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Ch. 4: Elasticity. Define, calculate, and explain the factors that influence the price elasticity of demand the cross elasticity of demand the income elasticity of demand the elasticity of supply. Price Elasticity of Demand.

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ch 4 elasticity
Ch. 4: Elasticity.

Define, calculate, and explain the factors that influence

  • the price elasticity of demand
  • the cross elasticity of demand
  • the income elasticity of demand
  • the elasticity of supply
price elasticity of demand
Price Elasticity of Demand
  • The slope of the demand curve affects how much equilibrium price and quantity change for a given change in supply.
price elasticity of demand1
Price Elasticity of Demand
  • Price elasticity of demand
    • units-free measure of the responsiveness of the quantity demanded of a good to a change in its price, ceteris paribus.
price elasticity of demand2
Price Elasticity of Demand

%DQ = DQ/Qavg

= 2/10

= .2

%DP = DP/Pavg

= -$1/$20

= -.05

e = .2/.05 =4

price elasticity of demand3
Price Elasticity of Demand
  • By using the average price and average quantity, we get the same elasticity value regardless of whether the price rises or falls.
  • Measuring as % changes leaves the elasticity value the same (“units free”).
  • Although the formula yields a negative value for elasticity because price and quantity move in opposite directions, we report the absolute value.
price elasticity of demand4
Price Elasticity of Demand
  • Inelastic and Elastic Demand
  • if e>1: elastic
  • if e=1: unit elastic
  • if e<1: inelastic
  • Shape of
    • Perfectly inelastic demand curve (e=0)
    • Perfectly elastic demand curve (e= infinite)
price elasticity of demand5
Price Elasticity of Demand

At prices above the mid-point of the demand curve, demand is elastic.

At prices below the mid-point of the demand curve, demand is inelastic.

price elasticity of demand6
Price Elasticity of Demand
  • Total Revenue and Elasticity
    • TR=P*QD
    • When P changes, TR could rise or fall because QD moves in opposite direction.
    • But a higher price doesn’t always increase total revenue.
price elasticity of demand7
Price Elasticity of Demand
  • %D TR = % D P + % D Q

= % D P - % D P(e)

= % D P(1-e)

  • If demand is elastic (e>1),

P increase  TR decreases

P decrease  TR increases

  • If demand is inelastic (e<1),

P increase  TR increases

P decrease  TR decreases

  • If demand is unitary elastic,

P increase or decrease  TR unchanged.

price elasticity of demand8
Price Elasticity of Demand
  • As P falls from $25 to $12.50, D is elastic, and TR rises.
  • At $12.50, D is unit elastic and TR stops increasing.
  • As P falls from $12.50 to 0, D is inelastic, and TR decreases.
price elasticity of demand10
Price Elasticity of Demand
  • The elasticity of demand for a good depends on:
      • The number & closeness of substitutes
      • The proportion of income spent on the good
      • The time elapsed since a price change
more elasticities of demand
More Elasticities of Demand
  • Cross Elasticity of Demand
    • measures responsiveness of demand for a good to a change in the price of another good.

exy= %D quantity demanded for x

%D change in price of y

    • exy > 0  substitutes
    • exy <0  complements
more elasticities of demand1
More Elasticities of Demand
  • Income Elasticity of Demand
    • measures how the quantity demanded of a good responds to a change in income, ceteris paribus. eI = %D in quantity demanded

% D in income

    • eI >0  normal good
    • eI >1 luxury good
    • eI <0 inferior good
price elasticity of supply
Price Elasticity of Supply

A change in demand causes

  • A larger change in equilibrium price if supply is supply is steeper,
  • A smaller change in equilibrium quantity if supply is steeper.
elasticity of supply
Elasticity of Supply

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 supply2
Elasticity of Supply
  • Factors That Influence the Elasticity of Supply
    • Elasticity of supply for inputs
    • Substitution possibilities for inputs
    • The time frame for supply decisions
    • Storage costs
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