Chapter 5 Macroeconomics Elasticity and Its Application

midpoint method for the price elasticity of demand

(Q2-Q1)/[(Q2+Q1)/2] / (P2-P1)/[(P2+P1)/2]

what influences price elasticity of demand?

- Availability of Close Substitutes, - Necessities versus Luxuries, - Definition of the Market - Time Horizon

what has more elastic demand?

- Goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others. (ex: butter and margarine) - luxuries have elastic demands - Narrowly defined markets tend to have more elastic demand because it is easier to find close substitutes for narrowly defined goods. - Goods tend to have more elastic demand over longer time horizons.

what has more inelastic demand?

- Necessities tend to have inelastic demands - broad markets have more inelastic demands

Elasticity

- a measure of how much buyers and sellers respond to changes in market conditions. - a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants

how much a economics question be answered?

1. First, we examine whether the supply or demand curve shifts. 2. Second, we consider the direction in which the curve shifts. 3. Third, we use the supply-and-demand diagram to see how the market equilibrium changes.

inferior goods

Higher income lowers the quantity demanded., have negative elasticities

normal goods

Higher income raises the quantity demanded, most goods are these, have positive income elasticities

how to remember the difference between elastic and inelastic

Inelastic curves, such as in panel (a) of Figure 1, look like the letter I.

total revenue formula

P × Q, the price of the good times the quantity of the good sold. (found of a graph via area)

price elasticity of demand formula

PED = % change in quantity demands / percent change in price

what determines if the cost-price elasticity of demand is negative or positive?

Whether the cross-price elasticity is a positive or negative number depends on whether the two goods are substitutes or complements. substitute = positve elasticity, complements = negative elasticity

income elasticity of demand

a measure of how much the quantity demanded of a good responds to a change in consumers' income, computed as the percentage change in quantity demanded divided by the percentage change in income

price elasticity of demand

a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price

cost-price elasticity of demand

a measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change in price of the second good

price elasticity of supply

a measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price

how is the cost-price elasticity of demand calculated?

calculated as the percentage change in quantity demanded of good 1 divided by the percentage change in the price of good 2.

the slope is the ratio of

changes in two variables

at points with high price and low quantity the demand curve is

elastic

substitutes

goods that are typically used in place of one another, such as hamburgers and hot dogs. An increase in hot dog prices induces people to grill hamburgers instead. Because the price of hot dogs and the quantity of hamburgers demanded move in the same direction, the cross-price elasticity is positive.

complements

goods that are typically used together, such as computers and software. In this case, the cross-price elasticity is negative, indicating that an increase in the price of computers reduces the quantity of software demanded.

demand for a good is inelastic when

if the quantity demanded responds only slightly to changes in the price.

demand for a good is elastic when

if the quantity demanded responds substantially to changes in the price.

at points with low price and high quantity the demand curve is

inelastic

will a demand curve always have a constant elasticity?

it can but that is not always the case.

elasticity is the ratio of

percent changes in two variables

denominator of midpoint method for price elasticity of demand represents...

percentage change in price

numerator of midpoint method for price elasticity of demand represents...

percentage change in quantity

When demand is elastic (a price elasticity greater than 1),

price and total revenue move in opposite directions: If the price increases, total revenue decreases.

When demand is inelastic (a price elasticity less than 1)

price and total revenue move in the same direction: If the price increases, total revenue also increases.

slope

rise over run

the midpoint method

standard procedure for computing a percentage change

total revenue

the amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold

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

absolute value.

the common practice of dropping the minus sign and reporting all price elasticities of demand as positive numbers.

Demand is considered elastic when....

the elasticity is greater than 1 ~which means the quantity moves proportionately more than the price

Demand is considered inelastic when....

the elasticity is less than 1 - which means the quantity moves proportionately less than the price.

The flatter the demand curve that passes through a given point....

the greater the price elasticity of demand.

supply of a good is inelastic when

the quantity supplied responds only slightly to changes in the price.

supply of a good is elastic when

the quantity supplied responds substantially to changes in the price.

The steeper the demand curve that passes through a given point

the smaller the price elasticity of demand.

what is a key determinant of the price elasticity of supply?

the time period being considered. supply is more elastic in the long run than the short run. ex: Over short periods of time, firms cannot easily change the size of their factories to make more or less of a good. Thus, in the short run, the quantity supplied is not very responsive to the price. Over longer periods of time, firms can build new factories or close old ones. In addition, new firms can enter a market, and old firms can exit.

If demand is unit elastic (a price elasticity exactly equal to 1),

total revenue remains constant when the price changes.

unit elasticity

when the demand is exactly one, - the percentage change in quantity equals the percentage change in price

perfectly elastic (why does this occur?)

when the supply curve is horizontal (occurs as the price elasticity of supply approaches infinity and the supply curve becomes horizontal, meaning that very small changes in the price lead to very large changes in the quantity supplied.)

perfectly inelastic (why does this occur?)

when the supply curve is vertical (as the elasticity rises, the supply curve gets flatter, which shows that the quantity supplied responds more to changes in the price.)

can price elasticities of demand be negative?

yes because they demonstrate a decrease in demand (for the book all negative signs are dropped)