Chapter 6 Elasticity Cutting the price of a good increases the quantity demanded and that raising the price reduces the quantity demanded Elasticity a measure of how much on economic variable responds to changes in another economic variable Price elasticity of demand the responsiveness of the quantity demanded to a change in price Price elasticity demand Percentage change in quantity demanded Percentage change in price Price elasticity of demand is not the same as the slop of the demand curve Price elasticity of demand is always negative Drop the minus sign and compare their absolute values Elastic demand when the percentage change in quantity demanded is greater than the percentage change in price Price elasticity is greater than 1 in absolute value Inelastic demand when the percentage change in quantity demanded is less than the percentage change in price Price elasticity is less than 1 in absolute value Midpoint formula Price elasticity demand Q2 Q1 P2 P1 Q1 Q2 P1 P2 2 2 When demand curves intersect the flatter curve is more elastic Elasticity is not the same thing as slope Perfectly inelastic demand Where the quantity demanded is completely unresponsive to price and the price elasticity of demand equals zero Demand curve is a vertical line Perfectly elastic demand Where the quantity demanded is infinitely responsive to price and the price elasticity of demand equals infinity Perfectly elastic demand curves are rare Horizontal line Determinants of Price elasticity of Demand Availability of close substitutes o How consumers react to a change in the price of a product depends on what alternatives they have o If a product has more substitutes available it will have more elastic o If a product has fewer substitutes available it will have less elastic o The more time that passes the more elastic the demand for a product demand demand Passage of time becomes Luxuries versus necessities o Goods that are luxuries usually have more elastic demand curves than goods that are necessities o The demand curve for a luxury is more elastic than the demand curve for a necessity Definition of the market available be o In a narrowly defined market consumers have more substitutes o The more narrowly we define a market the more elastic demand will Share of the good in the consumer s budget o Goods that take only a small fraction of consumer s budget tend to have less elastic demand than goods that take a large fraction o The demand for a good will be more elastic the larger the share of the good in the average consumer s budget Total revenue the total amount of funds received by a seller of a good or service calculated by multiplying price per unit by the number of units sold A firm is interested in price elasticity because it allows the firm to calculate how changes in price will affect its total revenue When demand is inelastic o Price and total revenue move in the same direction When demand is elastic o Price and total revenue move inversely Cross price elasticity Percentage change in quantity demanded of one good Of demand Percentage change in price of another good Income elasticity of demand Percentage change in quantity demanded Percentage change in income Productivity measures the ability of firms to produce goods and services with a given amount of economic inputs Price elasticity of supply Percentage change in quantity supplied Percentage change in price If the price elasticity of supply is less than 1 then the supply is inelastic If the price elasticity of supply is greater than 1 then supply is elastic If the price elasticity of supply is equal to 1 the supply is unit elastic If a supply curve is a vertical line it is perfectly inelastic If a supply curve is a horizontal line it is perfectly elastic If a supply curve is perfectly elastic a very small increase in price causes a very large increase in quantity supplied