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Chapter 5: Elasticity and Its Application

5.1 The Elasticity of Demand

The Price Elasticity of Demand and Its Determinants

● Elasticity: a measure of the responsiveness of quantity demanded or quantity supplied to

a change in one of its determinants

● price elasticity of demand: a measure of how much the quantity demanded of a good

responds to a change in the price of that good, computed as the percentage change in

quantity demanded divided by the percentage change in price

● Demand is said to be inelastic if the quantity demanded responds only slightly to

changes in the price.

● Availability of Close Substitutes: higher availability means higher elasticity

● Necessities vs. Luxuries: luxuries more elastic

● Definition of the Market: narrowly defined means more elastic

● Time Horizon: more elastic over longer time horizon

Computing the Price Elasticity of Demand

● Price elasticity of demand = % change in quantity demanded/ % change in price

The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities

● the midpoint method computes a percentage change by dividing the change by the

midpoint (or average) of the initial and final levels

● price elasticity of demand=(Q2-Q1)/[(Q2+Q1)/2](P2-P1)/[(P2+P1)/2]

The Variety of Demand Curves

● Demand is considered inelastic when the elasticity is less than 1, which means the

quantity moves proportionately less than the price

● if the elasticity is exactly 1, the percentage change in quantity equals the percentage

change in price, and demand is said to have unit elasticity.

● The flatter the demand curve that passes through a given point, the greater the price

elasticity of demand. The steeper the demand curve that passes through a given point,

the smaller the price elasticity of demand.

● Perfectly inelastic: 0 elasticity

Total Revenue and the Price Elasticity of Demand

● total revenue: the amount paid by buyers and received by sellers of a good, computed

as the price of the good times the quantity sold

● When demand is inelastic (a price elasticity less than 1), price and total revenue move in

the same direction: If the price increases, total revenue also increases.

● When demand is elastic (a price elasticity greater than 1), price and total revenue move

in opposite directions: If the price increases, total revenue decreases.

● If demand is unit elastic (a price elasticity exactly equal to 1), total revenue remains

constant when the price changes.

Elasticity and Total Revenue along a Linear Demand Curve

● the slope of a linear demand curve is constant, the elasticity is not.

● This is true because the slope is the ratio of changes in the two variables, whereas the

elasticity is the ratio of percentage changes in the two variables

● At points with a low price and high quantity, the demand curve is inelastic. At points with

a high price and low quantity, the demand curve is elastic.

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