Principles of Microeconomics: Chapter 5Elasticity 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 DeterminantsPrice elasticity of demand: measures how much qD responds to a change in price. Demand for a good is elastic when qD responds substantially to pricechanges. Demand for a good is inelastic when qD responds only slightly to price changes. ^measures how willing consumers are to buy less of a good as the 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 tohave 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 Computing the PED:PED = % change in qD % change in priceBecause 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.The Midpoint Method:PED: (q' - q)/[q' + q)/2] (p' - p)/[p' +p)/2]Variety of Demand Curves:Demand is elastic when elasticity > 1Demand is inelastic when elasticity < 1Demand is unit elastic when elasticity = 1The 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, thesmaller the price elasticity.Total revenue: the amount paid by buyers and received by sellers (inany 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; inferiorgoods 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 2The Price Elasticity of Supply: measures how much qS responds toa change in the price of that good. Supply of a good is elastic if qS responds substantially to a change inprice.Supply of a good is inelastic if qS responds only slightly to a change in price. ^Depends on the flexibility of sellers to change the amount of a good they produce. Supply is usually more elastic in the long run. Computing PES: PES: % change in qS % change in priceVariety 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
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