Chapter 4: Elasticity: The Measure of Responsiveness

Arc Elasticity

The elasticity at the midpoint between two points on a demand curve.

Point Elasticity

The elasticity of the responsiveness of the quantity demanded to changes in price.

Cross Elasticity of Demand

The measure of the responsiveness of changes in the demand for one good to changes in the price of another.

Income Elasticity of Demand

The measure of the responsiveness of demand to changes in income.

Price Elasticity of Supply

The measure of the responsiveness of the quantity supplied to changes in the price.

Elasticity

The measure of the sensitivity or responsiveness of quantity demanded or quantity supplied to changes in price (or other factors).

What does the text claim is the MOST important factor in determining price elasticity of demand?

The number of available substitutes The most important factor in determining price elasticity of demand is the number of substitutes that are available. If a product, such as wheat flour, has relatively few substitutes, it will tend to have a relatively inelastic demand. Conversely, the greater the number of substitutes available, the greater the price elasticity of demand will be.

Coefficient of Price Elasticity of Demand (Ed)

The numerical measure of price elasticity of demand, equal to the percent change in quantity demanded of a good divided by the percent change in its price.

Coefficient of Price Elasticity of Supply (Es)

The numerical measure of price elasticity of supply, equal to the percent change in the quantity supplied of a good divided by the percent change in its price.

What is the formula for elasticity?

The percent change in the dependent variable divided by the percent change in the independent variable.

Tax Incidence

The place where the burden of a tax actually falls after all shifting has occurred.

If the demand for bus transit is unit elastic, this would mean that a 10% fare increase will produce ...

A 10% decrease in quantity of rides. If a demand is unit elastic, any percent decrease or increase in price results in the exact same percent increase or decrease in the quantity demanded. In this case, a 10% bus fare increase will produce a 10% decrease in quantity of bus rides demanded.

A farmer sells wheat in an established commodity market that has a horizontal demand curve. If his asking price is above market price, he may not sell any wheat; conversely, if his price is below market price, he will be swamped by demand. In this perfectly elastic scenario, what is the coefficient of price elasticity of demand?

? A horizontal demand curve is called a perfectly elastic demand curve because the coefficient of price elasticity of demand (response to changes in price) is infinite.

Corinne needs to have an EpiPen available at all times for her son Jake in case he has a life-threatening asthma attack. What does the EpiPen represent for Corinne and Jake?

A perfectly inelastic demand To be perfectly inelastic, the good or service must be demanded regardless of price. In this scenario, Corinne would likely pay any price for her son's lifesaving medication. Therefore, her demand is perfectly inelastic.

Which of the following pairs represent complementary goods?

A printer and an ink cartridge Goods are complementary when the use of one is related to the use of an associated good, such as a printer and an ink cartridge. Other examples are pens and paper or coffee and creamer. If the price of one good rises and reduces its demand, it may reduce the demand for the complementary good as well.

Excise Tax

A tax on the purchase of a particular good, such as liquor, cigarettes, or electricity, or a broad class of goods, such as food.

Midpoint Method

A way to calculate coefficients of price elasticity of demand using the average value of two points on the demand curve to represent percent change.

Consider that there is a 10% increase in the price of tea. Subsequently, there is a 2% increase in quantity of coffee demanded. All other variables being equal, what is the term for the economic force in play in this scenario?

Cross Elasticity of Demand What occurred in this scenario is called cross elasticity of demand, which measures the responsiveness of changes in demand of one good to changes in the price of another. Substitute goods - such as coffee and tea or butter and margarine - will have a positive cross elasticity of demand.

Perfectly Elastic Demand

Demand represented by a horizontal demand curve with a coefficient of price elasticity of demand that is equal to infinity. The quantity demanded is infinitely responsive to a change in price.

Perfectly Inelastic Demand

Demand represented by a vertical demand curve with a coefficient of price elasticity of demand that is equal to zero. There is no response in quantity demanded to changes in price.

Gemma's Pet Parlor raises the prices of dog leashes by 15%, and the quantity demanded decreases by 7%. Therefore, the demand for dog leashes from this store is ..., and the shop's total revenue will ...

Elastic; Decrease In this scenario, the demand for leashes is affected by the price, so it is elastic. Due to the decrease in demand, the shop's total revenue will decrease.

Key Point 2

Elasticity is the measure of the sensitivity or responsiveness of quantity demanded or quantity supplied to changes in price (and to changes in other ceteris paribus conditions).

True or False: Excise tax is another form of sales tax.

FALSE. Excise tax - sometimes called "sin tax" - is levied by the government against the producer and is based on certain categories of goods and services (such as alcohol, cigarettes, electricity, and trucks' highway usage). Often, the excise tax is "hidden" in the cost to the consumer. Sales tax is paid by the consumer and based on the price of goods.

True or False: The extent to which consumers feel that a good is a necessity or a luxury does not impact price elasticity of demand.

FALSE. The extent to which consumers feel that a good is a necessity or a luxury does impact price elasticity of demand (how quantity demanded responds to changes in price). Other factors include the size of a purchase related to the consumer's income, the availability of acceptable substitute goods, and time to adjust buying behavior.

Among the following, for which products would consumers most likely be charged an excise tax?

Food Electricity An excise tax is an indirect tax charged the producer by the government on the sale of a particular good or service. Some examples are liquor, cigarettes, or electricity, or a broad class of goods, such as food. Sometimes the tax is passed on to the consumer.

What kind of income elasticity do luxury items, such as sports cars and foreign travel, have?

High and Positive Goods or services that have high and positive income elasticities (such as sports cars and foreign travel) are classified as luxury goods. Necessities, such as food, have a low (but positive) income elasticity.

Key Point 6

Income elasticity of demand measures the responsiveness of demand to changes in income. Cross elasticity of demand measures the responsiveness of changes in the demand for one good to changes in the price of another good.

Key Point 1

Movements along demand and supply curves are in response to a change in price. Shifts in demand and supply curves are in response to changes in ceteris paribus conditions

If the sign of the coefficient of the income elasticity of demand is positive, the good is a(n) ... good.

Normal A positive coefficient of the income elasticity of demand indicates the good is a normal good. Unlike the price elasticity of demand, the sign of the coefficient of the income elasticity of demand is important. If the sign is positive, the good is a normal good. If the sign is negative, indicating a negative relationship between income and demand, the good is said to be an inferior good.

The formula for the coefficient of price elasticity of supply is the...

Percent change in quantity supplied of a good divided by the percent change in price. Price elasticity of supply is the measure of the responsiveness of the quantity supplied to changes in the price. The coefficient of price elasticity of supply is the numerical measure of price elasticity of supply. The formula for the coefficient of price elasticity of supply is the percent change in quantity supplied of a good divided by the percent change in price.

A mere 34 paintings are attributed to the great Dutch painter Johannes Vermeer, who died young in 1675. A rise in the price of Vermeer paintings does not cause the quantity supplied to increase. Thus, a Vermeer supply curve would be ...

Perfectly inelastic A very valuable good or service that has a finite quantity and no substitutes, such as a Vermeer painting, has a perfectly inelastic supply curve. Whether the price is high or low, the quantity supplied does not change.

Key Point 4

Price elasticity of demand is higher when a good has many substitutes. The more substitutes an item has, the more elastic demand for it will be. Consumers will have more options and respond more readily to changes in price. Elasticity of demand is greater when the time period is longer because consumers have more opportunity to substitute between goods or services.

Key Point 7

Price elasticity of supply is the measure of the responsiveness of changes in quantity supplied to changes in price. As time passes, the elasticity of supply increases. The longer the time period, the more chance there is for adjustments to take place.

What are two factors that affect elasticity of supply?

Resource Availability Time Period The major factor affecting elasticity of supply is the availability of resources that can be pulled away from other uses. Another factor is the time period under consideration because, as the time period increases, the possibility of obtaining new and different inputs to increase the supply increases.

Key Point 3

Straight-line demand curves, except for those that are perfectly vertical or horizontal, have points on them that range from elastic to inelastic and one point that is unit elastic.

True or False: The coefficient of price elasticity of demand is the numerical measure of price elasticity of demand, equal to the percent change in quantity demanded of a good divided by the percent change in its price.

TRUE.

True or False: A horizontal demand curve is called a perfectly elastic demand curve because the response to changes in price is infinite.

TRUE. A horizontal demand curve is called a perfectly elastic demand curve because the response to changes in price is infinite. In other words, with a horizontal demand curve, if the price rises, no amount of the good will be purchased, and if the price falls, all that is available will be purchased.

True or False: Elasticity is the measure of how a dependent variable responds to changes in any of the independent variables.

TRUE. Elasticity is a measure of how the dependent variable responds to changes in any one of the independent variables. The general formula to determine this responsiveness is the percent change in the dependent variable divided by the percent change in the independent variable.

True or False: If the quantity demanded of a good is the dependent variable, then independent variables include the price of the good, income, tastes, the price of complements, and the price of substitutes.

TRUE. If the quantity demanded of a good is the dependent variable, the independent variables include factors such as the price of the good, income, tastes or preferences, the price of complements, and the price of substitutes.

True or False: Today's economists rely on income elasticity of demand and cross elasticity of demand as two measures of demand.

TRUE. Income elasticity of demand and cross elasticity of demand are customary demand elasticities. The first measures how demand responds to changes in income, assuming all other things, including price, are held constant. Cross elasticity of demand measures the responsiveness of changes in demand of one good to changes in the price of another, all else being equal.

True or False: Two goods that are completely unrelated have a zero cross elasticity of demand.

TRUE. Two goods that are completely unrelated (independent of one another) have a zero cross elasticity of demand. If the cross elasticity is equal to anything but zero, the two goods are related in some way: They are either complements or substitutes.

Total Revenue (TR)

The amount of money a firm takes in, equal to the quantity of the good or service sold multiplied by its price.

Key Point 8

The concepts of supply, demand, and elasticity can be used to determine tax incidence. The more inelastic the demand for a good or service and the more elastic the supply, the greater is the amount of an excise tax on the good or service paid by consumers. The more elastic the demand and the more inelastic the supply, the greater is the amount of the tax paid by producers.

Unit Elastic Demand

The situation in which the coefficient of price elasticity of demand is unitary (equal to 1).

Changes in demand occur in response to changes in one or more of the ceteris paribus conditions that underlie the demand curve. These conditions include ...

The size of the group demanding the good or service The prices of other goods and services Changes in demand occur in response to changes in one or more of the ceteris paribus conditions that underlie the demand curve, including the prices of other goods and services and the size of the group demanding the good or service, as well as their tastes, income, and wealth.

When a beer producer is hit with an excise tax, the owners decide to pay half of the tax and add half of the tax into the consumers' cost. Why would the producer do this?

To try to maintain sales on an inelastic demand Beer is a good example for this scenario because excise taxes are often levied on the manufacturer of items with fairly inelastic demand (such as alcohol and cigarettes). In order to try to maintain sales (and since supply is relatively inelastic for alcohol), beer producers might pay half of the tax and hide the other half in the consumers' price.

Key Point 5

Total revenue is closely related to elasticity because a demand curve is a price-quantity relationship, and total revenue is price times quantity. When price changes, the quantity demanded changes. This change affects total revenue. The amount of the change in total revenue will depend on the responsiveness of consumers to changes in price, or elasticity.