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GWU ECON 1011 - Chapter 6: Elasticity

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Chapter 6: ElasticityCutting the price of a good increases the quantity demanded and that raising the price reduces the quantity demandedElasticity: a measure of how much on economic variable responds to changes in another economic variablePrice elasticity of demand: the responsiveness of the quantity demanded to a change in pricePrice elasticity demand = Percentage change in quantity demandedPercentage 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 valuesElastic demand: when the percentage change in quantity demanded is greater than the percentage change in pricePrice elasticity is greater than 1 in absolute valueInelastic demand: when the percentage change in quantity demanded is less than the percentage change in pricePrice elasticity is less than 1 in absolute valueMidpoint formula:Price elasticity demand = (Q2 – Q1) / (P2 – P1)(Q1 +Q2) (P1 + P2) 2 2When demand curves intersect, the flatter curve is more elasticElasticity is not the same thing as slopePerfectly inelastic demand: Where the quantity demanded is completely unresponsive to price and the price elasticity of demand equals zeroDemand curve is a vertical linePerfectly elastic demand: Where the quantity demanded is infinitely responsive toprice and the price elasticity of demand equals infinityPerfectly elastic demand curves are rareHorizontal lineDeterminants of Price elasticity of Demand- Availability of close substituteso How consumers react to a change in the price of a product depends onwhat alternatives they haveo If a product has more substitutes available, it will have more elastic demando If a product has fewer substitutes available, it will have less elastic demand- Passage of timeo The more time that passes, the more elastic the demand for a product becomes- Luxuries versus necessitieso Goods that are luxuries usually have more elastic demand curves than goods that are necessitieso The demand curve for a luxury is more elastic than the demand curve for a necessity- Definition of the marketo In a narrowly defined market, consumers have more substitutes availableo The more narrowly we define a market, the more elastic demand will be- Share of the good in the consumer’s budgeto Goods that take only a small fraction of consumer’s budget tend to have less elastic demand than goods that take a large fractiono The demand for a good will be more elastic the larger the share of the good in the average consumer’s budgetTotal 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 inverselyCross-price elasticity = Percentage change in quantity demanded of one good Of demand Percentage change in price of another goodIncome elasticity of demand = Percentage change in quantity demanded Percentage change in incomeProductivity: measures the ability of firms to produce goods and services with a given amount of economic inputsPrice elasticity of supply = Percentage change in quantity suppliedPercentage change in priceIf the price elasticity of supply is less than 1, then the supply is inelasticIf the price elasticity of supply is greater than 1, then supply is elasticIf the price elasticity of supply is equal to 1, the supply is unit elasticIf a supply curve is a vertical line, it is perfectly inelasticIf 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


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