Price Elasticity of Demand Lecture Notes

Vocabulary practice flashcards covering price elasticity of demand, its calculation via the midpoint formula, extreme elasticity cases, determinants of elasticity, and revenue implications.

Competitive Market Equilibrium

A state where a specific price and quantity result in no market participant having an incentive to change their behavior, all produced goods are sold with none leftover, and consumers purchase exactly as much as they want at that price.

Price Elasticity of Demand ($\epsilon_d$)

A measure of the responsiveness of consumers' purchasing decisions to changes in price, formally defined as the percentage change in quantity demanded divided by the percentage change in price.

Substitution Effect

The economic mechanism causing quantity demanded to fall when price rises because consumers choose to purchase alternative goods instead.

Income Effect

The economic mechanism causing quantity demanded to fall when price rises because consumers' purchasing power is diminished and they cannot afford to buy as much.

Midpoint Formula

A mathematical technique that calculates percentage changes by dividing the difference in quantity and price by their respective averages (midpoints), ensuring that elasticity between two points remains identical regardless of the direction of change.

Elastic Demand

A market condition where the price elasticity of demand is greater than $1$ in absolute value (more negative than $-1$), characterized by a flatter demand curve where quantity demanded changes substantially in response to small price changes.

Inelastic Demand

A market condition where the price elasticity of demand is between $0$ and $-1$ (less than $1$ in absolute value), characterized by a steeper demand curve where consumers do not change their quantity purchased very much when price changes.

Perfectly Inelastic Demand

An extreme condition where price elasticity is zero, represented by a completely vertical demand curve, meaning consumers purchase the exact same quantity regardless of how high or low the price goes.

Perfectly Elastic Demand

An extreme condition where price elasticity is infinite (or negative infinity), represented by a completely horizontal demand curve, meaning consumers will cease purchasing the good entirely if the price increases by even one cent.

Availability of Close Substitutes

A determinant of elasticity stating that goods with numerous readily available alternatives have more elastic demand because consumers can easily switch away if the price rises.

Passage of Time (Determinant of Elasticity)

A determinant of elasticity establishing that demand tends to be more elastic over longer time horizons because consumers and businesses have greater opportunity to exit existing contracts and locate alternative goods or suppliers.

Definition of the Market

A determinant of elasticity dictating that narrowly defined goods have more elastic demand due to plentiful substitutes, whereas broadly defined markets have more inelastic demand because substitutes become far harder to find.

Share of Budget

A determinant of elasticity stating that goods comprising a large portion of a consumer's total budget have more elastic demand, while inexpensive goods comprising a tiny share have relatively inelastic demand.

Total Revenue

The overall money received from selling goods, calculated as price multiplied by quantity ($\text{Price} \times \text{Quantity}$) and visualized graphically as the area of a rectangle under the demand curve.

Price Effect vs. Quantity Effect

The trade-off in total revenue caused by a price change: higher prices increase revenue on units still sold (price effect) while reducing the total number of units sold (quantity effect), determining whether revenue rises or falls depending on elasticity.