Chapter 4 - ECON 0100

• responsiveness of quantity demanded of a good to change in terms of price of the slope of the demand curve

  steep = price changes a lot

  
  

  flat = prices barey changes
• price elasticity of demand


  a 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
• Calculating Price Elasticity of Demand


  % change in quantity demanded / % change in price

  
  

  
  

  use midpoint

  ex: 70-80, do 10/75

  
  

  look at magnitude or absolute value (disregard negative)
• average price


  average of the initial and new price
• average quantity demanded

  average of the initial and new quantity
• average price and quantity


  By using the average price and average quantity,we get the same elasticity value regardless of whether the price rises or falls
• percentages and proportions


  The ratio of two proportionate changes is the same as the ratio of two percentage changes.- %DQ / %DP = DQ / DP
• units free measure


  Elasticity is a ratio of percentages, so a change in the units of measurement of price or quantity leaves the elasticity value the same
• inelastic and elastic demand

  demand can be inelastic, unit elastic, or elastic (0-infinity)
• perfectly inelastic demand


  If the quantity demanded doesn't change when the price changes, the price elasticity of demand is zero

  
• unit elastic demand


  the percentage change in quantity demanded equals the percentage change in price; the resulting price elasticity has an absolute value of 1.0 (on a linear demand curve it is always the midpoint)

  
• inelastic demand


  if the percentage change in quantity demanded is smaller than the percentage change in price (on a linear demand curve it is always below the midpoint)

  
  

  <1
• elastic demand


  if the percentage change in the quantity demanded is greater than the percentage change in price (on a linear demand curve it is always above the midpoint)

  
  

  >1
• perfectly elastic demand


  If the percentage change in the quantity demanded is infinitely large when the price barely changes

  
  

  infinity

  
• factors that influence the elasticity of demand

  1. The closeness of substitutes

  2. The proportion of income spent on the good

  3. The time elapsed since the price change
• closeness of substitutes


  The closer the substitutes for a good or service,the more elastic is the demand for the good or service.

  
  

  Necessities, such as food or housing, generally have inelastic demand.

  
  

  Luxuries, such as exotic vacations, generally have elastic demand
• proportion of income spent on the good


  The greater the proportion of income consumers spend on a good, the larger is the elasticity of demand for that good
• time elapsed since price change

  The more time consumers have to adjust to a price change, or the longer that a good can be stored without losing its value, the more elastic is the demand for that good
• total revenue and elasticity


  total revenue from the sale of a good or service equals the price of a good multiplied by the quantity sold

  
  

  when the price changes, total revenue also changes

  
  

  but a rise in price doesn't always increase total revenue
• factors for change in total revenue

  If demand is elastic, a 1 percent price cut increases the quantity sold by more than 1 percent, and total revenue increases.

  
  

  If demand is inelastic, a 1 percent price cut increases the quantity sold by less than 1 percent, and total revenues decreases

  
  

  If demand is unit elastic, a 1 percent price cut increases the quantity sold by 1 percent, and total revenue remains unchanged
• total revenue test


  a method of estimating the price elasticity of demand by observing the change in total revenue that results from a change in the price, when all other influences on the quantity sold remain the same

  
  

  -price cut increase total revenue, demand is elastic

  -price cut decreases total revenue, demand is inelastic

  -price cut leaves total revenue unchanged, demand is unit elastic

  
  

  -price rise increase total revenue, demand is inelastic

  -price rise decreases total revenue, demand is elastic

  -price rise leaves total revenue unchanged, demand is unit elastic
• your expenditure and your elasticity

  If your demand is elastic, a 1 percent price cut increases the quantity you buy by more than 1 percent and your expenditure on the item increases.

  
  

  If your demand is inelastic, a 1 percent price cut increases the quantity you buy by less than 1 percent and your expenditure on the item decreases.

  
  

  If your demand is unit elastic, a 1 percent price cut increases the quantity you buy by 1 percent and your expenditure on the item does not change
• income elasticity of demand


  measures how the quantity demanded of a good responds to a change in income, ceteris paribus
• calculating the income elasticity of demand


  % change in quantity demanded / % change in income
• income and elasticity of demand

  If the income elasticity of demand is greater than 1, demand is income elastic and the good is a normal good.

  
  

  If the income elasticity of demand is greater than zero but less than 1, demand is income inelastic and the good is a normal good.

  
  

  If the income elasticity of demand is less than zero (negative) the good is an inferior good
• cross elasticity of demand


  measure of the responsiveness of demand for a good to a change in price of a substitute or a complement, ceteris paribus
• calculating the cross elasticity of demand

  % Change in Quantity Demanded / % Change in Price of Substitute or Complement
• cross elasticity and demand


  The cross elasticity of demand for

  -a substitute is positive.

  -a complement is negative.
• elasticity of supply


  measures the responsiveness of the quantity supplied to a change in the price of a good, ceteris paribus
• calculating the elasticity of supply

  % change in quantity supplied/% change in price
• perfectly inelastic


  supply curve is vertical and elasticity is 0
• unit elastic


  supply curve is linear and passes through origin (slope is irrelevant) and elasticity is 1
• perfectly elastic


  supply curve is horizontal and elasticity is infinite
• factors that influence the elasticity of supply

  Resource substitution possibilities

  
  

  Time frame for supply decision
• resource substitution possibilities


  the easier it is to substitute among the resources used to produce a good or service, the greater is its elasticity of supply
• time frame for supply decicision


  The more time that passes after a price change,the greater is the elasticity of supply.

  -Momentary supply

  -Short-run supply

  -Long-run supply
• momentary supply


  perfectly inelastic, quantity supplied immediately following a price change is constant
• short run supply


  Somewhat elastic supply
• long run supply

  most elastic supply (perfectly elastic)
• demand and price cuts and rises

  Demand is elastic if a price cut increases total revenue

  
  

  Demand is inelastic if a price rise increases total revenue

  
  

  Demand is unit elastic if a price rise or price cut leaves total revenue unchanged.