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

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8 Aug 2016

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Chapter 4 Concepts/Definitions ECON 1021 09/27/15

Price Elasticity of Demand

- When supply decreases, the equilibrium price rises and the equilibrium quantity decreases

- The size of effect on the price and quantity depends on the responsiveness of the quantity

demanded of a good to a change in its price

oIf the quantity demanded is not very responsive to a change in the price, the price rises

a lot and the equilibrium quantity doesn’t change much

oIf the quantity demanded is very responsive to a change in the price, the price barely

rises and the equilibrium quantity changes a lot

- Responsiveness of the quantity demanded of a good to change in its price can be thought of in

terms of the slope of the demand curve

oIf demand curve is steep, QD of good isn’t very responsive to change in price

oIf demand curve is almost flat, QD is very responsive to change in price

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

oWe can make the curve steep or almost flat just by changing the units in which we

measure the price and the quantity

Price elasticity of demand: 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 ED: Percentage change in quantity demanded / Percentage change in price

- To calculate price ED, we express the change in price as a percentage of the average price and

the change in QD as a percentage of the average quantity

- By using the average price and average quantity we calculate the elasticity at a point on the

demand curve midway between the original point and the new point

Average Price Quantity: Gives the most precise measurement of elasticity – at the midpoint between

the original price and the new price

- By using percentages of the average price and average quantity, we 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, so when we divide

percentages, the 100s cancel.

- Percentage change is proportionate change multiplied by 100

- Proportionate change in price is Delta P/ P Ave

- Proportionate change in quantity demanded is Delta Q/Q Ave

Units Free Measure: Percentage change in each variable is independent of the units in which the

variable is measured

- The ratio of the two percentages is a number without units

Minus Sign and Elasticity: When the price of a good rises, the quantity demanded decreases. Because a

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

negative number

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

responsive the quantity demanded is

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

minus sign

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Chapter 4 Concepts/Definitions ECON 1021 09/27/15

Perfectly Inelastic Demand: If the quantity demanded remains constant when the price changes, then

the price elasticity of demand is zero

Unit Elastic Demand: If the percentage change in the quantity demanded = the percentage change in

the price, the price elasticity = 1

Inelastic Demand: Between perfectly inelastic demand and unit elastic demand is a general case in

which the percentage change in the quantity demanded is less than the percentage change in price.

Price elasticity of demand is between zero and 1.

Perfectly Elastic 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. The demand for a good

that has a perfect substitute is perfectly elastic.

Elastic Demand: Between unit elastic demand and perfectly elastic demand is another general case in

which the percentage change in the quantity demanded exceeds the percentage change in price. The

price elasticity of demand is greater than 1.

The Elasticity of Demand for a good depends on:

- The Closeness of Substitutes

oThe closer the substitutes for a good, the more elastic is the demand for it

oThe degree of substitutability depends on how narrowly or broadly we define a good

oNecessities: Goods such as food and shelter

oLuxuries: Goods such as exotic vacations

oA necessity has poor substitutes, so it generally has an inelastic demand

oA luxury usually has many substitutes – one of which is not buying it, so it generally has

an elastic demand

- Proportion of Income Spent on the Good

oOther things remaining the same, the greater the proportion of income spent on a good,

the more elastic is the demand for it

- Time Elapsed Since Price Change

oThe longer the time that has elapsed since a price change, the more elastic is the

demand

Elasticity Along a Linear Demand Curve

- Not the same as slope

- At the midpoint of a linear demand curve, the price elasticity of demand = 1

oAt prices above the midpoint, the price elasticity of demand > 1 : Demand is elastic

oAt prices below the midpoint, the price elasticity of demand < 1 : Demand is inelastic

Total Revenue: Price of good x Quantity sold

- When price changes, total revenue also changes

- Cut in price does not always decrease total revenue

- Change in total revenue depends on the elasticity of demand

oIf demand is elastic, a 1% price cut increases the quantity sold by more than 1% =

revenue increases

oIf demand is inelastic, a 1% price cut increases the quantity sold by less than 1% =

revenue decreases

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