Chapter 6: Elasticity

unit elastic

(rectangular hyperbola) Ed=1 absolute value of % change in quantity demanded = absolute value of % change in price

inelastic

*necessity (steepish line) Ed< 1 Quantity demanded is relatively insensitive to a change in price, a change in price cause buyers to respond so quaky that the absolute value of % change in quantity demanded is less than the absolute value of % change in price.

elastic

*very many substitutes* (flattish line) Ed> 1 quantity demanded is relatively sensitive to a change in price, a change in P causes buyers to respond SO strongly that the absolute value of percent change in quantity demanded exceeds the absolute value of the percentage change in price.

cross elasticity of demand

-between two goods -measures the responsiveness or sensitivity of the quantity of good x demanded to a change in the price of good Y, ceteris paribus mathimatically, Exy= Percent change in quantity demanded of product x/ percent of price change in product y -indicates how much the demand curve for x shifts as price of y changes -examines the relatedness of two goods

inelastic supply

Es< 1 quantity supplied is relatively insensitive to a change in price, a change in price causes sellers to respond so weakly that the absolute value of the percent change in quantity supplied is less than the absolute value in the percent change in price.

elastic supply

Es>1 quantity supplied is relatively sensitive to a change in price, a change in P causes sellers to respond so strongly that the absolute value of the percent change in quantity supplied exceeds the absolute value of the percent change of price

Perfectly elastic

Extreme!! line parallel to the horizontal axis Ed= infinity buyers can purchase all they want at the going price any change in P causes a limitless response in quantity demanded

Perfectly inelastic

Extreme!! line parallel to the vertical axis Ed=0 Any change in price causes no response in quantity demanded % change in Qd = 0 No change in Quantity

negative cross elasticity

Exy<0 a. the price of y and the demand for x are negatively or inversely related b. thus, goods x and y are complementary goods

positive cross elasticity

Exy> 0 a. the price of old y and the demand for x are positively or directly related b.thus, goods X and Y are substitute goods

unitary elastic, Ed=1

Price rises or falls; total revenue does not change

Elastic Demand, Ed>1

Price rises; total revenue falls price falls; total revenue rises inverse relation If the price of a good increases and demand is relatively elastic, the gain in revenue due to the higher price is smaller than the loss in revenue due to the decrease in quantity demanded. If the price of a good decreases and demand is relatively elastic, the loss in revenue due to the lower price is smaller than the gain in revenue use to the increase in quantity demanded.

inelastic demand Ed<1

Price rises; total revenue rises price falls; total revenue falls direct relation if the price of a good increases and demand is relatively inelastic, the gain in revenue due to the higher price exceeds the loss in revenue due to the decrease in quantity demanded. if the price of a good decreases and demand is relatively inelastic, the loss in revenue to the lower price exceeds the gain in revenue due to the increase in quantity demanded,

broad

________ definition of a market -less elastic, inelastic -the product in general; EX: cars. ::: Economic books vs books

narrow

________ definition of a market -more elastic -specific product, EX: Lexus IS250 (theres a lot of substitutes!!!! Ex: Mercedes c400, audi Ti, etc)

Applications of price elasticity of demand

a. Prof Peter Drucker Owning a restaurant 1) whats my business? NOT restaurant business--- Building relationships 2) who is my customer? Ithaca, New York- Cornell students. 3) what do they want? relationshops! b. bumper crop- major issue for agriculturalists. many crops are inelastic. total revenue goes down, supply shifts during season, price decrease, total revenue decrease c. excise teax- should be placed on something inelastic to increase total revenue d. war on drugs- demand for addictive furs is highly inelastic!!!!!! decrease supply, increase price, which increases revenue for drug dealers and increases crime. SOLUTION: legal drug facilities.

positive income elasticity

a. income and demand are directly or positively related b. thus, the good is a normal good Einc>0

negative income elasticity

a. income and demand are negatively or inversely related b. thus, the good is an inferior good. Einc<0

price elasticity of supply

a. measures the responsive or sensitivity of the quantity of good x supplied to a change in the price of x b. reflects a movement along the supply curve, which is always upward sloping c. mathematically Es= percent change of quantity supplied/ percent change of price d. Es coefficient is usually positive because 1. there is a direct or positive relationship between price and quantity supplied, ceteris paribus, which means that supply curves are upward sloping/positive 2. thus, there is no total revenue test for the Es because P and Qs move in the SAME direction e. use the midpoint formula when using P and Qs data to calculate percent changes

income elasticity of demand

a. measures the responsiveness or sensitivity of the quantity of a good demanded to a change in buyers' income, ceteris paribus b. mathematically, Einc= percent change in quantity demanded of good x/ percent change in income c. indicates how much the demand curve for X shifts as buyers' income changes d. examines te type of good 1. positive income elasticity ** 2.negative income elasticity

determinants of the price elasticity of supply

a. the magnitude of the Es depends on the amount go time firms have to respond to price changes b. three time frames for supply 1. market period supply curve -supply is perfectly inelastic because the firm has NO time to adjust to changes in price 2. short run supply curve -supply is relatively inelastic because the firm has only a short amount of time to adjust to changes in price 3.long run supply curve -supply is relatively elastic because the firm has a considerable amount of time to adjust to changes in price

Price elasticity of demand and total revenue

applies only when the using the price elasticity of demand because demand curves are downward sloping Total revenue (TR= P times Q) revived by sellers equals total expenditures paid by buyers

long run

for a given increase in demand, price increases the least and the quantity supplied increases the most in the _____ ____

market period

if supply is PERFECTLY inelastic because the firm has NO time to adjust to price changes, it is a _______ __________ supply curve

short run

if supply is relatively inelastic because the firm only has a short amount of time to adjust changes in price, it is a __________________ supply curve

long run

if the firm has a considerable amount of time to adjust to changes in price, it will be a _______ ____ supply curve

perfectly elastic supply

line parallel to the horizontal axis Ed= infinity sellers can sell all they want at the going price, any changes in price causes a limitless response in quantity supplied

perfectly inelastic supply

line parallel to vertical axis Es=0 supply is fixed, any changes in price causes no response in quantity supplied

unit elastic supply

line through the origin Es= 1 as price goes up, total revenue goes up

price elasticity of demand

measures the responsiveness or sensitivity of the quantity of good X demanded to a change in the price of good X, ceteris paribus price elasticity of demand reflects a movement along a demand curve mathematically Ed= % change in Qd / % change in price price elasticity uses percent changes rather than absolute amounts, thus Ed is units free, and just a number.

more elastic

synonym for larger/more ex: the larger the number of subtitles for the good, the demand for product X is more elastic the more narrowly the market is defined, the demand for product X is more elastic the greater the percentage of a households' budget spent on the good, the demand for product X is more elastic

determinants of the price elasticity of demand

the magnitude of the Ed depends on four factors a. number of close substitutes available (most important of the four) -If demand is inelastic, there are very few substitutes -If demand is elastic, there are many substitutes an aside: Narrow vs Broad definition of a market B. Percentage of household budget (or income) spent on the good small chunk or big chunk out of income ex: toothpicks (inelastic), Bently (elastic) c. necessity vs. luxury -you have to have necessity (inelastic) -its NICE to have luxury (elastic) d. amount of time consumer has; short run and long run - the more time you have, demand becomes elastic -the less time you have, demand is inelastic Ex: the short run demand for gas is relatively inelastic (Ed= -0.2) the long- run demand for gas is relatively elastic (Ed= -1.50) 1. In the short run, higher oil prices causing a leftward shift in the supply of gas would increase the price of gas and increase total spending on gas. 2. In the long run, higher oil prices causing a leftward shift in the supply of gas would increase the price of gas and decrease total spending on gas(other substitutes)

zero cross elasticity

the price of y and the demand for x are not related Exy= 0 thus, goods and X and Y are independent goods

midpoint formula

when calculating the price-elasticity of demand using real-life prices and quantities the average price and average quantity serve as the bases fir the percent change calculation Ed= change in Qd/ (q1+q2)/2 / change in P/ (p1+p2)/2