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Chapter 6

# ECON 1116 Chapter 6: Chapter 6- ECON

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School
Northeastern University
Department
Economics
Course
ECON 1116
Professor
Michael P.Stone
Semester
Spring

Description
Chapter 6 Elasticity: The Responsiveness of Demand and Supply Elasticity: a measure of how much one economic variable responds to changes in another economic variable I. The Price Elasticity of Demand its measurement Price elasticity of demand: the responsiveness of the quantity demanded to a change in price, measured by dividing the percentage change in the quantity demanded of a product by the percentage change in the product’s price. Measuring the price elasticity of demand - Price elasticity of demand= percentage in quantity demanded/percentage change in price - Price elasticity of demand≠ slope of demand curve - Always negative Elastic demand and inelastic demand Elastic demand: when the percentage change in the quantity demanded is greater than the percentage change in price, so the price elasticity is greater than 1 in absolute value Inelastic demand: when the percentage change in quantity demanded is less than the percentage change in price, so the price elasticity is less than 1 in absolute value Unit Elastic demand: demand is unit elastic when the percentage change in quantity demanded is equal to the percentage change in price, so the price elasticity is equal to 1 in absolute value The Midpoint Formula Use: ensure that we have only one value of the price elasticity of demand between the same two points on a demand curve Polar cases of perfectly elastic and perfectly inelastic demand Perfectly inelastic demand: case where the quantity demanded is completely unresponsive to price and the price elasticity of demand equals zero - No matter how much price may increase or decrease the quantity demanded is completely unresponsive to price and the price elasticity of demand equals zero. Perfectly elastic demand: the case where the quantity demanded is infinitely responsive to price elasticity of demand equals infinity - An increase in price causes the quantity demanded to fall to zero II. The determinants of the price elasticity of demand Why price elasticities differ among products. The key determinants of the price elasticity of demand are: o Availability of close substitutes o The passage of time o Whether the good is a luxury or a necessity o The definition of the market o The share of the good in the consumer’s budget Availability of close substitutes - Consumers reaction to change in price of a product depends on whether there are alternative products - Availability of substitutes most important determinant of price elasticity of demand - If a product has more substitutes available, it will a more elastic demand. If a product has fewer substitutes available, it will have a less elastic demand. Passage of Time - It takes consumers some time to adjust their buying habits when prices change. - The more time passes the more elastic the demand for a product becomes Luxuries versus Necessities - Goods that are luxuries usually have more elastic demand curves than goods that are necessities - The demand curve for a luxury is more elastic than the demand curve for a necessity Definition of the Market - In a narrowly defined market, consumers have more substitutes available - The more narrowly we define a market the more elastic demand will be Share of a good in a consumer’s budget - Goods that take only a small fraction of a consumer’s budget tend to have less elastic demand than goods that take a larger fraction Some estimated price elasticities of demand - Estimates of the price elasticities of different goods can vary depending on the data and the time period over which the estimates were made - Goods for which there are few substitutes, are price inelastic III. Relationship between price elasticity of demand and t
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