MicroEcon LO6
LO6.5 Apply cross elasticity of demand and income elasticity of demand.
Cross elasticity of demand indicates how sensitive the purchase of one product is to changes in the price of another product. The coefficient of cross elasticity of demand is found by the formula Exy = [%d Qdx] / [%d $] Positive cross elasticity of demand identifies substitute goods; negative cross elasticity identifies complementary goods. Income elasticity of demand indicates the responsiveness of consumer purchases to a change in income. The coefficient of income elasticity of demand is found by the formula Ei = [%d Qdx] / [%d IncomeDelta] The coefficient is positive for normal goods and negative for inferior goods. Industries that sell products that have high income elasticity of demand coefficients are particularly hard hit by recessions. Those with products that have low or negative income elasticity of demand coefficients fare much better.
LO6.2 Explain the usefulness of the total revenue test for price elasticity of demand.
If total revenue changes in the opposite direction from prices, demand is elastic. If price and total revenue change in the same direction, demand is inelastic. Where demand is of unit elasticity, a change in price leaves total revenue unchanged.
LO6.1 Discuss price elasticity of demand and how it is calculated.
Price elasticity of demand measures consumer response to price changes. If consumers are relatively sensitive to price changes, demand is elastic. If they are relatively unresponsive to price changes, demand is inelastic. The price-elasticity coefficient Ed measures the degree of elasticity or inelasticity of demand. The coefficient is found by the formula Ed = [%delta Qd] / [%delta $] Economists use the averages of prices and quantities under consideration as reference points in determining percentage changes in price and quantity. If Ed is greater than 1, demand is elastic. If Ed is less than 1, demand is inelastic. Unit elasticity is the special case in which Ed equals 1. Perfectly inelastic demand is graphed as a line parallel to the vertical axis; perfectly elastic demand is shown by a line above and parallel to the horizontal axis. Elasticity varies at different price ranges on a demand curve, tending to be elastic in the upper-left segment and inelastic in the lower-right segment. Elasticity cannot be judged by the steepness or flatness of a demand curve.
LO6.4 Describe price elasticity of supply and how it can be applied.
The elasticity concept also applies to supply. The coefficient of price elasticity of supply is found by the formula Es = [%d Qs] / [%d $] The averages of the prices and quantities under consideration are used as reference points for computing percentage changes. Elasticity of supply depends on the ease of shifting resources between alternative uses, which varies directly with the time producers have to adjust to a price change.
LO6.3 List the factors that affect price elasticity of demand and describe some applications of price elasticity of demand.
The number of available substitutes, the size of an item's price relative to one's budget, whether the product is a luxury or a necessity, and length of time to adjust are all determinants of elasticity of demand.