Chapter 5: Elasticity and Its Application

When the demand curve is elastic, the extra revenue from selling at a higher price is less than the lost revenue from selling fewer units.

fact

inelastic supply: elasticity is less than 1

tilted line to the positive sign

How do economists classify demand curves?

based on their elasticity

price

height of the box under the demand curve

unit elastic supply: elasticity equals 1

y=x

perfectly inelastic supply: elasticity equals 0

An increase in price leaves the quantity unchanged. vertical line

inelastic demand: elasticity is less than 1, unit elastic demand: elasticity equals 1, elastic demand: elasticity is greater than 1

As the elasticity rises, the demand curve gets flatter and flatter.

perfectly elastic supply: elasticity equals infinity

At any price above the price on the demand curve, the quantity supplied is infinite. On the curve - producers will supply any quantity. below curve - quantity supplied is zero horizontal line

elastic

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

inelastic

Demand for a good is INELASTIC if the quantity demanded responds only slightly to changes in the price.

inferior goods

negative income elasticities

perfectly elastic demand: elasticity equals infinity

- any price above the demand curve, the quantity demanded is zero - on the demand curve, consumers will buy any quantity - below the price on the demand curve, the quantity demanded is infinity - occurs as the price elasticity of demand approaches infinity and the demand curve becomes horizontal, reflecting the fact that small changes in price lead to big changes in the quantity demanded

steps

1. consider whether the supply or demand curve shifts 2. consider the direction of the shift 3. see how the shift affects the equilibrium price and quantity

elastic demand

Demand is considered elastic when the elasticity is greater than 1 -> the quantity moves proportionately more than the price.

inelastic demand

Demand is considered inelastic when the elasticity is less than 1 -> the quantity moves proportionately less than the price.

time horizon

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

unit elasticity

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

consumers response

Many studies examined consumers' response to gasoline prices, and they typically find that the quantity demanded responds more in the long run than it does in the short run.

Even though the slope is constant in a linear demand curve, the elasticity is not.

This is true because the slope is the ratio of the changes in the two variables, whereas the elasticity is the ratio of the percentage changes in the two variables.

general rules

When demand is inelastic, price and total revenue move in the same direction - if the price increases, total revenue also increases. When demand is elastic, price and total revenue move in opposite directions - if price increases, total revenue decreases. If demand is unit elastic, total revenue remains constant when the price changes.

important

When studying how some event or policy affects a market, we can discuss not only the direction of its effects but their magnitude as well.

how total revenue changes when price changes

When the demand curve is inelastic, the extra revenue from selling at a higher price is greater than the lost revenue from selling fewer units.

price elasticity of demand

closely related to the slope of the demand curve

When the demand is inelastic, an increase in supply...

leads to a large fall in price and a proportionately smaller increase in quantity sold -> revenue falls

In the short run, when supply and demand are inelastic, a shift in the supply...

leads to a large increase in price

In the long run, when supply and demand are elastic, a shift in supply...

leads to a small increase in price

price elasticity of supply

measures how much the quantity supplied responds to changes in the price, computed as the percentage change in quantity supplied divided by the percentage change in price depends on the flexibility of the sellers to change the amount of the good they produce usually more elastic in the long run in the short run, the quantity supplied is not very responsive to the price

way to think of the graphs and determine their elasticity

perfectly inelastic (vertical line), inelastic (stiff curve), unit inelastic (curvier curve), elastic (more of a drawn out curve0, perfectly elastic (horizontal line)

linear curve help

points with a low price and high quantity - inelastic points with a high price and low quantity - elastic

normal goods

quantity demanded and price more in the same direction; positive income elasticities

slope

ratio of change in price to the change in quantity

elastic supply: elasticity is greater than 1

steep

luxuries

tend to have elastic demands

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

rule of thumb

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

zero elasticity (extreme case)

- demand is perfectly inelastic - demand curve is vertical - in this case, regardless of price, the quantity demanded stays the same

price elasticity price of demand measures...

- how much the quantity demanded responds to a change in price - how willing consumers are to buy less of the good as its price rises

elasticity

a measure of how much buyers and sellers respond to changes in market conditions

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; %delta quantity demanded/%delta 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 the price of the second good being positive or negative, depends on whether the goods are complements or substitutes

elasticity (again)

a measure of the responsiveness of the quantity demanded or quantity supplied to change in one of its determinants

elastic demand case

an increase in price causes a decrease in the quantity demanded that is proportionately larger, so total revenue decreases.

inelastic demand case

an increase in price leads to a decrease in the quantity demanded that is proportionately smaller, so the total revenue increases.

Why is there no simple, universal rule for what determines a demand curve's elasticity?

because a demand curve reflects the many economic, social, and psychological forces that shape consumer preferences

necessities

tend to have inelastic demands

goods with close substitutes

tend to have more elastic demand because it is easier for consumers to switch from that good to others

narrowly defined markets

tend to have more elastic demand than broadly defined markets because it is easier to find more close substitutes for narrowly defined goods