Chapter 6 Elasticity

Price Elasticity of Demand

Price elasticity of demand measures how responsive consumers are to price change.

If demand for a good is ________, an increase in price reduces total revenue. (Sales effect > Price effect).

elastic

If demand for a good is _________, a higher price increases total revenue. (Price effect > Sales effect).

inelastic

Price Elasticity of Supply

The price elasticity of demand measures how responsive consumers are to changes in price. In the same way, the price elasticity of supply measures how responsive producers or sellers are to a price change. Elasticity of supply is calculated in the same manner as the elasticity of demand: it is the percentage change in quantity-supplied divided by the percentage change in price.

Price Effect

After a price increase, each unit sold sells at a higher price, which increases revenue.

Sales Effect

After a price increase, fewer units are sold, which lowers revenue.

The Linear Demand Curve

As the price decreases, the curve becomes less elastic until it becomes unit elastic. As price continues to decrease, it becomes increasingly inelastic. This indicates that as price continues to fall, consumers become increasingly less sensitive to the effects of the price change.

Two Extreme Cases of Price Elasticity of Demand perfectly inelastic

Consumers will demand quantity Q at any price. perfectly elastic Consumers will demand all that is available at price = p but demand no quantity at a price above p.

Cross Price Elasticity

Cross-price elasticity refers to the responsiveness of the demand for one product when the price of another changes. Cross-price elasticity is measured by the percentage change of quantity demanded for good 1 divided by the percentage change in the price of good 2.

inealstic

E<1

unitelastic

E=1

Elastic

E>1

Arc or Midpoint Price Elasticity of Demand Formula

ED = [(Q'-Q)/(Q'+Q)] / [(P'-P)/(P'+P)]

Income Elasticity of Demand

Income elasticity measures the responsiveness of consumers to a change in income. Specifically, it measures the percentage change in quantity demanded for a percentage change in income with price held constant. If Y is current income and Y' is income after the change, the formula for income elasticity can be found.

Calculating Price Elasticity

Elasticity = percentage change in quantity-demanded divided by percentage change in price. This elasticity is precise at particular point on the demand curve. This can be written as (ΔQ/Q) / (ΔP/P), and rearranged as (P/Q) / (ΔP/ΔQ). If the curve is nonlinear, calculus can be used to find the precise slope (ΔQ/ΔP).

Percent Change

new-old/old * 100

If demand for a good is _______, an increase in price does not change total revenue. (Sales effect = Price effect).

unit elastic