# Economics 1021A/B Chapter Notes - Chapter 4: Negative Number, Demand Curve, Inferior Good

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Published on 9 Nov 2011

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Economics Chapter 4 Notes

October 2, 2010

Elasticity

•When supply increases, the equilibrium price falls and the equilibrium

quantity increases

•Does the price fall by a large amount and does the quantity increase by a

little? Does the price barely fall and the quantity increase by a large amount?

○Depends on the responsiveness of the quantity demanded compared

to a change in price

Price elasticity of Demand: a units free measure of the responsiveness of the

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

buying plans remain the same

•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 influences on buying plans remain the same

•We express the changes in price and quantity demanded as percentages of

the average price and the average quantity

○By using these we calculate the elasticity at the point on the demand

curve midway between the original point an a new point

•E.g

○original price is 20.50 and new price is 19.50, therefore, average price

is 20.00. 1.00 price decrease so.. ($1/$20) X 100 = 5%

○original quantity demanded is 9 pizzas and the new is 11 pizzas,

therefore, average quantity demanded is 10. 2 pizza increase so…

(2/10) X 100 = 20%

○price elasticity of demand = 20%/5% = 4.

•When the price of a good rises, the quantity demanded decreases. Because

of a positive change in price brings a negative change in the quantity

demanded, the price elasticity of demand is a negative number. This is the

magnitude or absolute value.

Perfectly inelastic demand: demand with a price elasticity of zero; the quantity

demanded remains constant when the price changes

Unit Elastic Demand: demand with a price elasticity of 1; the percentage change

in the quantity demanded equals the percentage change in price

Inelastic Demand: a demand with a price elasticity between 0 and 1; the

percentage change in quantity demanded is less than the percentage change in

price

Perfectly elastic Demand: demand with an infinite price elasticity; the quantity

demanded changes by an infinitely large percentage in response to a tiny price

change

•E.g. a soft drink from two campus machines located side by side. Same soft

drinks for the same price, people buy from both. If one has a higher price,

even by a small amount, no one will buy from the other one therefore

showing perfectly elastic demand.

Total revenue: from a sale of a good equals the price of the good multiplied by the

quantity sold

•When price changes, total revenue also changes but a rise in price does not

always increase totally revenue. It depends on the elasticity of demand in the

following way:

○In demand is elastic, a 1 percent price cut increase the quantity sold

by more than 1 percent and total revenue increases

○If demand is inelastic, a 1 percent price cut increases the quantity sold

by less than 1 percent and total revenue decreases

○If demand is unit elastic, a 1 percent price cut increases the quantity

sold by 1 percent and total revenue does not change

Total Revenue Test: 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 increase total revenue, demand is elastic