Elasticity Textbook NotesChapter 5To measure how much consumers respond to changes in variables, economists use the concept of elasticity.Elasticity= a measure of the responsiveness of quantity demanded or quantity supplied to a chance in one of it’s determinants.Price elasticity of demand= a measure of how much the quantity demanded of a good responds to a chance 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 for a good is said to be INELASTIC if the quantity demanded responds only slightly to changes in the price. - Price elasticity for any good measures the how willing consumers are to buy less of the good as it’s price rises. Influences of price-elasticity of Demand:AVAILABILITY OF CLOSE SUBSTITUTES:- Goods with close substitutes tend to have more elastic demand because it’s easier for consumers to switch from that good to others. (ex: butter and margarine). Small increase in price of butter (assuming margarine price remains fixed), causes quantity of butter to fall by large amt. However, b/c eggs are a food without a close substitute, demand for eggs is LESS ELASTIC than demand for butter.NECESSITIES VERSUS LUXURIES:- necessities tend to have inelastic demands, and luxuries tend to have elastic demands. When the price of a doctor’s visit rides, people will not dramatically reduce the number of times they go to the doctor, they might go somewhat less often. When the price of sailboats rides, the quantity demanded falls substantially. Doctor visits= necessity, sailboats= luxury. A good’s determinants of necessity vs. luxury depends on the preference of the buyer.Computing the price elasticity of demand: Price elasticity of demand = percentage change in quantity demanded / percentage change in price.Ex: Suppose the a 10 percent increase in the price of an ice-cream cone causes the amount of ice cream you buy to fall by 20 percent. We calculate your elasticity of demand as:Price elasticity of demand = 20 percent/10 percent= 2. Elasticity would = 2, reflecting that the change in quantity demanded is proportionately twice as large as the change in the price. - Because the quantity demanded of a good is negatively related to it’s price, the percentage change in quantity will always have the opposite sign as thepercentage change in price. (Ex: the percentage change in the price of ice-cream is a positive 10 percent; reflecting an increase in price, and the percentage change in quantity demanded is a negative 20 percent; reflecting a decrease in demand. THE MIDPOINT METHOD:Trying to calculate the price elasticity of demand between two points on a demand curve. Considering these numbers:Point A: Price= $4, Quantity= 120Point B: Price= $6, Quantity= 80Standard procedure to calculate a percentage change is to divide the change by the initial level. The Midpoint method calculates a percentage change by dividingthe change by the midpoint (or average) of the initial and final levels. Ex: $5 is the midpoint between $4 and $6. So, according to the midpoint method, a changefrom $4 to $6 is considered a 40 percent ride because (6-4) / 5 x 100 = 40. The 40 represents the 40 percent fall. To calculate price elasticity of demand using midpoint method:Price elasticity of demand = [(quantity 2 – quantity 1)/(quantity 2 + quantity 1) / 2] // [(price 2 – price 1) / (price 2 + price 1) / 2]- 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 priceelasticity of demand. The steeper the demand curve that passes through a given point, the smaller the price elasticity of demand. Perfectly inelastic demand curve = vertical**Inelastic curves look like the letter I. 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. If demand is inelastic, an increase in the price will cause an increase in the total revenue. (Only if the increase in price is proportionately larger than the decrease inquantity!!!) - For inelastic demand curves, total revenue moves in the same direction as the price. For elastic demand curves, total revenue moves in the opposite direction as the price.General Rules of Price Elasticity/Total Revenue Graphs:- 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 exactly equal to 1), total revenue remains constant when the price changes. Income elasticity of demand measures how the quantity demanded changes as consumer income changes. It is calculated:(percentage change in quantity demanded)/(percentage change in income)Cross-price elasticity of demand measures how the quantity demanded of one good responds to a change in the price of another good. It is calculated:(percentage change in quantity demanded of good 1)/(percentage change in the price of good 2)price elasticity of supply measures how much the quantity supplies responds to changes in the price. Calculated:(percentage change in quantity supplied)/(percentage change in price)- If quantity supplied moves proportionately less than the price, then the elasticity isless than 1, and supply is said to be inelastic. If quantity supplied moves proportionately more than the price, then the elasticity is greater than 1, and supplyis said to be
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