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Chapter 4

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**preview**shows page 1. to view the full**4 pages of the document.**Price Elasticity of Demand

ELASTICITY = HOW MUCH DEMAND FOR AN ITEM CHANGES WHEN PRICE CHANGES

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

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

When supply increases equilibrium price falls and equilibrium quantity increases

Different outcomes arise from differing degrees of responsiveness of the quantity demanded to a change in price

Can compare slopes of two demand curves

If supply increases the same in both cases

Steep slow = large fall in price and a small increase in quantity

Soft slope = small fall in price and a large increase in quantity

A demand curve with a very steep slope V. demand curve with a softer slope

Example: slope

Slope depends on units in which we measure for price and quantity

Often need to compare demand for different goods and services that are measured in unrelated units

Example: pizza producer wants to compare demand for pizza with demand for soft drinks

Cannot always use slope

Use elasticity as a measure

Answer depends on responsiveness of the quantity demanded to a change in price

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

Calculated using the formula

Price falls to $19.50 a pizza and quantity demanded increases to 11 pizzas an hours

By using this you can calculate elasticity at a point on the demand curve midway between original and new point

To calculate we express changes in price and quantity demanded as percentages of average price and average quantity

Average of 20.50 and 19.50 = 19.5 $20

$1 price decrease is 5 percent of average price

$1/$20 = $0.05 5%

Average of 9 and 11 = 11 10

2 increase in quantity demanded is 20 percent of average quantity

2/10 = 0.2 20%

Math:

Price elasticity of demand = 20%/5% = 400% = 400% = 4

When price falls by $1 a pizza the quantity demanded icnreases by 2 pizzas an hour

Example: pizza is initially sold at $20.50 and 9 sold in an hour

Price elasticity of demand:

Average Price and Quantity

At the midpoint between original and new price

Using average provides most precise measurement of elasticity

$1 price change is 4.9% of $20.50

This means elasticity of 22.2%/4.9%=453.0612% = 4.5

2 pizza change in quantity is 22.2% of 9 pizzas

Example: if price falls from $20.50 to $19.50

The $1 price change is 5.1% of $19.50

This means elasticity of 18.2%/5.1%=356.8627% = 3.6

The 2 pizza change in quantity is 18.2 percent of 11 pizzas

Example: if the price rises from $19.50 to $20.50

By using average you get same value of elasticity regardless if price falls from $20.50 to $19.50 or rises from $19.50 to $20.50

Percentages and Proportions

Elasticity is the ratio of two percentage changes

A percentage change is a proportionate change multiplied by 100

Divide the two proportions and you get same answer as using percentage change

Proportionate change in price is deltaP/Paverage and proportionate change in quantity demanded is delta Q/Q average

A Units-Free Measure

It is units-free because the percentage change is independent of units in which variable is measured

The ratio of the two percentages is a number without units

Minus Sign and Elasticity

When price of a good rises the quantity demanded decreases

Price elasticity is a negative number

So magnitude of elasticity is used and minus sign is ignored

The magnitude/absolute value of elasticity tells us how responsive the quantity demanded is

Positive change in price brings negative change in quantity demanded

Inelastic and Elastic Demand

Three demand curves cover entire range of possible elasticities of demand

If price changes quantity demanded remains the same

Price elasticity of demand is zero and it has perfectly inelastic demand

Example: insulin

Vertical Line

Price elasticity is 1 and it has unit elastic demand

If percentage change in quantity demanded equals percentage change in price

Elasticity of demand is between 1 and infinity and has elastic demand

Example: automobile and furniture

When percentage change in quantity demanded is more than the percentage change in price

Curved downwards

Horizontal Line

Chapter 4 - Elasticity

October-11-11

4:19 PM

ECON 1000 Page 1

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