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

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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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