ECON 100 1st Edition Lecture 7 Outline of Last Lecture I Market Equilibrium A Equilibrium Price B Equilibrium Quantity 1 Surplus 2 Shortage II Predicting Changes in Price and Quantity A Change in Demand B Change in Supply C Change in supply and demand Outline of Current Lecture I Price Elasticity of Demand A Types of Demand Elasticity 1 Inelastic Demand 2 Unit Elastic Demand 3 Elastic Demand B Factors that influence demand elasticity C Total Revenue and Elasticity D Expenditure and Elasticity E Income Elasticity of Demand F Cross Elasticity of Demand II Elasticity of Supply A Three Cases of Elasticity of Supply B Factors That Influence Elasticity of Supply C Time Frame For Supply Decision Current Lecture Price Elasticity of Demand How much the price rises falls and quantity increases decreases depends on the responsiveness of the quantity demanded of a good to a change in its price slope of demand curve If the demand curve is steep the price rises by a lot if the demand curve is almost flat the price barely rises These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute To measure responsiveness we need a measure that is independent of units of measurement elasticity The 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 remains the same Percentage change in the quantity demanded Percentage change in the price Express the change in price as a percentage of the average price the average of the initial and new price Express the change in the quantity demanded as a percentage of the average quantity demanded the average of the initial and new quantity Average Price and Average Quantity By using the average price and quantity we get the same elasticity values regardless of whether the price rises or falls Elasticity is a ratio of percentages The magnitude or absolute value reveals how responsive the quantity change has been to a price change Inelastic Demand Demand can be inelastic unit elastic or elastic and can range from zero to infinity If the quantity demanded doesn t change when the price changes the price elasticity of demand is zero and the good has a perfectly inelastic demand vertical demand curve If the percentage change in the quantity demanded equals the percentage change in price the price elasticity of demand equals 1 and the good has unit elastic demand ever declining slope on demand curve If the percentage change in the quantity demanded is smaller than the percentage change in price the price elasticity of demand is less than 1 and the good has inelastic demand If the percentage change in the quantity demanded is greater than the percentage change in price the price elasticity of demand is greater than 1 and the good has elastic demand If the percentage change in the quantity demanded is infinitely large when the price barely changes the price elasticity of demand is infinite and the good has a perfectly elastic demand horizontal demand curve Factors That Influence the Elasticity of Demand 1 Closeness of Substitutes a The closer the substitutes for a good or service the more elastic is the demand for the good or service b Necessities such as food or housing generally have inelastic demand c Luxuries such as exotic vacations generally have elastic demand 2 Proportion of Income Spent on the Good a The greater the proportion of income consumers spend on a good the larger is the elasticity of demand for that good 3 Time Elapsed Since Price Change a 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 Elasticity Along a Linear Demand Curve At the mid point of the demand curve demand is unit elastic At prices above the mid point of the demand curve demand is elastic At prices below the mid point of the demand curve demand is inelastic Total Revenue and Elasticity The total revenue from the sale of a good or service equals the price of the 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 The change in total revenue due to a change in price depends on the elasticity of demand 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 price change when all other influences on the quantity sold remain the same If a price cut increases total revenue demand is elastic If a price cut decreases total revenue demand is inelastic If a price cut leaves total revenue unchanged demand is unit elastic Expenditure and 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 The income elasticity of demand measures how the quantity demanded of a good responds to a change in income other things remaining the same Percentage change in quantity demanded percentage change in income 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 A measure of the responsiveness of demand for a good to change in the price of a substitute or a compliment other things remaining the same Percentage change in the quantity demanded percentage change in the price of a substitute or compliment The cross elasticity of demand for Asubstitute is