Ch. 6 Econ

Ed = 0 demand is perfectly inelastic

- Perfectly inelastic demand means that consumers will buy exactly the same amount no matter how high or low the price.

total revenue test with inelastic demand

- A lower price and inelastic demand means that total revenue will fall. - Blue gain (extra total revenue from extra sales) is less than the yellow loss (the loss in total revenue from the higher price).

total revenue test with unit-elastic demand

- A lower price and unit-elastic demand means that total revenue is unchanged. - Blue gain (extra total revenue from extra sales) is exactly equal to the yellow loss (the loss in total revenue from the higher price).

midpoint formula

- The midpoint formula calculates the average elasticity over a range of prices to avoid that problem. - change in quantity/sum of quantities/2 divided by change in price/sum of prices/2

elastic demand

- there is a large change in quantity demanded even when price changes by a small amount. - Sensitive to price changes

inelastic demand

- there is a very small change in quantity demanded even when there is a large change in price. - Insensitive to price changes

total revenue test with elastic demand

- A lower price and elastic demand means that total revenue will rise. - Blue gain (extra total revenue from extra sales) exceeds yellow loss (the loss in total revenue from the higher price).

applications of elasticity of supply

- Antiques and other non-reproducible commodities have an inelastic supply, for one-of-a-kind antiques, the supply is perfectly inelastic. - This makes their prices highly susceptible to fluctuations in demand. - The more inelastic the supply, the greater the change in price when demand changes. - Reproductions, on the other hand, have a much more elastic supply so the prices tend to remain lower even when there is an increase in demand. - Gold prices are volatile because the supply of gold is highly inelastic, and unstable demand from speculation causes prices to fluctuate significantly.

interpretation of elasticity of demand

- Ed > 1 demand is elastic - Ed = 1 demand is unit elastic - Ed < 1 demand is inelastic Extreme cases - Ed = 0 demand is perfectly inelastic - Ed = ∞ demand is perfectly elastic

Decriminalization of illegal drugs

- If heroin and cocaine were legalized, their prices would decline according to proponents of legalization. - Demand for illegal drugs like this are inelastic for a drug addict so if the price dropped, the amount consumed at that lower price wouldn't change by much. - Crime would subsequently decline since the addicts wouldn't need to steal as much to support their habit. - Opponents of legalization say that lower prices for these drugs would simply increase the quantity demanded for them and not benefit society at all.

the long run

- In the long run there is enough time to adjust output by increasing or decreasing all inputs since all inputs are variable by this time. - This means that supply will be even more elastic and with the same increase in demand, there is an even greater increase in the quantity than in the short run. - in the long run all inputs are variable, even the size of the firm; the firm can expand (reduce) the size of the firm in regard to long run price increases (decreases).

the short run

- In the short run there is enough time to adjust output by increasing or decreasing the variable inputs but not the fixed inputs. - Therefore, supply is more elastic in the short run than in the immediate market period, thereby resulting in a somewhat greater increase in quantity.

income elasticity insights

- Income elasticity helps us understand which products and industries will be most affected when household incomes fall during economic downturns. - High income elasticities Most affected by a recession - Low or negative income elasticity Not affected that much by a recession

time

- It takes time to alter the amount being purchased, so the more time available, the more elastic the demand. - A person doing his/her Christmas shopping on Christmas Eve has a very inelastic demand because he/she doesn't have the time to look around for alternative purchases.

applications of price elasticity of demand

- Large crop yields Inelastic demand, lower total revenue - Excise taxes Inelastic demand, more total revenue - Decriminalization of illegal drugs Inelastic demand, more total revenue

large crop yields

- Large crop yields mean that the supply of crops increases and shifts to the right. - When this occurs the equilibrium price falls. - Since demand is inelastic, the lower price actually leads to lower revenue for farmers. - Farmers are worse off when there is a large crop yield.

Ed = ∞ demand is perfectly elastic

- Perfectly elastic demand means that nothing will be purchased if there is any deviation from the current price.

price elasticity of demand formula

- Quantitative measure of elasticity, Ed = percentage change in quantity/percentage change in price. - Percentages also make it possible to compare elasticity of demand for different products. - Because of the inverse relationship between price and quantity demanded, the actual elasticity of demand will be a negative number. - However, we ignore the minus sign and use absolute value. - This makes it less confusing to interpret the elasticity coefficient.

price elasticity of supply formula

- Quantitative measure of elasticity, Es = percentage change in quantity/ percentage change in price. - The concept of price elasticity also applies to supply. - We use percentages so it doesn't matter which unit of measure we are using. - The elasticity formula is the same as that for demand, but we substitute the word "supplied" for the word "demanded" everywhere in the formula. - Just like with price elasticity of demand, we will compute the price elasticity of supply using the midpoint formula. - Elasticity of supply will always be positive since price and quantity supplied move in the same direction. - Elasticity of supply depends on how easily producers can shift resources between alternative uses.

Luxuries versus necessities

- Since luxuries are goods that consumers can go without, they will change the amount they purchase by a greater amount even if the price changes by a small amount. necessities are inelastic luxuries are elastic

elasticity and pricing power

- Some firms have "market power" or "pricing power" that allows them to set their product at prices that are in their best interests. - For some goods and services, firms may find it advantageous to determine differences in price elasticity of demand and then charge different prices to different buyers. - Business air travelers have a more inelastic demand for air travel, so they are charged higher prices since they will pay it. - Families are sensitive to prices, so firms will charge lower prices for children as a result of the more elastic demand. - Students from low income households are offered assistance with paying for college since they have a higher price elasticity of demand; students from higher income households will pay full price for their education unless they receive some type of merit based scholarship.

determinants of price elasticity of demand

- Substitutability - proportion of income - Luxuries versus necessities - time

price elasticity of supply and time

- The ease of shifting resources between alternative uses is very important in price elasticity of supply because it will determine how much flexibility a producer has to adjust his/her output to a change in the price. - The degree of flexibility, and therefore the time period, will be different in different industries. - The immediate market period. - The short run - The long run

proportion of income

- The greater the proportion of income needed to buy the good the more elastic the demand. - Consumers will be more sensitive to changes in prices because the price change can result in thousands of dollars difference. - durable goods are elastic - non durable goods are inelastic

the immediate market period

- There is no time for sellers to adjust to a price change, making supply perfectly inelastic. - With a perfectly inelastic supply, the increase in demand does not change the quantity demanded at all. - Some industries may not have an immediate market period if they are able to store their product.

extreme cases

- This extreme situation is called perfectly inelastic demand and it is very rare. - The demand curve would be vertical and graphs as a line parallel to the vertical axis. - The elasticity coefficient is 0. An example of a perfectly inelastic demand might be a diabetic's demand for insulin. - This extreme situation, in which a small price reduction would cause buyers to increase their purchases from zero to all that is possible to obtain, is perfectly elastic demand, and the demand curve would be horizontal. - The elasticity coefficient is infinite. An example of a perfectly elastic demand is a firm's demand curve in a purely competitive industry, such as the mining industry, that is unable to change the price.

total revenue test concluded

- This graph shows the relationship between price elasticity of demand for movie tickets and total revenue. - Demand curve D in the top graph is based on Table 6.1 and is marked to show that the hypothetical weekly demand for movie tickets is elastic at higher price ranges and inelastic at lower price ranges. - The total-revenue curve, TR, in the lower graph is derived from demand curve D. - When price falls and TR increases, demand is elastic; when price falls and TR is unchanged, demand is unit elastic; and when price falls and TR declines, demand is inelastic. - You can see from the graph that elasticity changes along a demand curve. - Demand tends to be more elastic in the upper-left portion of demand and more inelastic in the lower-right portion of demand.

excise taxes

- When government wants to impose taxes on goods, it is important for them to understand the elasticity of demand for the good. - If they place a tax on a good with an inelastic demand, the higher price won't decrease the quantity purchased by much, thereby increasing the amount of tax revenue that government collects.

Ed = 1 demand is unit elastic

- When the elasticity coefficient equals 1, this is a special case called unit elasticity. - This means that the percentage change in price and the percentage change in quantity are exactly equal

Ed > 1 demand is elastic

- When the elasticity coefficient is greater than 1, it means that the percentage change in quantity demanded is greater than the percentage change in price (based on the formula), indicating that consumers are sensitive to the change in price, so demand is elastic.

Ed < 1 demand is inelastic

- When the elasticity coefficient is less than 1, the percentage change in quantity demanded is less than the percentage change in price (based on the formula), indicating that consumers are not very sensitive to price changes.

substitutability

- With more substitutes available, consumers have more alternative options, so when there is a change in price, there is a greater percentage change in quantity demanded, making the demand more elastic. - The broader the definition of the market, the more elastic the demand. - With a more narrow definition of the market, demand is more inelastic.

price elasticity of demand

- definition: Measures buyers' responsiveness to price changes - The law of demand tells us that consumers will respond to a price decrease by buying more of a product (other things remaining constant), but it does not tell us how much more.

price elasticity of supply

- definition: Measures sellers' responsiveness to price changes - At higher prices firms are willing and able to produce more, whereas at lower prices, firms are willing and able to produce less. - If supply is elastic, small changes in price will result in firms greatly altering the quantity being produced. - On the other hand, when supply is inelastic, the firm is unresponsive to price changes and therefore will not change the amount being produced by much, even when the change in price is large.

cross elasticity of demand

- percentage change in Qdx/percentage change in Py - Cross elasticity of demand refers to the effect of a change in a product's price on the quantity demanded for another product. - If the goods are substitutes, they will have a positive cross elasticity of demand since the change in the price of one good and the change in the demand for its substitute move in the same direction. - If the goods are complements, they will have a negative cross elasticity of demand since the change in the price of one good and the demand for its complement move in opposite directions. - If the goods are unrelated they will show a cross elasticity of zero (independent good) - Companies can use cross-price elasticity to determine whether raising the price of one of their products will affect sales of another of their products. - Government can use it to determine whether to allow a proposed merger of two companies or not. - If there is a high cross-price elasticity between the two companies' products the government will likely not allow the merger.

income elasticity of demand

- percentage change in quantity demanded/ percentage change in income - Measures responsiveness of buyers to changes in their income - Most goods are normal goods that have a positive income elasticity but the value of elasticity of income can vary widely among these goods. - Consumers decrease their purchases of inferior goods when their income rises. - Those industries with products that are income elastic will expand at a higher rate as the economy grows.

total revenue test

- total revenue = price x quantity - The total-revenue test is the easiest way to judge whether demand is elastic or inelastic. - This test can be used in place of the elasticity formula, unless there is a need to determine the elasticity coefficient. - The total revenue test is important to understand the relationship between price elasticity and total revenue. - Demand is inelastic if a decrease in price results in a decrease in total revenue, or an increase in price results in a rise in total revenue. - Demand is elastic if a decrease in price results in a rise in total revenue, or if an increase in price results in a decline in total revenue. - Demand is unit elastic if total revenue does not change when the price changes.