Principles of Microeconomics Chapter 5 Elasticity is a measure of how much buyers and sellers respond to changes in market conditions responsiveness of quantity demanded or quantity supplied to a change in a determinant Price Elasticity of Demand and Its Determinants Price elasticity of demand measures how much qD responds to a Demand for a good is elastic when qD responds substantially to price Demand for a good is inelastic when qD responds only slightly to measures how willing consumers are to buy less of a good as the change in price changes price changes price rises Influences on PED Availability of close substitutes Goods with close substitutes have more elastic demand b c it is easier for consumers to switch from that good to a substitute Necessities vs Luxuries Necessities have inelastic demand b c they are NECESSARY while luxuries have elastic demand NOT NECESSARY Definition of the Market Narrowly defined markets tend to have more elastic demand than broadly defined markets b c it is easier to find substitutes for narrowly defined goods Time Horizon Goods tend to have a more elastic demand over longer time horizons Because the qD of a good is negatively relate to its price the change in q will always have the opposite sign as change in price Computing the PED PED change in qD change in price The Midpoint Method PED q q q q 2 p p p p 2 Variety of Demand Curves Demand is elastic when elasticity 1 Demand is inelastic when elasticity 1 Demand is unit elastic when elasticity 1 The flatter the demand curve that passes through a given point the greater price elasticity The steeper the demand curve that passes through a given point the smaller the price elasticity Total revenue the amount paid by buyers and received by sellers in any market revenue P x Q If demand is inelastic an increase in price will increase revenue the higher price offsets the selling of fewer units If demand is elastic an increase in price will decrease revenue If demand is unit elastic total revenue remains constant when the price changes When the demand curve is linear the elasticity is not constant at points with low price and high quantity the demand is inelastic At points with high price and low quantity the demand is elastic Other Demand Elasticities Income elasticity of demand measures how qD changes as consumer income changes change in qD change in income Normal goods have positive income elasticities inferior goods have negative income elasticities Cross price elasticity of demand measures how the qD of one good responds to a change in the price of another good change in qD of good 1 change in price of good 2 The Price Elasticity of Supply measures how much qS responds to a change in the price of that good Supply of a good is elastic if qS responds substantially to a change in Supply of a good is inelastic if qS responds only slightly to a change Depends on the flexibility of sellers to change the amount of a good price in price they produce Supply is usually more elastic in the long run Computing PES PES change in qS change in price Variety of Supply Curves When the supply is perfectly inelastic the curve is vertical and qS cannot change regardless of price change As elasticity rises the supply curve gets flatter showing it responds more to changes in price When the supply curve is perfectly elastic the curve is horizontal and qS will change greatly in response to little changes in price
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