Chapter 05 Elasticity and Its Application

Flashcards about Elasticity and Its Application based on lecture notes.

Elasticity

Measures how much the quantity demanded or supplied of a good changes when one of its determinants changes.

Elasticity

A measure of responsiveness of quantity demanded or quantity supplied to a change in its determinants.

Price Elasticity of Demand

Measures how much the quantity demanded of a good responds to a change in the price of that good.

Price Elasticity of Demand Formula

Percentage change in quantity demanded divided by the percentage change in price.

Elastic Demand

Quantity demanded responds substantially to changes in price.

Inelastic Demand

Quantity demanded responds only slightly to changes in price.

Availability of Close Substitutes

Goods with close substitutes tend to have more elastic demand.

Necessities vs. Luxuries

Necessities tend to have inelastic demand, while luxuries have elastic demand.

Definition of the Market

Narrowly defined markets tend to have more elastic demand than broadly defined markets.

Time Horizon

Demand tends to be more elastic over longer time horizons.

Price Elasticity of Demand Formula

Formula: $\text{Price elasticity of demand} = \frac{\text{Percentage change in quantity demanded}}{\text{Percentage change in price}}$

Absolute Value

Use the absolute value (drop the minus sign) for the price elasticity of demand.

Midpoint Method

$\text{Price elasticity of demand} = \frac{(Q2 - Q1)/[(Q1 + Q2)/2]} {(P2 - P1)/[(P1 + P2)/2]}$

Elastic Demand

Price elasticity of demand > 1

Inelastic Demand

Price elasticity of demand < 1

Unit Elasticity

Price elasticity of demand = 1

Perfectly Inelastic Demand

Price elasticity of demand = 0. Demand curve is vertical.

Perfectly Elastic Demand

Price elasticity of demand = infinity. Demand curve is horizontal.

Flatter Demand Curve

Indicates a greater price elasticity of demand.

Total Revenue (TR)

Amount paid by buyers and received by sellers.

Total Revenue (TR)

Amount paid by buyers and received by sellers. $TR = P \times Q$

Price Increase and Inelastic Demand

If demand is inelastic, a price increase leads to an increase in total revenue.

Price Increase and Elastic Demand

If demand is elastic, a price increase leads to a decrease in total revenue.

Inelastic Demand (Elasticity < 1)

Price and total revenue move in the same direction.

Elastic Demand (Elasticity > 1)

Price and total revenue move in opposite directions.

Unit Elastic Demand (Elasticity = 1)

Total revenue remains constant when the price changes.

Income Elasticity of Demand

Measures how much the quantity demanded of a good responds to a change in consumers' income.

Income Elasticity of Demand Formula

Percentage change in quantity demanded divided by the percentage change in income.

Normal Goods

Positive income elasticity.

Necessities

Smaller income elasticities.

Luxuries

Large income elasticities.

Inferior Goods

Negative income elasticities.

Cross-Price Elasticity of Demand

Measures how the quantity demanded of one good responds to a change in the price of another good.

Cross-Price Elasticity of Demand Formula

Percentage change in quantity demanded of the first good divided by the percentage change in price of the second good.

Substitutes

Goods typically used in place of one another. Positive cross-price elasticity.

Complements

Goods that are typically used together. Negative cross-price elasticity.

Price Elasticity of Supply

How much the quantity supplied of a good responds to a change in the price of that good.

Price Elasticity of Supply Formula

Percentage change in quantity supplied divided by the percentage change in price.

Elastic Supply

Quantity supplied responds substantially to changes in the price.

Inelastic Supply

Quantity supplied responds only slightly to changes in the price.

Time Period

Supply is more elastic in the long run.

Price Elasticity of Supply Formula

$\text{Price elasticity of supply} = \frac{\text{Percentage change in quantity supplied}}{\text{Percentage change in price}}$

Always Positive

Price elasticity of supply is always positive.

Midpoint Method

$\text{Price elasticity of supply} = \frac{(Q2 - Q1)/[(Q 1 + Q2)/2]}{(P2 - P1)/[(P1 + P2)/2]}$

Unit Elastic Supply

Price elasticity of supply = 1

Elastic Supply

Price elasticity of supply > 1

Inelastic Supply

Price elasticity of supply < 1

Perfectly Inelastic Supply

Price elasticity of supply = 0. Supply curve is vertical.

Perfectly Elastic Supply

Price elasticity of supply = infinity. Supply curve is horizontal.

Low Price and Low Quantity

Elastic supply, capacity for production not being fully used.

High Price and High Quantity

Inelastic supply.

Good News for Farming

New hybrid wheat increases production by 20%. Supply curve shifts to the right. Higher quantity and lower price. If demand is inelastic, total revenue falls, potentially harming farmers.

OPEC and Oil Prices

Short-run: Supply and demand are inelastic, so a decrease in supply leads to a large increase in price. Long-run: Supply and demand are elastic, so a decrease in supply leads to a smaller increase in price.

Drug Interdiction

Supply curve shifts left, leading to a higher price and lower quantity. If demand is inelastic, higher drug prices lead to higher total revenue for drug dealers, potentially increasing drug-related crime.

Supply Shift

Supply curve shifts to the right.

Inelastic Demand

Demand for wheat is generally inelastic.

Short-Run Inelasticity

In the short run, both supply and demand for oil are relatively inelastic.

Long-Run Elasticity

In the long run, both supply and demand become more elastic.

Drug Interdiction

Supply curve shifts left, leading to higher prices and lower quantities.

Drug Education

Demand curve shifts left, leading to lower prices and quantities.