Econ 110 chapter 5
Breakfast cereal vs. Sunscreen Prices of both of these goods rise by 20%. For which good does Qd drop the most?
-Breakfast cereal has close substitutes, so buyers can easily switch if the price rises -Sunscreen has no close substitutes, so a price increase would not affect demand very much -Price elasticity is higher when close substitutes are available
Blue Jeans vs. Clothing Prices of both of these goods rise by 20%. For which good does Qd drop the most?
-For a narrowly defined good, blue jeans, there are many substitutes There are fewer substitutes available for broadly defined goods (clothing) -Price elasticity is higher for narrowly defined goods than for broadly defined ones.
Insulin vs. Yachts Prices of both of these goods rise by 20%. For which good does Qd drop the most?
-Insulin is a necessity to diabetics. A rise in price would cause little or no decrease in demand -A yacht is a luxury. If the price rises, some people will forego it. -Price elasticity is higher for luxuries than for necessities.
Gasoline in the Short Run vs. Gasoline in the Long Run The price of gasoline rises 20%. Does Qd drop more in the short run or the long run?
-There's not much people can do in the short run, other than ride the bus or carpool. -In the long run, people can buy smaller cars or live closer to work. -Price elasticity is higher in the long run
Variety of demand curves
Demand is elastic Price elasticity of demand > 1 -Demand is perfectly elastic Price elasticity of demand = infinity Demand curve is horizontal Demand is inelastic Price elasticity of demand < 1 -Demand is perfectly inelastic Price elasticity of demand = 0 Demand curve is vertical Demand has unit elasticity Price elasticity of demand = 1
relationship with elasticity and price increases
Elastic- lowering prices will raise revenue Inelastic- raising prices will raise revenue
summary
Elasticity measures the responsiveness of Qd or Qs to one of its determinants. Price elasticity of demand equals percentage change in Qd divided by percentage change in P. When it's less than one, demand is "inelastic." When greater than one, demand is "elastic." When demand is inelastic, total revenue rises when price rises. When demand is elastic, total revenue falls when price rises. Demand is less elastic in the short run, for necessities, for broadly defined goods, and for goods with few close substitutes. Price elasticity of supply equals percentage change in Qs divided by percentage change in P. When it's less than one, supply is "inelastic." When greater than one, supply is "elastic." Price elasticity of supply is greater in the long run than in the short run. The income elasticity of demand measures how much quantity demanded responds to changes in buyers' incomes. The cross-price elasticity of demand measures how much demand for one good responds to changes in the price of another good. The tools of supply and demand can be applied in many different kinds of markets. This chapter uses them to analyze the market for wheat, the market for oil, and the market for illegal drugs.
Cross-price elasticity of demand
How much the Qd of one good responds to a change in the price of another good Percentage change in Qd of the first good Divided by the percentage change in price of the second good Substitutes: cross-price elasticity > 0 (+) Complements: cross-price elasticity < 0 (-)
Income elasticity of demand
How much the quantity demanded of a good responds to a change in consumers' income Percentage change in quantity demanded Divided by the percentage change in income Normal goods: income elasticity > 0 Inferior goods: income elasticity < 0
Price elasticity of supply
How much the quantity supplied of a good responds to a change in the price of that good Percentage change in quantity supplied Divided by the percentage change in price Loosely speaking, it measures sellers' price-sensitivity
Variety of supply curves
Supply is unit elastic Price elasticity of supply = 1 Supply is elastic Price elasticity of supply > 1 Supply is inelastic Price elasticity of supply < 1 -Supply is perfectly inelastic Price elasticity of supply = 0 Supply curve is vertical -Supply is perfectly elastic Price elasticity of supply = infinity Supply curve is horizontal The flatter the supply curve The greater the price elasticity of supply
The flatter the demand curve
The greater the price elasticity of demand
Use the following information to calculate the price elasticity of demand for iPhones: if P = $400, Qd = 10,600 if P = $600, Qd = 8,400 Use the midpoint method to calculate percentage changes.
Using the midpoint method to calculate percentage changes: % change in P = [($600 - $400)/$500] ×100 = 40% % change in Qd = [(10,600 - 8,400)/9,500] ×100 = 23.16% Price elasticity of demand = = % change in Qd / % change in P = 23.16/40 = 0.58 inelastic- for every 1% change in price there is a .58% change in Qd -raise prices to raise revenue
As a result of a fare war, the price of a luxury cruise falls 20%. Does luxury cruise companies' total revenue rise or fall?
cruises are a luxury item, they are elastic so the drop in price will make the demand rise and revenue rise Revenue = P x Q The fall in P reduces revenue, but Q increases, which increases revenue. Which effect is bigger? Since demand is elastic, Q will increase more than 20%, so revenue rises.
Pharmacies raise the price of insulin by 10%. Does total expenditure on insulin rise or fall?
rise, because it is inelastic Since demand is inelastic, Q will fall less than 10%, so expenditure rises.
What is elasticity?
small change in one variable, large change in another. Measure of the responsiveness of Qd or Qs to a change in one of its determinants
