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Chapter 4

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Chapter 4 ElasticityOctober1111419 PMPrice Elasticity of DemandELASTICITYHOW MUCH DEMAND FOR AN ITEM CHANGES WHEN PRICE CHANGESWhen supply increases equilibrium price falls and equilibrium quantity increasesDoes price fall by a large amount and quantity increase by a littleDoes price barely fall and quantity increase by a large amountAnswer depends on responsiveness of the quantity demanded to a change in priceDifferent outcomes arise from differing degrees of responsiveness of the quantity demanded to a change in priceExample slopeCan compare slopes of two demand curvesA demand curve with a very steep slope V demand curve with a softer slopeIf supply increases the same in both casesSteep slowlarge fall in price and a small increase in quantitySoft slopesmall fall in price and a large increase in quantityCannot always use slopeSlope depends on units in which we measure for price and quantityOften need to compare demand for different goods and services that are measured in unrelated unitsExample pizza producer wants to compare demand for pizza with demand for soft drinksUse elasticity as a measurePrice elasticity of demandUnitsfree 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 sameCalculated using the formulaPrice elasticity of demandpercentage change in quantity demandedpercentage change in priceExample pizza is initially sold at 2050 and 9 sold in an hourPrice falls to 1950 a pizza and quantity demanded increases to 11 pizzas an hoursWhen price falls by 1 a pizza the quantity demanded icnreases by 2 pizzas an hourTo calculate we express changes in price and quantity demanded as percentages of average price and average quantityBy using this you can calculate elasticity at a point on the demand curve midway between original and new pointMathAverage of 2050 and 1950195 20120005 51 price decrease is 5 percent of average priceAverage of 9 and 1111 1021002 202 increase in quantity demanded is 20 percent of average quantityPrice elasticity of demand2054004004Average Price and QuantityUsing average provides most precise measurement of elasticityAt the midpoint between original and new priceExample if price falls from 2050 to 19501 price change is 49 of 20502 pizza change in quantity is 222 of 9 pizzasThis means elasticity of 22249453061245 Example if the price rises from 1950 to 2050The 1 price change is 51 of 1950The 2 pizza change in quantity is 182 percent of 11 pizzasThis means elasticity of 18251356862736By using average you get same value of elasticity regardless if price falls from 2050 to 1950 or rises from 1950 to 2050Percentages and ProportionsElasticity is the ratio of two percentage changesA percentage change is a proportionate change multiplied by 100Proportionate change in price is deltaPPaverage and proportionate change in quantity demanded is delta QQ averageDivide the two proportions and you get same answer as using percentage changeA UnitsFree MeasureIt is unitsfree because the percentage change is independent of units in which variable is measuredThe ratio of the two percentages is a number without unitsMinus Sign and ElasticityWhen price of a good rises the quantity demanded decreasesPositive change in price brings negative change in quantity demandedPrice elasticity is a negative numberThe magnitudeabsolute value of elasticity tells us how responsive the quantity demanded isSo magnitude of elasticity is used and minus sign is ignoredInelastic and Elastic DemandThree demand curves cover entire range of possible elasticities of demandVertical LineIf price changes quantity demanded remains the samePrice elasticity of demand is zero and it has perfectly inelastic demandExample insulinCurved downwardsIf percentage change in quantity demanded equals percentage change in pricePrice elasticity is 1 and it has unit elastic demandWhen percentage change in quantity demanded is more than the percentage change in priceElasticity of demand is between 1 and infinity and has elastic demandExample automobile and furnitureHorizontal Line ECON 1000 Page 1

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