ECON 201, Chapter 6

The more time that passes (after a price change), the higher the price elasticity of demand for the good; the shorter the time span, the lower the price elasticity of demand. That is, price elasticity is higher in the long run than in the short run.

Time

Cross elasticity of demand measures the responsiveness of the quantity demanded of one good to a change in the price of another good. Ec = Percentage Change in Quantity Demanded of One Good/Percentage Change in Price of Another Good

Cross Elasticity of Demand

The government can maximize tax revenues by placing the tax on the seller who faces the more inelastic (less elastic) demand curve. Ed = [(10 - 12) / (10 + 12) / 2] ÷ [(12 - 10) / (12 + 10) / 2] = 1

Degree of Elasticity and Tax Revenue

(1) the number of substitute goods available. (2) whether the good is determined to be a necessity or a luxury. (3) the percentage of one's budget spent on the good in question. (4) the amount of time that has passed since the price change.

Determinants of Price Elasticity of Demand

the two goods are complements

EC < 0

the two goods are unrelated.

EC = 0

the two goods (X and Y) are substitutes

EC > 0

X is an inferior good

EY < 0

demand is income inelastic

EY < 1

demand is income unit elastic

EY = 1

X is a normal good

EY > 0

demand is income elastic

EY > 1

If the percentage change in quantity demanded is greater than the percentage change in price, demand is said to be elastic.

Elastic Demand (Ed > 1)

there is an inverse relationship between price and total revenue (total expenditure).

Elastic demand

We look at price elasticities of supply and demand to determine who pays a tax. If demand is perfectly inelastic or if supply is perfectly elastic, consumers pay the full tax. If demand is perfectly elastic or if supply is perfectly inelastic, producers pay the full tax.

Elasticity and the Tax

measures the responsiveness of the quantity demanded of a good to a change in income. EY = Percentage Change in Quantity Demanded / Percentage Change in Income

Income Elasticity of Demand

If the percentage change in price is greater than the percentage change in quantity demanded, demand is said to be inelastic.

Inelastic Demand (Ed < 1)

there is a direct or positive relationship between price and total revenue.

Inelastic demand

The more a good is considered a luxury, the higher the price elasticity of demand. The more a good is considered a necessity; the lower will be its price elasticity of demand.

Necessities versus luxuries

The more broadly defined the good, the fewer the substitutes; the more narrowly defined the good, the greater the substitutes. The more substitutes that are available for a good, the higher its price elasticity of demand; the fewer substitutes, the lower the price elasticity of demand.

Number of substitutes

The greater the percentage of one's budget that goes to purchase a good, the higher the price elasticity of demand; the smaller the percentage of one's budget that goes to purchase a good, the lower the price elasticity of demand.

Percentage of one's budget spent on the good

If quantity demanded changes dramatically in response to a change in price—indeed, in the purest sense, if quantity demanded drops to zero in light of a price change—demand is said to be perfectly elastic.

Perfectly Elastic Demand (Ed = ∞)

If quantity demanded is completely unresponsive to a change in price, demand is said to be perfectly inelastic.

Perfectly Inelastic Demand (Ed = 0)

As we move down the demand curve from higher to lower prices (top-left to bottom-right), the price elasticity of demand goes from elastic to unit elastic to inelastic.

Price Elasticity of Demand Along a Straight-Line Demand Curve

Over time, as producers are able to adjust their behavior and production patterns, supply becomes more price elastic than it is in the short run.

Price Elasticity of Supply and Time

measures the responsiveness of quantity demanded of a product to a change in the price of that product. The (midpoint) formula for calculating price elasticity of demand is: Ed = (ΔQd / Qd Average) / (ΔP / PAverage).

Price elasticity of demand

Whether total revenue rises, falls, or remains constant after a price change depends on whether the percentage change in the quantity demanded is less than, greater than, or equal to the percentage change in price.

Price elasticity of demand influences total revenue

of a seller equals the price of a good times the quantity of the good sold.

Total revenue (TR)

If the percentage change in quantity demanded equals the percentage change in price, demand is said to be unit elastic.

Unit Elastic Demand (Ed = 1)

a change in price will have no effect on total revenue.

Unit elastic demand

Government can place a tax on whomever it wants, but the laws of supply and demand determine who actually ends up paying the tax.

Who Pays the Tax?