Microeconomics- Chapter 6

Elasticity

Elasticity

A measure of how much one economic variable responds to changes in another economic variable.

Price elasticity of demand

The responsiveness of the quantity demanded to a change in price, measured by dividing the percentage change in the quantity demanded of a product by the change in the products’ price.

Elastic demand

the case where the percentage change in quantity demanded is greater than the percentage change in price, so the price elasticity is greater than 1 in absolute value.

Inelastic demand

The case where the percentage change in quantity demanded is less than the percentage change in price, so the elasticity is less than 1 in absolute value.

Unit-elastic demand

The case where the percentage change in quantity demanded is equal to the percentage change in price, so the price elasticity is equal to 1 in absolute value.

Price Elasticity of demand =

Percentage change in quantity demanded / percentage change in price

Midpoint formula

We use the midpoint formula when we only have one value of the price elasticity of demand between the same two points on a demand curve. The midpoint formula used the averages of the initial and final quantities and the initial and final prices.

Price elasticity of demand = [(Q2-Q1)/average of Q1 and Q2] / [(P2-P1) / average of P1 and P2]

Perfectly inelastic demand

The case where the quantity demanded is completely unresponsive to price and the price elasticity of demand equals zero

perfectly elastic demand

The case where the quantity demanded is infinitely responsive to price and the price of elasticity of demand equals infinity.

Determinants of the Price Elasticity of Demand

1. Availability of close substitutes

2. Passage of Time

3. Luxuries versus Necessities

4. Definition of the Market

5. Share of a Good in a Consumer’s Budget

Total Revenue

The total amount of funds a seller receives from selling a good or service, calculated by multiplying price per unit by the number of units sold.

Id demand is elastic then an increase in price reduces revenue

because the decrease in quantity demanded is proportionality greater than the increase in price

Id the demand is elastic than an increase in price increase revenue

the increase in quantity demanded is proportionally greater than the decrease in price

If demand is inelastic than an increase in price increases revenue

the decrease in quantity demanded is proportionally smaller than the increase in price

If demand is inelastic then a decrease in price reduces revenue

because the increase in quantity demanded is proportionally smaller than the decrease in price

If demand is unit elastic than an increase in price does not affect revenue

because the decrease in quantity demanded is proportionally the same as the increase in price

If demand is unit elastic then a decrease in price does not affect revenue

because the increase in quantity demanded is proportionally the same as the decrease in price

Cross-price elasticity of demand

The percentage change in the quantity demanded of one good divided by the percentage change in the price of another good.

Cross-Price elasticity of demand =

Percentage change in quantity demanded of one good / Percentage change in price of another good

With Cross-price elasticity of demand an increase in price of a substitute will

lead to an increase in the quantity demanded, so the cross-price elasticity will be posisitive

With cross-price elasticity of demand an increase in of an complement will

lead to a decrease in the quantity demanded, so the cross-price elasticity of demand will be negative

If the products are substitutes

then the cross-price elasticity of demand will be positive

IF the products are complements

then the cross-price elasticity of demand will be negative

If the products are unrelated

then the cross-price elasticity of demand will be zero

IF the income elasticity of demand is positive but less than 1

then the good is normal and a necessity

IF the income elasticity of demand is

then the good is normal and a luxury

IF the income elasticity of demand is negative

then the good is inferior

income elasticity of demand

A measure of the responsiveness of the quantity demanded to change in income, measured by the percentage change in the quantity demanded divided by the percentage change in income

Income elasticity of demand =

Percentage change in quantity demanded / percentage change in income

Price elasticity of supply

The responsiveness of the quantity supplied to a change in price, measured by dividing the percentage change in the quantity supplied of a product by the percentage change in the products’ price