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Econ 201 chapter 4

Elasticity

QuestionAnswer
A measure of the responsiveness of buyers and sellers to changes in price or income. Elasticity
A measure of the responsiveness of quantity demanded to a change in price. Price elasticity of demand This gives us the sensitivity of the relationship between these two variables
Demand is elastic if: quantity demanded changes significantly as the result of a price change. Elastic = “sensitive” or “responsive.”
Demand is inelastic if: quantity demanded changes a small amount as the result of a price change. Inelastic = “insensitive” or “unresponsive.”
Determinants of the Price Elasticity of Demand Existence of substitutes Share of the budget spent on the good Necessities versus luxuries Whether the market is broadly or narrowly defined Time and adjustment process
Many substitutes ➔ What elasticity demand elastic demand Examples: toothpaste, breakfast cereals, fruits, vegetables, and fast food
Few substitutes ➔ What elasticity demand inelastic demand Examples: electricity, gasoline, and medical goods such as insulin
Share of the budget spent on the good INFORMATION • Determines how much the price change affects the consumer. 20 percent sale on a new vehicle you want 20 percent sale on candy bar • “Big-ticket items” ➔ elastic demand • Inexpensive items ➔ inelastic demand
Luxuries ➔ What elasticity demand elastic demand Examples: vacations, dining out, jewelry, and designer clothes
Necessities ➔ What elasticity demand inelastic demand Examples: electricity, internet, gasoline, mobile phone service, and medication
Narrowly defined ➔ What elasticity demand elastic demand Examples: Toyota RAV4 and Sony 56” Smart TV
Broadly defined ➔ What elasticity demand inelastic demand Examples: Cars and TVs
Long time horizon ➔ What elasticity demand elastic demand Consumers can fully adjust to market conditions
Short time horizon ➔ What elasticity demand inelastic demand Consumers cannot fully adjust to market conditions
In terms of price elasticity of demand, which of the following goods do you think is the least elastic (most inelastic)? A. new house B. electricity to power your home C. a specific brand of breakfast cereal D. new vehicle B. electricity to power your home
What is the equation for Price elasticity of demand Percentage change in quantity demanded/ Percentage change in price
What is the equation for price elasticity of demand = ED % change in quantity demanded/ % change in price
What is the midpoint elasticity equation Change in Qd/avg Qd Change in P/avg P
the price of candy bars increases by 100%. Now you purchase 50% fewer candy bars. How would you describe your demand for candy bars? A. Demand is elastic. B. Demand is unit elastic. C. Demand is inelastic. D. Demand is perfectly inelastic. C. Demand is inelastic. 50/100=.5<1
Price elasticity of demand > 1 (in absolute value) Elastic or inelastic? elastic
Price elasticity of demand < 1 (in absolute value) Elastic or inelastic? inelastic
Price elasticity of demand = 1 Elastic or inelastic? Unit elastic
What does it mean if price elasticity of demand = 0 Demand is perfectly inelastic Demand curve is vertical
What does it mean if price elasticity of demand = infinity Demand is perfectly elastic Demand curve is horizontal
The flatter the demand curve means: The greater the price elasticity of demand
When demand curve is vertical this means: Perfectly inelastic. It doesn't matter the price, you will still buy it
When demand curve is horizontal this means: Perfectly elastic Any change in price causes hesitation or completely stops you from buying
Steep curve means: Low elasticity
Relatively flat curve means: High elasticity
has a positive income elasticity → EI > 0 Normal good
has a negative income elasticity → EI < 0. Inferior good
INFORMATION Necessities: 1 > EI > 0. Luxuries: EI > 1.
What is the equation for income elasticity of demand = EI % change in quantity demanded/ % change in income
INFORMATION For normal goods: ➢ Higher income increases the quantity demanded. Because quantity demanded and income move in the same direction, normal goods have positive income elasticities
INFORMATION For inferior goods: ➢ Higher income reduces the quantity demanded. Because quantity demanded and income move in opposite directions, inferior goods have negative income elasticities.
Measures the percentage change in the quantity demanded of one good to the percentage change in the price of a related good Cross-price elasticity of demand (EC)
INFORMATION EC can be positive or negative Substitute goods: EC > 0 Complementary goods: EC < 0
What is the equation for cross-price elasticity of demand = EC % change in quantity demanded of one good/ % change in price of a related good
INFORMATION When goods are substitutes: ➢ An increase in the price of beef causes an increase in demand for chicken. Because the Q (of chicken) and the P (of beef) move in the same direction → The cross-price elasticity of demand is > 0
INFORMATION When goods are complements: ➢ An increase in the price of computers causes a decrease in demand for software. Because the Q (of software) and the P (of computers) move in opposite directions → The cross-price elasticity is < 0
When the price of chicken increases, people purchase less rice. A. EC < 0, chicken and rice are complements. B. EC > 0, chicken and rice are complements. C. EC < 0, chicken and rice are substitutes. D. EC > 0, chicken and rice are substitutes A. EC < 0, chicken and rice are complements.
Measures the responsiveness of the quantity supplied to a change in price. Price elasticity of supply
Greater price elasticity of supply means: the sellers can more easily change the quantity they produce More production flexibility implies firms are more able to respond to changes in price A firm will have more production flexibility if it is able to: • have spare capacity • maintain inventory • relocate easily.
Immediate run → Suppliers are stuck with what they have on hand; no adjustment.
Quantity supplied is not very responsive to changes in price Short run Price elasticity of supply is greater in the long run than in the short run
Quantity supplied responds substantially Long run Price elasticity of supply is greater in the long run than in the short run
What is the equation for price elasticity of supply = ES % change in quantity supplied/ % change in price
Price elasticity of supply > 1 Supply is elastic
Price elasticity of supply < 1 Supply is inelastic
Price elasticity of supply = 1 Supply has unit elasticity
Price elasticity of supply = 0 Supply is perfectly inelastic Supply curve is vertical
Price elasticity of supply = infinity Supply is perfectly elastic Supply curve is horizontal
The flatter the supply curve The greater the price elasticity of supply
Created by: logandubois5
 

 



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