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

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Published on 15 Nov 2011

Department

Economics

Course

Economics 1021A/B

Professor

Microeconomics Chapter 4

Price Elasticity of Demand

•different outcomes arise from differing degrees of responsiveness of the quantity demanded to

a change in price

•the slope of a demand curve depends on the units in which we measure the price and quantity

•units of measurement are unrelated, can’t compare demands for different goods

•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

CALCULATING PRICE ELASTICITY OF DEMAND

•price elasticity of demand = percentage change in quantity demanded/ percentage change in

price

•to use this formula, need to know the quantities demanded at different prices

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

average quantity

AVERAGE PRICE AND QUANTITY

•use average price and average quantity because it gives the most precise measurement of

elasticity- at the midpoint between the original price and the new price

•get the same value for the elasticity regardless of whether the price falls or rises

PERCENTAGES AND PROPORTIONS

•elasticity is the ratio of two percentage changes

•when we divide one percentage change by another, the 100s cancel

•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 demanded 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 measure

MINUS SIGN AND ELASTICITY

•positive change in price brings a negative change in the quantity demanded, the price elasticity

of demand is a negative number

•the magnitude, or absolute value, of the price elasticity of demand that tells us how responsive

the quantity demanded is, 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 i.e. insulin

•if the percentage change in the quantity demanded equals the percentage change in the price,

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

•the percentage change in the quantity demanded is more than the percentage change in the

price, price elasticity of demand is between 1 and infinity and the good is said to have an elastic

demand

•if the quantity demanded changes by an infinitely large percentage is 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 i.e. soft drink from two machines located side by side

•the demand for a good that has a perfect substitute is perfectly elastic

•the percentage change in the quantity demanded is less than the percentage change in the price,

price elasticity of demand is between zero and 1 and the good is said to have an inelastic demand

i.e. automobiles

Elasticity Along a Straight-Line Demand Curve

•elasticity along a straight-line demand curve- a demand curve that has a constant slope

•elasticity changes along a straight-line demand curve

•at the midpoint of the curve, demand is unit elastic

•above the midpoint, demand is elastic

•below the midpoint, demand is inelastic

Total Revenue and Elasticity

•total revenue from the 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

•if demand is elastic, a 1% price cut increases the quantity sold by more than 1% and total

revenue increases

•if demand is inelastic, a 1% price cut increases the quantity sold by less than 1% and total

revenue decreases

•if demand is unit elastic, a 1% price cut increases the quantity sold by 1% 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 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

•at unit elasticity, total revenue is at a maximum

Your Expenditure and Your Elasticity

•if your demand is elastic, a 1% price cut increases the quantity you buy by more than 1% and

your expenditure on the item increases

•if your demand is inelastic, a 1% price cut increases the quantity you buy by less than 1% and

your expenditure on the item decreases

•if your demand is unit elastic, a 1% price cut increases the quantity you buy by 1% and your

expenditure on the item does not change

The Factors that Influence the Elasticity of Demand

•elasticity of demand for a good depends on the closeness of substitutes, proportion of income

spent on the good and time elapsed since a price change

CLOSENESS OF SUBSTITUTES