Chapter 5 Definitions Elasticity A measure of how much buyers and sellers respond to changes in market conditions Used to measure how much consumers respond to changes in these variables Price Elasticity of Demand Measures how much the quantity demanded of a good responds to a change in price of that good Found by the Change in quantity demanded divided by the change in price Price Elasticity of Demand Q2 Q1 Q2 Q1 2 P2 P1 P2 P1 2 Elastic Demand for a good is said to be elastic if the quantity demanded responds substantially to the changes in price 1 Inelastic Demand is said to be inelastic if the quantity demanded responds only slightly to changes in the price 1 Unit Elasticity Elasticity is exactly 1 Total Revenue the amount paid by buyers and received by sellers of the good Total Revenue Price x Quantity TR PxQ Income Elasticity of Demand Measures how the quantity demanded changes as consumer income changes Income Elasticity of Demand change in quantity demanded change in income The Cross Price Elasticity of Demand Measures how the quantity demanded of one good responds to a change in the price of another good Cross Price Elasticity of Demand Change in quantity demanded of good 1 Change in the price of good 2 For substitute goods the cross price elasticity is positive For complement goods the cross price elasticity is negative Midpoint Method a better way to calculate percentage changes and elasticity s Change in quantity change in price Computes a percentage change by dividing the change by the midpoint or the average of the initial and final levels Answer is always positive Gives the same answer regardless of the direction of change Often used when calculating the price elasticity of demand between two points The elasticity from point A to point B seems different from the elasticity from point B to point A Price elasticity of supply Measures how much the quantity supplied of a good responds to changes in the price of that good Price elasticity of supply depends on the flexibility of sellers to change the amount of the good they produce Ex Beachfront land has inelastic supply because it is almost impossible to produce more of it Ex Manufactured goods cars books pencils computers etc have an elastic supply because companies can run their factories longer in response to a higher price Time is a key determinant of the price elasticity of supply Supply is more elastic in the long run than in the short run Price elasticity of Supply Change in quantity supplied Change in price Information Consumers usually buy more of a good when its price is lower when their incomes are higher when the prices of substitutes for the good are higher or when the prices of complements of the good are lower Goods tend to have more elastic demand over longer time horizons Long run companies can expand factories and build more Short run companies cannot easily change the size of their factories Whether a good is a necessity or a luxury depends not on the intrinsic properties of the good but on the preferences of the buyer The price elasticity of demand for any good measures how willing consumers are to buy less of the good as its price rises Because the quantity demanded of a good is negatively related to its price the change in quantity will always have the opposite sign as the percentage change in 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 If demand is unit elastic a price exactly equal to 1 total revenue remains constant when the price changes Slope is the ratio of changes in the two variables whereas elasticity is the ratio of percentage changes in the two variables Positive outcome normal good Negative outcome inferior good ELASTIC Demand is considered elastic when the elasticity is greater than 1 if the quantity demanded responds substantially to changes in the price If the demand is elastic an i ncrease in the price causes a decrease in total revenue Opposite Directions Demand is perfectly elastic Elasticity approaches infinity when the demand curve is horizontal Supply changes in price of a good is elastic if the quantity supplied responds substantially to Goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others Narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly defined goods INELASTIC If the demand is inelastic an increase in price causes and increase in total revenue Demand is said to be inelastic less than 1 if the quantity demanded responds only slightly to changes in the price Demand is perfectly inelastic 0 Elasticity when the demand curve is vertical Necessities tend to have inelastic demands whereas luxuries have elastic demands
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