ECON 2030 Chapter : Notes Chapter 7
1
Chapter 7 Notes
Describing Supply and Demand: Elasticities June 10, 2011
Practice Problems (Chapter 7): 1-4, 7, 8, 11-17, 20, 24, 25
Motivation
• Need reflects our responsiveness
• If something is elastic, it changes; it is very sensitive and responsive to a stimulus.
• If something is inelastic, it is insensitive and unresponsive to a stimulus.
Price Elasticity of Demand
• Elasticity tells us how much the demand will change (how much the behavior of buyers
will change).
• How responsive buyers are when there is a change in price
• Example: If there is a 2% increase in price, there is a 6% decrease in Quantity demanded.
This results in an elasticity of 3.
1 Price Elastic
1 Unit Elastic
1 Not Elastic
Determinants (Demand)
• Number and availability of substitutes (options)
o The more options available, the more likely a similar product will have a lower,
more appealing price. With options, you can find something better.
o With more options, we are more sensitive to price. (price elastic)
• Necessity or luxury
2
o If it is determined by the buyer to be a necessity, there will be less sensitivity to
price (price inelastic)
o Luxuries – price elastic
• Proportion of budget spent on good
o Everything else held constant, the greater the portion of your budget spent on
the good, the more elastic the price is. We are sensitive to changes that are
major expensive.
o Example: rent, car note, gas
• Time
o If there is a time constraint, people are less elastic to change in price.
o For example, if you are running out of gas and need to fill up, you will not “shop
around” for gas stations. You will fill up at whatever station, no matter the price
of gas.
D1 – Inelastic
No matter what the price, the quantity
demanded will not change.
D3 – Elastic
Key relationship:
Total revenue TR = P Q
If the price elasticity demand is more than one (price elastic), then price will increase
• Quantity demanded will go down by a larger amount, therefore, the total revenue will
decrease.
If the demand is price inelastic, then price will increase.
• Quantity demand will have a small change.
• Total revenue will increase
3
Price discrimination – charging 2 different prices to 2 different customers for the same good
• Senior citizen discounts
• Student discounts
• “Ladies Night”
• Goal: charge the lower price to the group that is more sensitive to price
Price Elasticity of Supply
How responsive sellers are in response to a change in price
Determinants (Supply)
• Time
o It takes a finite amount of time to produce a good
Cross-price elasticity of demand
How responsive are buyers in a response to
a change in price of one good with respect
to another.
Income elasticity of demand
> 0 normal good
< 0 if inferior good
