Economics 101, Introduction to Economics, Ch. 5 Notes

A linear, downward-sloping demand curve is...

Inelastic at some points, elastic at others.

Cross-price elasticity of demand formula

(Percentage change in quantity demanded of good 1) / (Percentage change in the price of good 2)

Income elasticity of demand formula

(Percentage change in quantity demanded) / (Percentage change in income)

Price elasticity of demand formula

(Percentage change in quantity demanded) / (Percentage change in price) NOTE: Because the quantity demanded of a good is negatively related to its price, the percentage change in quantity will always have the opposite sign as the percentage change in price. We follow the common practice of dropping the minus sign and reporting all price elasticities of demand as positive numbers.

Price elasticity of supply formula

(Percentage change in quantity supplied) / (Percentage change in price)

Price elasticity of demand midpoint formula

(Q2 - Q1) / [(Q2 + Q1)/2] / (P2 - P1) / [(P2 + P1)/2]

Unit elasticity

If the elasticity is exactly 1, the percentage change in quantity equals the percentage change in price, and demand is said to have unit elasticity.

Time Horizon

Goods tend to have more elastic demand over long time horizons.

Availability of close substitutes

Goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others.

Total revenue change, elastic v. inelastic demand.

If demand is inelastic, then an increase in the price causes an increase in total revenue. If demand is elastic, then an increase in price leads to a decrease in quantity demanded, so total revenue decreases. If demand is unit elastic (price elasticity exactly equal 1, then total revenue remains constant when price changes.

Elasticity

Measure of how much buyers and sellers respond to changes in market conditions. A measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants.

Definition of the Market

Narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly defined goods. Food has a fairly inelastic demand because there are no good substitutes for food.

Necessities versus Luxuries

Necessities tend to have inelastic demands, whereas luxuries have elastic demands.

Income elasticities of necessities and luxuries

Necessities, such as food and clothing, tend to have small income elasticities. People buy some of these goods even when their incomes are low. Luxuries tend to have large income elasticities.

Perfectly elastic supply curve

Occurs at the price elasticity of supply approaches infinity and supply curve becomes horizontal. Very small changes in the price lead to very large changes in quantity supplied.

Perfectly elastic demand

Price of elasticity equals infinity, the demand curve is horizontal.

Substitutes and Complements and Cross-elasticity

Substitutes mean that cross-elasticity of demand between two goods is positive. Complements mean that cross-elasticity of demand between two goods is negative.

Zero elasticity supply curve (extreme cases)

Supply is perfectly inelastic, supply curve is vertical. As elasticity rises, the supply curve gets flatter, which shows that the quantity supplied responds more to changes in the price.

Elastic vs. inelastic price elasticity of supply

Supply of a good is said to be elastic if the quantity supplied responds substantially to changes in the price. Supply is said to be inelastic if the quantity supplied responds only slightly to changes in the price.

Total Revenue

The amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold. TR = P x Q, the price of the good times the quantity of the good sold.

An increase in the supply of a good will decrease the total revenue producers receive if...

The demand curve is inelastic.

Demand is considered elastic when...

The elasticity is greater than 1, which means the quantity moves proportionately more than the price.

Demand is considered inelastic when...

The elasticity is less than 1, which means the quantity moves proportionately less than the price.

The flatter the demand curve that passes through a given point...

The greater the price elasticity of demand.

The steeper the demand curve that passes through a given point...

The smaller the price elasticity of demand.

The ability of firms to enter and exist a market over time means that, in the long run...

The supply curve is more elastic.

Key determinant of the price elasticity of supply

The time period being considered. Supply is usually more elastic in the long run than in the short run.

As price elasticity of supply increases...

The supply curve becomes steeper and steeper.

Tip on inelastic demand graphs

Inelastic curves look like the letter "I". Good tip to know.

Determinants of Price Elasticity of Demand

1. Availability of Close Substitutes. 2. Necessities versus Luxuries. 3. Definition of the Market. 4. Time Horizon.

Income elasticity of demand

A measure of how much the quantity demanded of a good responds to a change in consumers' income, computed as the percentage change in quantity demanded divided by the percentage change in income.

Price elasticity of demand

A measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price.

Cross-price elasticity of demand

A measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change in price of the second good.

Price elasticity of supply

A measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price.

Determining elasticity on a demand curve.

At points with low price and high quantity, the demand curve is inelastic. At points with a high price and low quantity, the demand curve is elastic.

Elastic Demand

Demand for a good is said to be elastic if the quantity demanded responds substantially to changes in the price.

Inelastic Demand

Demand is said to be inelastic if the quantity demanded responds only slightly to changes in the price.

Perfectly inelastic demand

Elasticity equals zero. Demand curve is vertical.