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Chapter 5

Chapter 5-Elasticity.docx

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York University
ECON 1000
Sadia Mariam Malik

Chapter 5- Elasticity Elasticity measures how much one variable responds to changes in another variable. • One type of elasticity measures how much demand for your goods and services  will fall if you raise your price Elasticity d S It is a numerical measure of the responsiveness of Q  or Q  to one of its determinants. Price Elasticity of Demand Price Elasticity of Demand= (% change in Q /% change in P) Example: Price Elasticity of demand =  (15%/10%)=1.5 Along a D curve, P and Q move in  opposite directions, which would make  price elasticity negative. We will drop the minus sign and report all  price elasticities as positive numbers. Calculating percentages changes Standard method of computing the percentage change: [(End value­start value)/(start value)]*100% Going from A to B, the % change in P  Demand for your websites equals ($250­$200)/$200=25% Problem The standard method gives different answers depending  on where you start. From A to B, P rises 25%, Q falls 33%,  elasticity=33/25=1.33 From B to A, P falls 20%, Q rises 50%, elasticity =50/20=2.5 Midpoint method [(End value­start value)/(midpoint)]*100% • The midpoint is the number halfway  between the start and end values, the average of those values • It doesn’t matter which value you use as the ‘start’ and which as the ‘end’­ you  get the same answer either way! Calculating Percentage Changes • Using the midpoint method, the % change in P equals  [($250­$200)/$225]*100%= 22.2% • The % change in Q equals  [(12­8)/10]*100%= 40% • The price elasticity of demand equals  [40/22.2]=1.8 The Determinants of Price Elasticity • The extent to which close substitutes are available o Price elasticity is higher when close substitutes are available  • How broadly or narrowly the good is defined o Price elasticity is higher for narrowly defined goods than broadly defined goods • Whether the good is a necessity or a luxury o Price elasticity is higher for luxuries than for necessities  • The time horizon­ elasticity is higher in the long run than the short run o Price elasticity is higher in the long run than the short run The Variety of Demand Curves • The price elasticity of demand is closely related to the slope of the demand curve • Rule of thumb: o The flatter the curve, the bigger the elasticity o The steeper the curve, the smaller the elasticity Five different classifications of D curves: 1. Perfe Price elasticity of demand=[(% change in Q)/(% change in P)=(0%)/(10%)=0 c t l y inelastic demand (one extreme case) • D curve: vertical • Consumers’ price sensitivity: none • Elasticity: 0 P falls by  10% Q falls  2. Inelastic demand by 0% Price elasticity of demand=[(% change in Q)/(% change in P)=(<10%)/(10%)=<1 • D curve: relatively steep • Consumers’ price sensitivity: relatively low • Elasticity: <1 P falls by  10% Q rises less than  10% 3. Price elasticity of demand=[(% change in Q)/(% change in P)=(10%)/(10%)=1 3. Unit elastic demand • D curve: intermediate slope • Consumers’ price sensitivity: intermediate P falls by  • Elasticity: 1 10% Q rises by  10% 4. El a Price elasticity of demand=[(% change in Q)/(% change in P)=(>10%)/(10%)=>1 s t ic demand • D curve: relatively flat • Consumers’ price sensitivity: none P falls by  • Elasticity: >1 10% that 10%more 
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