Chapter 4 P 20 50 19 50 Price elasticity of demand a units free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buying plans remain the same Price elasticity of demand percentage change in quantity demanded We must know the quantity demanded of pizza at two different prices Percentage change in price Change in price a percentage of the average price Change in quantity demanded a percentage of the average quantity Price Price Average price 100 Quantity Quantity Average Quantity 100 Price of elasticity of demand Q P D Q 9 11 Quantity increase from 9 to 11 11 9 10 100 1 20 100 4 11 9 change in quantity 10 average quantity 1 change in price 20 average price Elasticity is a units free measure because the percentage change in each variable is independent of the units in which the variable is measured When the price of a good rises the quantity demanded decreases A positive change in price brings a negative change in the quantity demanded the price elasticity of demand is a negative number but it is the absolute value of the number Perfectly inelastic demand if the quantity demanded remains constant when the price changes then the price elasticity of demand is zero Quantity never changes vertical line Ex Insulin no matter what the price the quantity diabetics buy remains the same Unit elastic demand if the percentage change in the quantity demanded equals the percentage change in the price Q P then price elasticity equals 1 Inelastic demand the price elasticity of demand is between zero and 1 relatively steep line Ex Food and shelter Perfectly elastic demand if the quantity demanded changes by an infinitely large percentage in response to a tiny price change then the price elasticity of demand is infinity horizontal line Ex Two soda machines with the same price goods that have perfect substitutes Elastic demand the percentage change in the quantity demanded exceeds the percentage change in price The price elasticity of demand is greater than 1 Relatively flat line Ex Automobiles and furniture A linear demand curve has a constant slope but a varying elasticity Elasticity is NOT a slope Demand is unit elastic at the midpoint elastic above the midpoint and inelastic below midpoint Total revenue the price of the good multiplied by the quantity sold Changed when prices change If demand is elastic a 10 price cut increases the quantity sold by more than 10 and total revenue increases If demand is inelastic a 10 price cut increases the quantity sold by less than 10 and total revenue decreases If demand is unit elastic a 10 price cut increases the quantity sold by 10 and total revenue does not change A price cut in the elastic range brings an increase in total revenue the percentage increase in the quantity demanded is greater than the percentage decrease in price A price cut in the inelastic range brings a decrease in total revenue the percentage increase in the quantity demanded is less than the percentage decrease in price At unit elasticity total revenue is at a maximum Total revenue test a method of estimating the price elasticity of demand by observing the change in total revenue that results from a change in the price when all other influences on the quantity sold remain the same If a price cut increases total revenue demand is elastic If a price cut decreases total revenue demand is inelastic If a price cut leaves total revenue unchanged demand is unit elastic When a price changes the change in your spending on the good depends on your elasticity of demand If demand is elastic a 1 price cut increases the quantity you buy by more than 1 and your spending on that item increases If your demand is inelastic a 1 price cut increases the quantity you buy by less than 1 and your spending on that item decreases If your demand is unit elastic a 1 price cut increases the quantity you buy by 1 and your spending on the item does not change If you spend more on an item when its price falls your demand is elastic If you spend the same amount when its price falls your demand is unit elastic If you spend less on an item when its price falls your demand is inelastic The elasticity of demand for a good depends on The closeness of substitutes o The closer the substitutes the more elastic is the demand for it Ex Oil does not have any substitutes so it is inelastic Necessities food have poor substitutes inelastic Luxuries are elastic The proportion of income spent on the good o Other things remaining the same the greater the proportion of income spent on a good the more elastic is the demand for it o Gum inelastic vs housing elastic If gum price doubles you continue buying it If rent doubles you look for ways to lower it more roommates etc Rent takes up a higher amount of budget than gum The time elapsed since the price change o The longer the time that has elapsed since a price change the more elastic the demand o Demand for oil became more elastic as more time elapsed following the price increase Cross elasticity of demand a measure of the responsiveness of the demand for a good to a change in the price of a substitute or complement other things remaining the same Cross elasticity of demand in quantity demanded in price of substitute or complement Q Qave Price of s or c Pave s or c Cross elasticity of demand is positive for a substitute and negative for complement If two items are close substitutes burgers and hotdogs the cross elasticity is large If two items are close complements movies and popcorn the cross elasticity is large Income elasticity of demand a measure of the responsiveness of the demand for a good or service to a change in income other things remaining the same Income elasticity of demand in quantity demanded in income Greater than 1 normal good income elastic Positive and less than 1 normal good income inelastic Negative inferior good Income elastic demand the of income spent on that good increases as income increases ex luxury items Income inelastic demand the of income spent on that good decreases as income increases ex necessities food shelter Inferior goods quantity demanded of an inferior good and the amount spent on it decrease when income increases Ex small motorcycles potatoes mostly low income consumers buy these Elasticity of supply measures the responsiveness of the quantity supplied to a change in the price of a good when all other influences on selling plans remain the same Elasticity of supply quantity