Microeconomics- Roger Arnold- Chapter 6-Elasticity

Elasticity

provides a technique for estimating the response of one variable to changes in some other variable, and has numerous applications in economics.

What are four major determinants of the price elasticity of demand:

(1) the number of substitute goods available; (2) whether the good is determined to be a necessity or a luxury; (3) the percentage of one's budget spent on the good in question; (4) the amount of time that has passed since the price change.

Price Elasticity of Demand Along a Straight-Line Demand Curve

As we move down the demand curve from higher to lower prices (top-left to bottom-right), the price elasticity of demand goes from elastic to unit elastic to inelastic.

The (midpoint) formula for calculating price elasticity of demand is:

Ed =(▲Qd / Qd Average) / (▲P / PAverage)

Perfectly Inelastic Demand

If quantity demanded is completely unresponsive to a change in price

Inelastic Demand

If the percentage change in price is greater than the percentage change in quantity demanded

Unit Elastic Demand

If the percentage change in quantity demanded equals the percentage change in price

Correlation between Price Elasticity of Supply and Time

Over time, as producers are able to adjust their behavior and production patterns, supply becomes more price elastic than it is in the short run.

Effect of Price elasticity Percentage of one's budget spent on the good

The greater the percentage of one's budget that goes to purchase a good, the higher the price elasticity of demand; the smaller the percentage of one's budget that goes to purchase a good, the lower the price elasticity of demand.

Effect of Price elasticity Necessities versus luxuries

The more a good is considered a luxury, the higher the price elasticity of demand. The more a good is considered a necessity; the lower will be its price elasticity of demand.

Effect of Price elasticity Number of substitutes

The more substitutes that are available for a good, the higher its price elasticity of demand; the fewer substitutes, the lower the price elasticity of demand.

Effect of Price elasticity with regards to time

The more time that passes (after a price change), the higher the price elasticity of demand for the good; the shorter the time span, the lower the price elasticity of demand. That is, price elasticity is higher in the long run than in the short run.

THE RELATIONSHIP BETWEEN TAXES AND ELASTICITY

We look at price elasticities of supply and demand to determine who pays a tax. If demand is perfectly inelastic or if supply is perfectly elastic, consumers pay the full tax. If demand is perfectly elastic or if supply is perfectly inelastic, producers pay the full tax.

Does price elasticity of demand influences total revenue?

Yes-Whether total revenue rises, falls, or remains constant after a price change depends on whether the percentage change in the quantity demanded is less than, greater than, or equal to the percentage change in price.

Three other elasticities concepts are

cross elasticity of demand, income elasticity of demand, and price elasticity of supply.

What is the relationship between price and total revenue if the demand is inelastic

direct or positive relationship, a change in price will have no effect on total revenue.

Total revenue (TR)

equals the price of a good multiplied by the quantity of the good sold.

Perfectly Elastic Demand

if quantity demanded drops to zero in light of a price change

Elastic Demand

if the percentage change in quantity demanded is greater than the percentage change in price

What is the relationship between price and total revenue if the demand is elastic

inverse relationship

Price Elasticity of Supply

measures the responsiveness of quantity supplied of a good to a change in the price of that good. Price elasticity of supply (ES) is defined as: ES = Percentage Change in Quantity Supplied /Percentage Change in Price

Income Elasticity of Demand

measures the responsiveness of the quantity demanded of a good to a change in income. Income elasticity of demand (EY) is defined as: EY =Percentage Change in Quantity Demanded /Percentage Change in Income

Cross Elasticity of Demand

measures the responsiveness of the quantity demanded of one good to a change in the price of another good. Ec =Percentage Change in Quantity Demanded of One Good/Percentage Change in Price of Another Good

Demand can range from being ____________ to being ___________

perfectly elastic/perfectly inelastic.

Price elasticity of demand measures

the responsiveness of quantity demanded of a product to a change in the price of that product.

Why do we use cross elasticity

to determine whether two goods are substitutes, complements, or unrelated. If EC > 0, the two goods (X and Y) are substitutes; if EC < 0, the two goods are complements; and, if EC = 0, the two goods are unrelated.

Why do we use Income elasticity

to distinguish between normal and inferior goods.