Econ 102: Elasticity

What are other demand elsaticities are there?

-Cross-Price Elasticity of Demand -Income Elasticity of Demand

When is a good a necessity?

A good is a necessity if the quantity demanded is not very responsive to changes in income so that a 10 percent increase in income results in less than a 10 percent increase in the quantity demanded.

Why is computing elasticities important?

Computing elasticities is important in economics because it allows us to measure how one variable changes in response to changes in another variable.

How does the passage of time affect elasticity?

It usually takes consumers some time to adjust their buying habits when prices change. -If the price of gasoline increases, it also takes a while for consumers to decide to begin taking public transportation, to buy more fuel-efficient cars, or to find new jobs closer to where they live. -The more time that passes, the more elastic the demand for a product becomes.

If supply is more inelastic, then...

Price will increase a lot with a small increase in quantity.

Is the price elsaticity the same as the slope?

The price elasticity of demand is not the same as the slope of the demand curve.

How can these firms tell whether their advertising campaigns have been effective?

One way is by seeing whether the cross-price elasticity of demand has changed. -In other words, the value of the cross-price elasticity of demand should have declined.

So the second bottom line is...

-Elastic-An increase in price reduces revenue because the decrease in quantity demanded is proportionally greater than the increase in price. -Elastic-A decrease in price increases revenue because the increase in quantity demanded is proportionally greater than the decrease in price. -Inelastic-An increase in price increases revenue because the decrease in quantity demanded is proportionally smaller than the increase in price. -Inelastic-A decrease in price reduces revenue because the increase in quantity demanded is proportionally smaller than the decrease in price. -Unit Elastic-An increase in price does not affect revenue because the decrease in quantity demanded is proportionally the same as the increase in price. -Unit Elastic-a decrease in price does not affect revenue because the increase in quantity demanded is proportionally the same as the decrease in price.

So the bottom line is...

-Elastic-Greater than 1. -Inelastic-Less than 1. -Unit Elastic-Equal to 1. -Perfectly Elastic-Equal to Infnity -Perfectly Inelastic-Equal to Zero

How do we measure the elasticity of supply?

-If the price elasticity of supply is less than 1, then supply is inelastic. -If the price elasticity of supply is greater than 1, then supply is elastic. -If the price elasticity of supply is equal to 1, the supply is unit elastic.

If the income elasticity of demand is . . .

-Positive but less than 1, then the good is normal and a necessicity. -Positive and greater than 1, then the good is normal and a luxury. -Negative, then he good is inferior.

What the key determinants of the price elasticity of demand?

-The availability of close substitutes for the good -The passage of time -Whether the good is a luxury or a necessity -The definition of the market -The share of the good in the consumer's budget

How can you tell which demand curve is more elastic/inelastic?

-The demand curve with the smaller slope (in absolute value)—the flatter demand curve—is more elastic. -The demand curve with the larger slope (in absolute value)—the steeper demand curve—is less elastic.

Why are goods that are luxuries usually have more elastic demand curves than goods that are necessities?

-The demand for milk is inelastic because milk is a necessity, and the quantity that people buy is not very dependent on its price. -Tickets to a concert are a luxury, so the demand for concert tickets is much more elastic than the demand for bread.

When is a good a luxury?

A good is a luxury if the quantity demanded is very responsive to changes in income so that a 10 percent increase in income results in more than a 10 percent increase in the quantity demanded. -Sellers of luxuries can expect particularly large increases during economic expanisions.

When is a good inferior?

A good is inferior if the quantity demanded falls when income increases. -During recessions, falling consumer income can cause firms to experience increases in demand for inferior goods.

What is 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.

What is a narrowly defined market?

Consumers have more substitutes available. -The more narrowly we define a market, the more elastic demand will be.

Why is cross-price elasticity of demand so important?

Cross-price elasticity of demand is important to firm managers because it allows them to measure whether products sold by other firms are close substitutes for their products.

Is elasticity constant at every point?

Elasticity is not constant at every point. -Basically, you have to make a chart with three columns titled orice, quantity, and total revenue. -Find the price and quantity demanded from the graph, and use them to calculate total revenue. -The graph is most elastic when revenue is increasing, then midpoint, then inelastic when revenue is decreasing. -Unite elastic is the midpoint, i.e. where total revenue is maximized at a specific price and quantity.

How does a consumer's budget affect elasticty of demand?

Goods that take only a small fraction of a consumer's budget tend to have less elastic demand than goods that take a large fraction. -Most people buy table salt infrequently and in relatively small quantities. The share of an average consumer's budget that is spent on salt is very low. -"Big-ticket items," such as houses, cars, and furniture, take up a larger share in the average consumer's budget. -The demand for a good will be more elastic the larger the share of the good in the average consumer's budget.

How do you know when the demand is elastic?

If the quantity demanded is very responsive to changes in price, the percentage change in quantity demanded will be greater than the percentage change in price, and the price elasticity of demand will be greater than 1 in absolute value. -When the quantity demanded is not very responsive to price, however, the percentage change in quantity demanded will be less than the percentage change in price, and the price elasticity of demand will be less than 1 in absolute value, therefore its inelastic.

How do normal goods fit into income elasticity?

If the quantity demanded of a good increases as income increases, the good is a normal good. -Normal goods are often further subdivided into luxuries and necessities. -Because most goods are normal goods, during periods of economic expansion when consumer income is rising, most firms can expect—holding other factors constant—that the quantity demanded of their products will increase.

If a firm wants to increase its revenue, should it raise or lower prices?

It depends on the price elasticity of demand.

What is percentage change of the elasticity of demand?

It is used to measure the elasticity of demand. -Percentage changes are not dependent on units of measurement. -The price elasticity of demand is measured by dividing the percentage change in the quantity demanded by the percentage change in the product's price. -If we calculate the price elasticity of demand for a price cut, the percentage change in price will be negative, and the percentage change in quantity demanded will be positive. -Similarly, if we calculate the price elasticity of demand for a price increase, the percentage change in price will be positive, and the percentage change in quantity demanded will be negative. Therefore, the price elasticity of demand is always negative. -In comparing elasticities, though, we are usually interested in their relative size. So, we often drop the minus sign and compare their absolute values.

What happens when the supply curve is perfectly elastic?

It would be a horizontal line. -The quantity supplied is infinitely responsive to price, and the price elasticity of supply equals infinity. -If a supply curve is perfectly elastic, a very small increase in price causes a very large increase in the quantity supplied.

What happens when the supply curve is perfectly inelastic?

It would be a vertical line. -In this case, the quantity supplied is completely unresponsive to price, and the price elasticity of supply equals zero.

If supply is more elastic, then...

Quantity will increase alot with a small increase in price.

What is the most important determinant of the price elasticity of demand?

Substitutes -when the price of gasoline rises, consumers have few alternatives, so the quantity demanded falls only a little. But if the price of pizza rises, consumers have many alternative foods they can eat, so the quantity demanded is likely to fall substantially. -if a product has more substitutes available, it will have a more elastic demand. If a product has fewer substitutes available, it will have a less elastic demand.

What is unit elastic?

The case where 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.

What happend when a demand curve is a vertical line?

The case where the quantity demanded is completely unresponsive to price and the price elasticity of demand equals zero, it is perfectly inelastic. -The quantity demanded is completely unresponsive to price. -No matter how much price may increase or decrease, the quantity remains the same. -Insulin is an example because diabetics need it to live.

What happens when the demand curve is horizontal?

The case where the quantity demanded is infinitely responsive to price and the price elasticity of demand equals infinity, it is perfectly elastic. -If a demand curve is perfectly elastic, an increase in price causes the quantity demanded to fall to zero. -They are extremely

Why wouldn't we want to measure the price elasticity of demand using the slope of the demand curve?

The measurement of slope is sensitive to the units chosen for quantity and price. -If we measure price in cents, rather than in dollars, the slope is −0.1/100=−0.001. -If we measure price in dollars and bottles in thousands, instead of millions, the slope is −100/1=−100. -If we measure price in cents and bottles in thousands, the slope is −100/100=−1.

What is the midpoint formula?

The midpoint formula uses the average of the initial and final quantities and the initial and final prices. -We can use it to ensure that we have only one value of the price elasticity of demand between the same two points on a demand curve.

What is 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. -The cross-price elasticity of demand is positive or negative, depending on whether the two products are substitutes or complements. -An increase in the price of a substitute will lead to an increase in the quantity demanded, so the cross-price elasticity of demand will be positive. -An increase in the price of a complement will lead to a decrease in the quantity demanded, so the cross-price elasticity of demand will be negative. -Two unrelated prodcucts (phones and peanut butter) will result in zero.

What is the price elasticity of demand?

The responsiveness of the quantity demanded to a change in price, measured by dividing the percentage change in the quantity demanded of a product by the percentage change in the product's price.

What is total revenue?

The total amount of funds a seller receives from selling a good or service -Calculated by multiplying price per unit by the number of units sold.

When would you need to use price elasticity of supply?

To measure how much the quantity supplied increases when price increases. -Supply curves are upward sloping, the price elasticity of supply will be a positive number. -The important point that when demand increases, the amount by which price increases depends on the price elasticity of supply.

What happens to total revenue, when demand is elastic?

When demand is elastic, price and total revenue move inversely. -An increase in price reduces total revenue, and a decrease in price raises total revenue.

What happens to total revenue, when demand is inelastic?

When demand is inelastic, price and total revenue move in the same direction. -An increase in price raises total revenue, and a decrease in price reduces total revenue.