Chapter 6
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 Two key points to note: (1) 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. (2) 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.
price elasticity of demand
the responsiveness of the quantity demanded to a change in price measure the price elasticity of demand by using the slope of the demand curve because the slope tells us how much quantity changes as price changes the price elasticity of demand is not the same as the slope of the demand curve.
Income elasticity of demand
the responsiveness of the quantity demanded to changes in income
Total revenue
the total amount of funds it receives from selling a good or service calculated by multiplying price per unit by the number of units sold: (1) When demand is inelastic, price and total revenue move in the same direction: An increase in price raises total revenue, and a decrease in price reduces total revenue. (2) When demand is elastic, price and total revenue move inversely: An increase in price reduces total revenue, and a decrease in price raises total revenue.
In addition to price elasticity, two other demand elasticities are important:
(1) Cross-price elasticity of demand (2) Income elasticity of demand
The key determinants of the price elasticity of demand:
(1) The availability of close substitutes for the good -if a product has more substitutes available, it will have a more elastic demand. If a product has fewer substitutes available, it will have a less elastic demand. (2) The passage of time -The more time that passes, the more elastic the demand for a product becomes. (3) Whether the good is a luxury or a necessity -The demand curve for a luxury is more elastic than the demand curve for a necessity. (4) The definition of the market -The more narrowly we define a market, the more elastic demand will be. (5) The share of the good in the consumer's budget -the demand for a good will be more elastic the larger the share of the good in the average consumer's budget.
Summary of the Price Elasticity of Demand
*Perfectly inelastic*: When a demand curve is a vertical line *Perfectly elastic*: When a demand curve is a horizontal line
Midpoint formula
1) Demand curve D1 is elastic between points A and B. 2) The value for the price elasticity calculated using the midpoint formula 3) The midpoint formula will give us the same value whether we are moving from the higher price to the lower price or from the lower price to the higher price.
Summary of Cross-Price Elasticity of Demand
If products are substitutes, then the cross-price elasticity of deman will be positive. If products are complements, then the cross-price elasticity of deman will be negative. If products are unrelated, then the cross-price elasticity of deman will be zero.
Price elasticity of supply
We categorize the price elasticity of supply the same way we categorize the price elasticity of demand: (1) If the price elasticity of supply is less than 1, then supply is inelastic. (2) If the price elasticity of supply is greater than 1, then supply is elastic. (3) If the price elasticity of supply is equal to 1, the supply is unit elastic.
Elastisity
elasticity is not the same thing as slope unless 1) The demand curve with the smaller slope (in absolute value)—the flatter demand curve—is more elastic. 2) The demand curve with the larger slope (in absolute value)—the steeper demand curve—is less elastic.
