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Elasticity

Elasticity. Price Elasticity of Demand. Ed= % Δ Qd/% Δ P Choice of units, comparing products Absolute value Ed> 1 = elastic Ed< 1= inelastic Ed=1 = unit elastic Slope does not measure elasticity Except in perfectly elastic/inelastic. Total Revenue Test.

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Elasticity

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  1. Elasticity

  2. Price Elasticity of Demand • Ed= %ΔQd/% ΔP • Choice of units, comparing products • Absolute value • Ed> 1 = elastic • Ed< 1= inelastic • Ed=1 = unit elastic • Slope does not measure elasticity • Except in perfectly elastic/inelastic

  3. Total Revenue Test • ΔP same direction change TR (QdxP)= inelastic • ΔP opposite direction change TR= elastic • ΔP no change TR= unit elastic

  4. Marginal Revenue • When marginal revenue is positive: elastic • MR = 0: unit elastic • MR negative: inelastic

  5. Determinants Elasticity • Substitutability • Proportion of income • Luxury/necessity • Time

  6. Examples • Water • Automation • Drugs and street crime • Minimum wage

  7. Price Elasticity of Supply • Es= % ΔQs/% ΔP • “Shiftability”: ability to shift resources to/from production in response price change

  8. Time • Immediate market period: unable change production perfectly inelastic • Short-run: “a period in which producers are able to change the quantity of some but not all of the resources they emply; a period in which some resources (usually plant) are fixed and some are variable” relatively elastic • Long-run: “a period of time long enough to enable producers of a produce to change the quantities of all the resources they employ; period in which all resources and costs are variable and no resources or costs are fixed” more elastic

  9. Cross-price elasticity of demand • Exy= % Δ QD product x/ % Δ P product y • Substitute goods: positive: c-p e • Complementary goods: negative c-p e • Independent goods: zero or near zero c-p e

  10. Income elasticity of demand • Ei= % Δ Qd/ % Δ income • Ei positive = Normal good • Ei negative = Inferior good • Insights: • 1) Relative expansion/contraction industries • 2) Health care costs

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