Econ 3050 Ch 3

Time and elasticity

Demand tends to be more (price) elastic in the long run than in the short run. In the long run, consumers have more time to react to price changes. Over time, consumers can find substitutes.

Assume that the price elasticity of demand is -0.7 for a certain firm's product. If the firm decreases price, the firm's managers can expect total revenue to increase.

FALSE. Demand is inelastic, i.e. a 1% decrease in (own) price will increase quantity demanded by only 0.7%. Total revenue will decrease.

The own-price elasticity of demand for apples is -1.2. If the price of apples falls by 5%, the quantity of apples demanded will fall by 5%.

FALSE. First, the quantity of apples demanded will increase as the price of apples falls. Second, the quantity of apples demanded will increase by more than 5%. It will increase by (- 1.2)(-5%)=6%.

If the short-term own price elasticity for transportation is estimated to be -0.6, then long-term own price elasticity is expected to be more than -0.6

FALSE. Long-term demand is more elastic than short-term demand. Hence, absolute value of long-term elasticity should be greater than 0.6. Or, without the absolute value, it should be less than -0.6.

A perfectly elastic demand curve is vertical while a perfectly inelastic demand is horizontal.

FALSE. Vice versa. A perfectly inelastic demand means quantity demanded does not respond to price changes, i.e. the corresponding demand curve is a vertical line.

Own Price Elasticity of Demand

Measures the responsiveness of quantity demanded to changes in own price. Should be negative.

A positive sign of elasticity means that

S and G move in the same direction: as S increases, G increases; and as S decreases, G decreases.

Income Elasticity

Shows how responsive is demand to changes in income

Lemonade, a good with many close substitutes, should have an own-price elasticity that is relatively elastic.

TRUE. The availability of close substitutes for a good makes the demand for that good more elastic. This is so because when there are many close substitutes, the consumers will switch to these substitutes if the price increases, i.e. quantity demanded will be very sensitive to changes in (own) price.

Demand is more inelastic in the short-term than in the long-term.

TRUE. The more time the consumer has, the more opportunities she has to find substitutes. For example, your demand for taxi ride will be more elastic if you have 5 hours to catch your flight than your demand for taxi ride if you had only 1 hour.

The demand for gasoline from Gus's gas station is more (price) elastic than the demand for gasoline in general.

TRUE: There are more close substitutes for Gus's gas (like gas sold by other gas stations) than for gas in general. The availability of close substitutes makes demand more (price) elasticity.

Availability of substitutes

The more substitutes the good has, the more (price) elastic is the demand for that good.

Elasticity is a ratio of two percentage changes

it is scale free, i.e. it is just a number

An elastic demand means that

quantity demanded of a good is highly responsive to changes in the price of the good.

A negative sign would imply

that as S increases, G decreases; and as S decreases, G increases.

An inelastic demand means that

the quantity demanded of a good reacts very little to changes in the price of the good.

elasticity measures

the responsiveness of variable Y to changes in another variable X, holding all else fixed