Chapter 5: Elasticity and Its Applications

price elasticity of demand

how much the quantity demanded responds to a change in the price.

demand for a good is said to be elastic if

the quantity demanded responds substantially to price changes

demand is said to be inelastic if

the quantity only slightly responds to price changes

determinants of price elasticity of demand

(1) availability of close substitutes

(2) necessities and luxuries

(3) narrow or broad market

(4) time horizon

availability of close substitutes

if a good has availability of a close substitute, it’s price elasticity of demand will be elastic bc the demand will change a lot bc people will just go buy something else if the price goes up

if a good does not have availability of a close substitute, it’s price elasticity of demand will be inelastic because people can’t buy something else so they’ll just keep buying it

necessities and luxuries

necessity: price increase won’t diminish amount you purchase by a lot = inelastic

luxury: price increase will diminsih amount purchased by a lot = elastic

defining the market broadly or narrowly

broadly defined market = inelastic bc less substitutes

narrowly defined = elastic bc more substitutes

ex. food as a whole = inelastic but carrots = more elastic bc you could get another vegetable

time horizon

demand tends to be more elastic over longer periods of time bc people can make changes easier over time but sometimes it’s really difficult to do in the moment, there’s not enough time

long-term -= elastic

short-term = inelastic

midpoint method

**make sure to write down formula

if elasticity > 1, <1, or =1

>1 elastic

<1 inelastic

=1 unit elastic

rule of thumb for demand curve slope and elasticity (demand)

flatter demand = more elastic

steeper demand = more inelastic

**straight line up = perfectly inelastic

**straight line horizontal = perfectly elastic

total revenue

the amount paid by buyers and received by sellers of the good

P*Q

how does total revenue change as one moves along the demand curve?

depends on the price elasticity of demand:
if demand = inelastic, increase in price = increase in total revenue

if demand = elastic, increase in price = decrease in total revenue

if demand = unit elastic, total revenue remains constant when price increases/decreases

the slope of a linear demand curve is constant, does this mean the elasticity is also constant? why?

NO bc the slope is the ratio of changes in the two vairbales, while the elasticity is the ratio of percentage changes in them

**at points with a low price and high quantity, a linear demand curve is inelastic. at points with a high price and low quantity, a linear demand curve is elastic

**demand curve w/ constant elasticity is possible but RARE

**linear demand curves never have a constant elasticity

income elasticity of demand

measures how the quantity demanded changes as consumer income changes

income elasticity of demand equation

= % change in quant demanded / % change in income

income elasticity of inferior goods

negative income elasticity

**it’s positive for normal goods

cross-price elasticity of demand

how the quant demanded of one good responds to a change in the price of another

cross-price elasticity of demand equation

= % change in quantity demanded good #1 / % change good #2

**think about if it’s a substitute or complement and see what happens

price elasticity of supply

how much the quantity supplied responds to changes in the price

supply is said to be elastic if

quant supplied responds substantially to price changes

supply is said to be inelastic if

the quant supplied only changes a little when price changes

in most markets, is supply more elastic or inelastic in the long run?

more elastic in long run than short run

**SAME AS ELASTICITY OF DEMAND

price elasticity of supply equation

= % change in quant supplied / % change in price

shapes of supply curves and elasticity

perfectly inelastic = vertical

perfectly elastic = horizontal

**SAME AS DEMAND ELASTICITY