Chapter 6 / Elasticity

*the midpoint method* (an alternative way to calculate elasticities)

% change in quantity demanded ------------------------------------ % change in price but % change in X is defined as = change in x -------------- x 100 average value of x avg. value of x = starting value of x + final value x ------------------------------------ 2

revenue when unit-elastic

(the price elasticity of demand is 1) -an increase in price does not change total revenue -the quantity effect and the price effect offset each other -a fall in price has no effect on total revenue

revenue when elastic

(the price elasticity of demand is greater than 1) -an increase in price reduces total revenue -quantity effect is stronger than the price effect -a fall in price increases total revenue

revenue when inelastic

(the price elasticity of demand is less than 1) -a higher price increases total revenue -quantity effect is weaker than the price effect -a fall in price reduces total revenue

when price elasticity of supply is *∞*

*perfectly elastic supply* -when even a tiny increase or reduction in the price will lead to very large changes in the quantity supplied, so that the price elasticity of supply in infinite -a perfectly elastic supply curve is a horizontal line

when price elasticity of supply is *zero*

*perfectly inelastic supply* -when the price elasticity of supply is 0, so that changes in price have no effect on the quantity supplied -a perfectly inelastic supply curve is a vertical line

price elasticity along the demand curve

for the majority of demand curves, the price elasticity of demand at one point along the curve is different from the price elasticity of demand at other points along the same curve

income elasticity of demand is *positive, >1* when

it is a *normal good, income-elastic*: quantity demanded rises when income rises, and more rapidly than income (income-elastic)

income elasticity of demand is *positive, <1* when

it is a *normal good, income-inelastic*: quantity demanded rises when income rises, but not as rapidly as income (income-inelastic)

income elasticity of demand is *negative* when

it is an *inferior good*: quantity demanded falls when income rises

why drop the negative sign?

law of demand: says that demand curves are downward sloping, so price and quantity demanded always move in opposite directions -a positive percent change in price (a rise in price) leads to a negative percent change in the quantity demanded -a negative percent change in price (a fall in price) leads to a positive percent change in the quantity demanded -price elasticity is always a negative number, repetitive to always write the -, economists just use the absolute value and assume you know it's negative

when price elasticity of demand = ∞

perfectly elastic: any rise in price causes quantity demanded to fall to 0. Any fall in price leads to an infinite quantity demanded (horizontal demand curve)

when price elasticity of demand = 0

perfectly inelastic: price has no effect on quantity demanded (vertical demand curve)

if quantity effect > price effect

revenue decreases

if price effect > quantity effect

revenue increases

income elasticity of demand

the percent change in the quantity of a good demanded when a consumer's income changes divided by the percent change in the consumer's income % change in quantity demanded ------------------------------------ % change in income

is price effect = quantity effect

total revenue is unchanged by price increase

when price elasticity of demand = 1

unit-elastic: changes in price have no effect on total revenue -q demanded falls by exactly 1%

when price elasticity of demand = between 0 and 1

-inelastic: a rise in price increases total revenue -q demanded falls by less than 1%

cross-price elasticity of demand

-the cross-price elasticity of demand between two goods measures the effect of the change in one good's price on the quantity demanded of the other good -it is equal to the percent change in the quantity demanded of one good divided by the percent change in the other good's price % change in quantity of A demanded ------------------------------------------ % change in price of B

cross-price elasticity of demand is *negative* when

-the goods are *complements* (e.g. hot dogs and hot dog buns): quantity demanded of one good falls when the price of another rises -demand curve shifts left -if the cross-price elasticity is only slightly below 0, they are weak complements; if it is very negative, they are strong complements

cross-price elasticity of demand is *positive* when

-the goods are *substitutes* (e.g. hot dogs and hamburgers): quantity demanded of one good rises when the price of another rises -demand curve shifts right -if the goods are close substitutes, the cross-price elasticity will be positive and large; if they are not close substitutes, the cross-price elasticity will be positive and small

elasticity

-the percentage change in one variable resulting from a 1% increase in another -the strength of a relationship between two variables (e.g. what makes quantity demanded "uninterested" in price change) -e.g. "elasticity of 3" = when price changes by 1%, quantity demanded changes by 3%

*price elasticity of demand*

-the percentage change in quantity demanded of a good resulting from a 1% increase in its price -when price changes, how does that change my response in quantity demanded? % change in quantity demanded ------------------------------------ % change in price (dropping the minus sign)

total revenue

-the total value of sales of a good or service *total revenue = price x quantity sold* -between price and q, one is going up while the other is going down, so total revenue may also be going up or down

perfectly elastic demand

-when any price increase will cause the quantity demanded to drop to zero -when demand is perfectly elastic, the demand curve is a horizontal line (e.g. choosing pink tennis balls over regular yellow ones... you will only buy the pink if they are cheaper than the yellow, but are not willing to pay a pricer higher than that of the yellow)

perfectly inelastic demand

-when the quantity demanded does not respond at all to changes in the price -when demand is perfectly inelastic, the demand curve is a vertical line (e.g. demand for an ambulance ride is pretty (not perfectly) inelastic because it is something people *need* - so the price doesn't really affect whether they are going to pay for a ride or not)

what factors determine the price elasticity of supply?

1. the availability of inputs -price elasticity of supply tends to be large when inputs are readily available and can be shifted into and out of production at a relatively low cost 2. time -price elasticity of supply tends to grow larger as producers have more time to respond to a price change -long-run price elasticity of supply is often higher than the short-run elasticity

four main factors that determine elasticity

1. whether a good is a necessity or a luxury (low elasticity for necessities) 2. the availability of close substitutes (low elasticity is there are no close substitutes) 3. the share of income a consumer spends on the good (high elasticity for goods that require a larger portion of someone's income - since they're spending so much, they're willing to put time and energy into finding cheaper alternatives) 4. how much time has elapsed since a change in price (increase in elasticity with an increase in time to adjust / long-run price elasticity of demand is greater than short-run elasticity . . . e.g. people adjusting their lifestyles over time to adjust to increasing gasoline prices)

price elasticity of supply

a measure of the responsiveness of the quantity of a good supplied to the price of that good -the ratio of percent change in the quantity supplied to the percent change in the price as we move along the supply curve % change in quantity supplied ---------------------------------- % change in price

% change in price

change in price ------------------ x 100 initial price

% change in quantity demanded

change in quantity demanded ---------------------------------- x 100 initial quantity demanded

when price elasticity of demand > 1, less than ∞

elastic: a rise in price reduces total revenue -q demanded falls by greater than 1%

when price elasticity of supply is *greater than 0, less than ∞*

ordinary upward-sloping supply curve