Microconomics - Chapter 6: Elasticity: The Responsiveness of Demand and Supply

Elasticity

A measure of how much one economic variable responds to changes in another economic variable. (based on percentage changes in the variables)

formula for price elasticity of demand

% change in quantity demanded / % change in price

True or False: price elasticity of demand is a negative number

True

we say demand is elastic if its price elasticity of demand is _________ (in absolute value) than 1.

larger/greater

we say demand is inelastic if its price elasticity of demand is _________ (in absolute value) than 1.

smaller/less

we say demand is unit-elastic if its price elasticity of demand is _________ (in absolute value) to 1.

equal

midpoint formula for percentage changes (avoids the confusion of whether we are going from A to B or from B to A)

percentage change = (A-B)/(A+B/2)x100

Price elasticity of demand becomes:

Price elasticity of demand = [(Q2-Q1)/(Q1+Q2/2)]/[(p2-p1)/(p1+p2/2)]

-This first term is the percentage change in quantity, using the midpoint formula.

-The second term is the percentage change in price, using the midpoint formula.

steps to finding price elasticity of demand

1) find avg Q & p (A+B/2)

2) then find the percentage change in Q & p (A-B)/(what you found in step 1) x 100 {since its a percentage}

3) then divide (Percentage change in quantity demanded)/(Percentage change in price) which gives you the Price elasticity of demand

remember to look at answer in abs value (positive)

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 elasticity of demand equals infinity

unit elastic demand

demand is unit elastic when 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

Total Revenue (TR)

The total amount of funds a seller receives from selling a good or service, calculated by price x quantity.

If demand is elastic then an increase in price _________ revenue

reduces

If demand is elastic then an decrease in price _________ revenue

increases

If demand is inelastic then an increase in price _________ revenue

increases

If demand is inelastic then an decrease in price _________ revenue

reduces/decreases

If demand is unit then an increase/decrease in price _____ ___ ______ revenue

does not affect

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

It measures the strength of substitute or complement relationships between goods.

If the products are substitutes then the cross price elasticity of demand will be

positive

ex: two brands of smartphones

If the products are compliments then the cross price elasticity of demand will be

negative

ex: iphones and apps downloaded from stores

If the products are unrelated then the cross price elasticity of demand will be

zero

ex: iphones and peanut butter

income elasticity of demand

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

if the income elasticity of demand is positive but less than 1 then the good is

normal and a necessity

ex: bread

if the income elasticity of demand is positve but greater than 1 then the good is

normal and a luxury

ex: caviar

if the income elasticity of demand is negative then the good is

inferior

ex: high-fat meat

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 product's price

its similar to price elasticity of demand so the same sort of calculation methods apply (midpoint formula, etc.)

If supply is elastic then the value of price elasticity is _______ than 1

greater

If supply is inelastic then the value of price elasticity is _______ than 1

less

If supply is unit elastic then the value of price elasticity is _______ to 1

equal

If supply is perfectly elastic then the value of price elasticity is

equal to infinity

If supply is perfectly inelastic then the value of price elasticity is

equal to 0

True or False: Price increases more when supply is inelastic

True

Price elasticity of demand is a

measure of the responsiveness of quantity demanded to a change in price

The key determinants of the price elasticity of demand for a good are

the availability of close substitutes, the passage of time, weather the good is luxury or a necessity, the definition of the market, and the share of the good in the consumer’s budget