- When supply increases, the equilibrium price falls and the equilibrium quantity

increases

- Price changes depends on responsiveness of quantity demanded to a change in price

- Responsiveness depends on slope

- Slope of a demand curve depends on the units in which we measure the price and the

quantity

- The price elasticity of demand is a units-free measure of the responsiveness of the

quantity demanded if a good to a change in its price when all other influences on

buyers’ plans remain the same

Calculating Price Elasticity of Demand

Price elasticity of demand = percentage change in quantity demanded

percentage change in price

- To use this formula, we need to know the quantities demanded at different prices when

all other incluences on buyers’ plans remain the same

- To calculate the price elasticity of demand, we express the changes in price and quantity

demanded as percentages of the average price and the average quantity

- Average price and quantity gives most precise measurement of elasticity – at the

midpoint between original price and new price

Percentages and Proportions

- Elasticity is the ratio of two percentage changes

- A percentage change is a proportionate change multiplied by 100

- The proportionate change in price is change in price / average price, and the

proportionate change in quantity is change in quantity / average quantity

A Units-Free Measure

- Elasticity is a units-free measure because the percentage change in each variable is

independent of the units in which the variable is measured

- The ratio of two percentages is a number without units

Minus Sign and Elasticity

- When the price of a good rises, the quantity demanded decreases along the demand

curve

- Because a positive change in price brings a negative change in the quantity demanded,

the price elasticity of demand is a negative number

- It is the magnitude, or absolute value, of the price elasticity of demand that tell us how

responsive, how elastic, demand is

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- To compare the price elasticities of demand, we us the magnitude of the elasticity and

ignore the minus sign

Inelastic and Elastic Demand

- If the quantity demanded remains constant when the price changes, then the price

elasticity of demand is zero and the good is said to have a perfectly inelastic demand

- If the percentage change in the quantity demanded equals the percentage change in

price, then the price elasticity equals 1 and the good is said to have a unit elastic

demand

- If the elasticity of demand is between zero and 1 then the good is said to have an

inelastic demand

- If the quantity demanded changes by an infinitely large percentage in response to a tiny

price change, then the price elasticity of demand is infinity and the good is said to have

a perfectly elastic demand

- If the price elasticity of demand is greater than 1 then the good is said to have an elastic

demand

Elasticity Along a Straight-Line Demand Curve

- Elasticity and slope are not the same, but they are related

- At the midpoint of the curve, demand is unit elastic

- Above midpoint, demand is elastic

- Below midpoint, demand is inelastic

Total Revenue and Elasticity

- The total revenue from sale of a good equals the price of the good multiplied by the

quantity sold

- When a price changes, total revenue also changes

- A rise in price does not always increase total revenue

Change in total revenue depends on elasticity of demand:

- If demand is elastic, 1 percent price cut increases the quantity sold by more than 1

percent and total revenue increases

- If demand is inelastic, 1 percent price cut increases the quantity sold by less than 1

percent and total revenue decreases

- If demand is unit elastic, 1 percent price cut increases the quantity sold by 1 percent and

so total revenue does not change

- The total revenue test is a method of estimating the price elasticity of demand by

observing the change in total revenue that results from a change in price, when all other

influences on the quantity sold remain the same

- If a price cut increases total revenue, demand is elastic

- If a price cut decreases total revenue, demand is inelastic

- If a price cut leaves total revenue unchanged, demand is unit elastic

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