Econ: Ch. 6
Equation of Price Elasticity of Demand - Also known as the Midpoint Formula
(Q2-Q1)/[(Q1+Q2)/2] / (P2-P1)/[(P1+P2)/2]
Key Determinants of the Price Elasticity of Demand
1. Availability of close substitutes to the good 2. The passage of time 3. Whether the good is a luxury or a necessity 4. The definition of the market 5. The share of the good in the consumer's budget
Elasticity
A measure of how much one economic variable responds to changes in another economic value
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
In a narrowly defined market,
Consumers have more substitutes available
Elastic Demand
Demand is elastic when the percentage change in the quantity demanded is greater than the percentage change in price, so the price elasticity is greater than 1 in absolute value
Inelastic Demand
Demand is inelastic when the percentage change in quantity demanded is less than the percentage change in price, so the price elasticity is less than 1 in absolute value
Unit-Elastic Demand
Demand is unit elastic when 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
When demand is inelastic, price and total revenue move...
In the same direction
When demand is elastic, price and total revenue move...
Inversely
If a supply curve is a horizontal line,
It is perfectly elastic The quantity supplied is infinitely responsive to price, and the price elasticity of supply equals infinity
If a supply curve is a vertical line,
It is perfectly inelastic The quantity supplied is completely unresponsive to price, and the price elasticity of supply equals zero Example: A parking lot may have only a fixed number of parking spaces. If a demand increases, the price to park in the lot may rise, but no more spaces will become available
If a product has fewer substitutes available,
It will have less elastic demand
If a product has more substitutes available,
It will have more elastic demand
Remember that the price elasticity of demand is...
Not the same as the slope of the demand curve
Equation of Cross-Price Elasticity of Demand
Percentage change in quantity demanded of one good/ Percentage change in price of another good
Equation of Income Elasticity of Demand
Percentage change in quantity demanded/ Percentage change in income
Equation of Price Elasticity of Demand
Percentage change in quantity demanded/ Percentage change in price
Formula for Price Elasticity of Demand
Percentage change in quantity demanded/ Percentage change in price
Equation of Price Elasticity of Supply
Percentage change in quantity supplied/ Percent change in price
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
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
Whether supply is elastic or inelastic depends on...
The ability and willingness of firms to alter the quantity they produce as price increases
What is the most important determinant of price elasticity of demand?
The availability of substitutes
Perfectly Inelastic Demand
The case where the quantity demanded is completely unresponsive to price and the price elasticity of demand equals zero. The graph is a vertical line Example: The drug insulin. If the price of insulin declines, it will not affect the required dose and therefore it will not increase the quantity demanded. Similarly, a price increase will not affect the required dose or decrease the quantity demanded
Perfectly Elastic Demand
The case where the quantity demanded is infinitely responsive to price and the price elasticity of demand equals infinity. The graph is a horizontal line
If demand is elastic, then an increase in price reduces revenue because
The decrease in quantity demanded is proportionally greater than the increase in price
If demand is inelastic, then an increase in price increases revenue because
The decrease in quantity demanded is proportionally smaller than the increase in price
If demand is unit elastic, then an increase in price does not affect revenue because
The decrease in quantity demanded is proportionally the same as the increase in price
The demand curve for a luxury is more elastic than
The demand curve for a necessity
If demand is elastic, then a decrease in price increases revenue because
The increase in quantity demanded is proportionally greater than the decrease in price
If demand is inelastic, then a decrease a price reduces revenue because
The increase in quantity demanded is proportionally smaller than the decrease in price
If demand is unit elastic, then a decrease in price does not affect revenue because
The increase in quantity demanded is proportionally the same as the decrease in price
The demand for a good will be more elastic...
The larger the share of the good in the average consumer's budget
The more narrowly we define a market,
The more elastic demand will be
The more time that passes,
The more elastic the demand for a product becomes
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
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
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
When it comes to a demand curve being perfectly inelastic,
The quantity demanded is completely unresponsive to price, and the price elasticity of demand equals zero
We know that from the law of supply that when the price of a product increase,
The quantity supplied increases
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
Price Elasticity of Supply
The responsiveness of the quantity supplied to a change in price, measured by dividing the percentage change in the quantity supplied of a product by the percentage change in the product's price
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
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 unit elastic
If demand is perfectly inelastic,
Then the absolute value of price elasticity is equal to 0 (Vertical line)
If demand is unit elastic,
Then the absolute value of price elasticity is equal to 1
If demand is perfectly elastic,
Then the absolute value of price elasticity is equal to infinity (Horizontal line)
If demand is elastic,
Then the absolute value of price elasticity is greater than 1
If demand is inelastic,
Then the absolute value of price elasticity is less than 1
If the income elasticity of demand is negative,
Then the good is inferior
If the income elasticity of demand is positive and greater than 1,
Then the good is normal and a luxury
If the income elasticity of demand is positive but less than 1,
Then the good is normal and a necessity
If the supply is perfectly inelastic,
Then the value of price elasticity is equal to 0
If supply is unit elastic,
Then the value of price elasticity is equal to 1
If supply is perfectly elastic,
Then the value of price elasticity is equal to infinity
If supply is elastic,
Then the value of price elasticity is greater than 1
If supply is inelastic,
Then the value of price elasticity is less than 1
The cross-price elasticity of demand is positive or negative, depending on...
Whether the two products are substitutes or compliments
If the products are unrelated, then the cross-price elasticity of demand will be
Zero