Chapter 5: Price Elasticity of Demand and Supply
income elasticity of demand
ratio of percentage change in the QUANTITY DEMANDED of a good to a given percentage change in INCOME
definition of price elasticity of demand
ratio of the percentage change in the quantity demanded of a product to a percentage change in its price.
If there is an increase from a quantity demanded of 3 units at point A on a demand curve to 5 units, what is the percentage increase?
(5-3)/3=2/3 = 66%
If there is a decrease in quantity demanded of 5 units at point B to 3 units at point A on a demand curve, what is the percentage decrease?
(5-3)/5 = 2/5 = 40%
Price Elasticity =
(change in QUANTITY DEMANDED divided by the mean of the sum of QUANTITIES) / (change in PRICE divided by the mean of the sum of PRICES)
What factors influence demand elasticity?
- Availability of substitutes - Share of budget on the product - Adjustment to a price change over time.
Does price elasticity of demand vary along a demand curve?
Yes. The price elasticity of demand coefficient of demand applies only to a specific range of prices along the demand curve.
Price Elasticity of Demand
percentage change in the quantity demanded divided by the percentage change in price
unitary elastic demand curve
percentage change in the quantity demanded is equal to the percentage change in price.
inelastic demand
percentage change in the quantity demanded is less than the percentage change in price.
Why is elasticity 2 in the previous example and not -2?
quantity demanded and price are inversely related.
cross-elasticity of demand
ratio of percentage change in QUANTITY DEMANDED of a good to a given percentage change in PRICE IN ANOTHER GOOD
What decides who pays what part of the tax increase?
The more elastic the demand, the more the corporation pays; the less elastic the demand, the more the consumer pays
What do substitutes have to do with a price change?
The more substitutes a product has, the more sensitive consumers are to a price change, and the more elastic the demand curve.
The price elasticity coefficient of demand HIGHER the LONGER a price change persists.
The price elasticity coefficient of demand HIGHER the LONGER a price change persists.
The price elasticity of demand is DIRECTLY RELATED to the availability of good SUBSTITUTES for a product.
The price elasticity of demand is DIRECTLY RELATED to the availability of good SUBSTITUTES for a product.
Perfectly INELASTIC Supply
= 0 - vertical line
price elasticity of demand
responsiveness, or sensitivity, to a change in price.
Price Elasticity of Demand using the MIDPOINTS FORMULA
review/print slide 17
If a college raises tuition, what happens to total revenue?
- If demand is ELASTIC, total revenue DECREASES. - If demand is unitary elastic, total revenue is CONSTANT. - If demand is INELASTIC, total revenue INCREASES.
What are other elasticity measures?
- Income elasticity of demand - Cross-elasticity of demand
- Increase in gasoline tax - Decrease in supply - Consumers and suppliers share burden of tax
- Increase in gasoline tax - Decrease in supply - Consumers and suppliers share burden of tax
- Increase in gasoline tax - Decrease in supply - Consumers bear full burden of tax
- Increase in gasoline tax - Decrease in supply - Consumers bear full burden of tax
What does the share of one's budget have to do with a price change?
- The LARGER the purchase is to one's budget, - the MORE SENSITIVE consumers are to a price change, - and the MORE ELASTIC the demand curve
What does time have to do with sensitivity?
- The LONGER consumers have to adjust, - the MORE SENSITIVE they are to a price change, - and the MORE ELASTIC the demand curve
Concerning Inelastic Demand:
- a price INCREASE leads to an INCREASE in total revenue (direct relationship).
Economists can solve this problem of different base points by using the _________________________ as the base points of changes in prices and quantity demanded
- midpoints
Suppose a university's enrollment drops by 20% because tuition rises by 10%, what is the price elasticity of demand?
2
Unitary Elastic
= 1 - 45 degree angle diagonal line
Perfectly ELASTIC Supply
= infinity - horizontal line
What is a perfectly elastic demand curve?
An extreme condition in which a SMALL percentage change in price brings about an INFINITE percentage change in the quantity demanded.
What is a perfectly inelastic demand curve?
Another extreme condition in which the quantity demanded DOES NOT change as the price changes. - vertical line
Why is the demand curve in the previous slide perfectly elastic?
At a price of $20, buyers will purchase an infinite quantity. But at any other price, they will purchase zero. Therefore, the change in quantity demanded is infinite and Ed =∞. - horizontal line
Why does curve B represent the demand curve for candy (FLATTER CURVE-GRADUAL)?
Because candy has many substitutes, a price change can bring about a big change in the quantity demanded
Why does curve A represent the demand curve for medicine (STEEP CURVE)?
Because medicine is a necessity with few substitutes, and the price can change with little effect on the quantity demanded
If price increases and the revenue gained is greater than the revenue lost, the demand curve is price inelastic < 1
If price increases and the revenue gained is greater than the revenue lost, the demand curve is price inelastic < 1
If price increases and the revenue gained is less than the revenue lost, the demand curve is price elastic > 1
If price increases and the revenue gained is less than the revenue lost, the demand curve is price elastic > 1
If total revenue does not change when price increases, the demand curve is unitary elastic =1
If total revenue does not change when price increases, the demand curve is unitary elastic =1
Who pays the tax levied on sellers of goods such as gasoline, cigarettes, and alcoholic beverages?
It all depends; the corporation pays all, some, or very little of the tax.
REFER TO SLIDE 41
REFER TO SLIDE 41
Why is the demand curve in the previous slide perfectly inelastic ?
Regardless of the percentage change in ticket price, buyers will purchase a quantity demanded of 20,000. Therefore, Ed =0.
The LESS ELASTIC the demand, the more the CONSUMER pays
The LESS ELASTIC the demand, the more the CONSUMER pays
The MORE ELASTIC the demand, the MORE the CORPORATION pays
The MORE ELASTIC the demand, the MORE the CORPORATION pays
Concerning Inelastic Demand:
a price DECREASE leads to a DECREASE in total revenue (direct relationship).
Concerning Elastic Demand:
a price DECREASE leads to an INCREASE in total revenue.
Concerning Elastic Demand:
a price INCREASE leads to a DECREASE in total revenue.
How is the percent increase or decrease of two numbers calculated?
difference between the two numbers divided by the original number.
Price Elasticity of Supply
percentage change in quantity supplied divided by the percentage change in price.
Income Elasticity of Demand
percentage change in quantity demanded divided by the percentage change in income.
elastic demand
percentage change in quantity demanded is greater than the percentage change in price.
Cross-elasticity of Demand
percentage change in quantity demanded of good A divided by the percentage change of price of good B
