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Chapter 4

Chapter 4 - Elasticity.docx

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ECON 101
Robert Gateman

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4.1 Price Elasticity of Demand 09-30-2012  By how much will Eq price and Eq quantity change if there is a change in demand  Elastic – Qd is quite responsive to changes in price  Inelastic – relatively unresponsive Measurement of Price Elasticity  To compare, both curves have to be drawn on the same scale and initial Eq prices and quantities have to be the same  Usually more revealing to know the percentage changes (vs. absolute changes) in the prices of the various products  Price elasticity of demand – responsiveness of Qd to a change in the commodity’s price o % Change in Qd / % Change in P o Aka demand elasticity / own price elasticity of demand The Use of Average Price and Quantity in Computing Elasticity o When a price or quantity changes, the change is a different percentage of the original value than it is of the new value o Independent of whether the movement is from A to B or from B to A o (ΔQ/avg. Q) / (ΔP/avg. P) o Elasticity is unit free Interpreting Numerical Statistics o Ignore the negative sign o The greater the elasticity, the more responsive Qd is to a ΔP o 0 to infinity o E = 0 – no change in Qd; vertical demand curve o E = very large – enormous change in Qd; almost horizontal o E = 1 – unit elastic  Rectangular hyperbola  % increase in P = % decrease in Qd o Inelastic demand – e < 1; smaller % Δ in Qd than price o Elastic demand – e < 1; greater % Δ in Qd than price Linear Demand Curves  Constant slope ≠ constant elasticity  Constant elasticity – vertical or horizontal demand curves  Because these absolute changes represent different percentage changes  E approaches infinity as the demand curve hits the y-axis  E approaches 0 as the demand curve hits the x-axis What determines Elasticity of Demand?  Availability of Substitutes o Fall in price of product A will increase demand for A and lower demand for product B, the substitute o Product definition – all vegetables (fewer substitutes, inelastic) vs. broccoli (many substitutes, elastic) o Products with close substitutes tend to have elastic demands; products with no close substitutes tend to have inelastic demands. Narrowly defined products have more elastic demands than do more broadly defined products.  Short Run and Long Run o Takes time to develop satisfactory substitutes o Short run – inelastic – shows immediate response o Long run – more elastic (more substitutes) – after enough time has passed o The response to a price change, and thus the measured price elasticity of demand, will tend to be greater the longer the time span. o The magnitude of the changes in the Eq price and quantity following a shift in supply depends on the time allowed for demand to adjust. Elasticity and Total Expenditure  Total expenditure depends on the price elasticity of demand o Total expenditure = price x quantity  Price and quantity move in opposite directions along the demand curve  Change in total expenditure depends on the relative changes in the price and quantity o Elastic – price goes down  total expenditure goes up o Inelastic – price goes down  total expenditure goes down o Unit elastic  total expenditure doesn’t fall 4.2 Price Elasticity of Supply 09-30-2012  Price elasticity of supply – responsiveness of Qs to a change in price  %
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