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Chapter 4

Chapter 4 - Elasticity.docx

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Department
Economics
Course
ECON 101
Professor
Shi Lei Niu
Semester
Winter

Description
ECON 101 Notes 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 - 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 - A price cut in the inelastic range brings a decrease in total revenue – the percentage increase in the quantity demanded is less than the percentage decrease in price - At unit elasticity, total revenue is at a maximum Your Expenditure and Your Elasticity When a price changes, the change in your expenditure on the good depends on your elasticity of demand. - If your demand is elastic, a 1 percent price cut increases the quantity you buy more than 1 percent and your expenditure on the item increases - If your demand is inelastic, a 1 percent price cut increases the quantity you buy by less than 1 percent and your expenditure on the item decreases - If your demand is unit elastic, a 1 percent price cut increases the quantity you buy by 1 percent and your expenditure on the item does not change The Factors That Influence the Elasticity of Demand The magnitude of elasticity of demand depends on: - The closeness of substitutes - The proportion of income spent on the good - The time elapsed since a price change Closeness of Substitutes - The closer the substitutes for a good or service, the more elastic is the demand for it - The degree of substitutability between
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