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