Ch 5: Elasticity and Its ApplicationSunday, September 21, 20149:27 PM -Elasticity: a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants The Elasticity of Demand-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 for a good is said to be elastic if the quantity demanded responds substantially to changes in the price. -Demand is said to be inelastic if the quantity demanded responds only slightly to changes in price. -What influences the price elasticity of demand: oAvailability of Close Substitutes (goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others)oNecessities versus luxuries (Necessities tend to have inelastic demands, whereas luxuries have elastic demands)oDefinition of market (Narrowly defined markets tend to have more elastic demand than broadly defined markets because its easier to find close substitutes for narrowly defined goods)oTime horizon (Goods tend to have more elastic demand over longer time horizons)Price elasticity of demand = (Percentage change in quantity demanded)/(Percentage change in price)-A larger price elasticity implies a greater responsiveness of quantity demanded to changes in price. (02-0)/402+-97712](Pa-Pell-DPT-PS/2]Price elasticity of demand = -Demand is considered elastic when the elasticity is greater than 1, which means the quantity moves proportionately more than the price. -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 quantity moves the same amount proportionately as the 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 ofdemand-The steeper the demand curve that passes through a given point, the smaller the price elasticity of demand. -Perfectly inelastic: demand curve is vertical and the elasticity = 0, regardless of price, the demand stays the same. -Perfectly elastic: Demand curve is horizontal and the elasticity = infinity, very small changes in the price lead to huge changes in the quantity demanded.-As the elasticity rises, the demand curve gets flatter and flatter-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 (P*Q)-When the demand curve is inelastic, the extra revenue from selling at a higher price is greater than the lost revenue from selling fewer units. -When the demand curve is elastic, the extra revenue from selling at a higher price is less than the lost revenue from selling fewer units. -When demand is inelastic (a price elasticity less than 1), price and total revenue move in the same direction-When demand is elastic (a price elasticity greater than 1), price and total revenue move in opposite directions-If demand is unit elastic (a price elasticity equal to 1), total revenue remains constant when the price changes. -Income Elasticity of Demand: a measure of how much the quantity demanded of a good responds to a change in consumers' income, computed as the percentage change in quantity demanded divided by the percentage change in incomeoNormal goods have positive income elasticities because quantity demanded and income move in the same directionoInferior goods have negative income elasticities because quantity demanded and incomemove in opposite directions-Cross-price elasticity of demand: a measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantitydemanded of the first good divided by the percentage change in the price of the second goodoBecause the price and the quantity demanded of substitutes move in the same direction, substitutes have a positive elasticityoBecause the price and the quantity demanded of compliments move in opposite directions, compliments have a negative elasticity The Elasticity of Supply -Price elasticity of supply: a measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in priceoSupply of a good is elastic if the quantity supplied responds substantially to changes in the priceoSupply is inelastic if the quantity supplied responds only slightly to changes in the price. -In most markets, a key determinant of the price elasticity of supply is the time period being consideredoSupply is usually more elastic in the long run than in the short run. Price elasticity of supply = percentage change in quantity supplied / percentage change in price-Supply is perfectly inelastic when there is 0 elasticity and the supply curve is vertical. The quantity supplied is the same, regardless of the price. oAs the elasticity rises, the supply curve gets flatter, which shows that the quantity supplied responds more to changes in price.-Supply is perfectly elastic when the price elasticity of supply approaches infinity and the supply curve becomes horizontal, meaning that very small changes in the price lead to very large changes in the quantity supplied. In the short run, when supply and demand are inelastic, a shift in supply leads to a large increase in price. In the long run, when supply and demand are elastic, a shift in supply leads to a small increase in