ECON Chapter 6

Perfectly Elastic Demand

Represented on a graph by a horizontal line going straight across. (Ed=∞) A small price reduction cause buyers to increase their purchases from zero to all that is possible to be obtained.

Perfectly Inelastic Demand

Represented on a graph by a vertical line going straight up. (Ed=0) This is very rare. An example of this might be a diabetics need for insulin.

Examples of Price Elasticity of Demand

1. Large crop yields: (Inelastic demand, lower TR) The increase in crop yields shifts supply to the right, causing the equilibrium price to fall. Since demand is inelastic, the farmers lose money. 2. Excise tax: (Inelastic demand, more TR) If the govt. taxes an inelastic good TR increase because demand stays the same regardless. If they tax an elastic good, TR might go down. 3. Legalization of illegal drugs: (Inelastic demand, more TR) If drugs became legalized than revenues would increase due to the more easily accessible product. Demand would be constant since drugs are an inelastic good.

Midpoint Formula

Ed= change in quantity/(sum of quantities/2) ÷ change in price/(sum of prices/2)

Ed <1

Demand is Inelastic. Qd changes by a smaller % than does price. If the price increase, TR increases. If the price decreases, TR decreases.

Ed > 1

Demand is elastic. Qd changes by a larger % than does price. If prices increase, TR decrease. If prices decrease, TR increases.

Total Revenue Curve

Derived from the demand curve (D). Demand is more elastic at higher prices, unit-elastic in a mid section, and inelastic at the lower prices.

Formula for Price Elasticity of Demand

Ed = % change in quantity/% change in price

Substitutability

If there are more substitutes available, demand is more elastic. If there are less substitutes, demand is inelastic.

Luxury Goods vs Necessities

Luxury goods are goods that consumers can do without so they tend to be more elastic. Necessities tend to be inelastic because people need them no matter what.

Price Elasticity of Supply

Measures sellers' responsiveness to price changes.

Lower Price and Elastic Demand

Revenues will increase because even though a product is being sold at a lower price, more are sold surpassing the total revenue at the higher price. (Image: Blue gains exceed orange loss)

Total Revenue Test

The easiest way to judge if demand is elastic or inelastic. Can be used in place of the elasticity test unless there is a need to determine the elasticity coefficient. This test is important to help understand the relationship between price elasticity and total revenue.

Proportion of Income

The greater the proportion of income needed to buy the good, the more elastic it will be. Consumers are more sensitive because the change can be thousands of dollars.

Price Elasticity of Demand

The measure of the degree of responsivness or sensitivity consumers have to change in price.

Time and Elasticity

Time effects elasticity, the more time a person has, the more elastic the goods are to them. If there is a time crunch, goods are more inelastic because they don't have the opportunity to "shop around." (i.e. - last minute shopping on Christmas Eve)

Total Revenue

Total Revenue = Price * Quantity

Lower Price and Unit Elastic Demand

Total revenue is unchanged. Less sold at a higher price or more sold at a lower price is the same. (Image: Blue gain = orange loss)

Lower Price and Inelastic Demand

Total revenue will fall because the inelastic good is bought at the same rate despite the price change and people will usually buy it regardless of its price. (Image: Orange loss exceeds blue gain)

Ed = 1

Unit or unitary elastic. Qd changes by the same % price does. If price increases or decreases TR remain unchanged.

What is the Midpoint Formula used for?

Using traditional calculations, the measured elasticity over a given range of prices is sensitive to whether one starts at the higher price and goes down or vice versa. The Midpoint Formula helps give consistent results by calculating elasticity over a range of prices.

Inelastic Demand

• Insensitive to price changes • Small change in quantity

Elastic Demand

• Sensitive to price changes • Large change in quanyity