Chapter 5 Elasticity and Its Application Learn the ...
Chapter 5 Elasticity and Its Application Learn the meaning of the elasticity of demand Examine what determines the elasticity of demand Learn the meaning of the elasticity of supply Examine what determines the elasticity of supply Apply the concept of elasticity in two very different markets. Introduction Gas prices rise: consumers buy less. But, by HOW MUCH did the consumption of gas fall? Elasticity: Measure of how much buyers a2nd sellers respond to changes in market conditions. Studying an event or policy affecting a market: we can discuss direction and magnitude of the curve. Gas prices response: QD responds more in the long run than in the short run. About half of long run reduction in QD arises because people drive less and half because they switch to more fuel efficient cars.
Elasticity of Demand Elasticity: a measure of the responsiveness of quantity demanded or QS to one of its determinants. Price of Elasticity of Demand and its determinants Law of demand: Fall price in good raises Qd. Price elasticity: A measure of how much the Qd of a good responds to a change in QD divided by the percentage change in price. Demand of good is ELASTIC if Qd responds substantially to changes in price. Demand of good is INELASTIC if Qd responds only slightly to changes in price. Price elasticity of demand for any good, measure HOW WILLING consumers are to move away from the good as its prices rises. reflects the economic, social, psychological forces that shape consumer tastes.
General Rules about Price Elasticity of Demand 1. Availability of Close Substitutes: Goods with close substitutes have more elastic demand b/c it is easier for consumers to
switch
from that good to others. Ex: Butter and Margarine. Butter price slightly rises, Margarine stays fixed= decrease in consumption for butter. Eggs are food without substitute the demand for eggs is less elastic than the demand for butter. 2. Necessities versus Luxuries Necessities have inelastic demands whereas luxuries have elastic demands. dentists: necessity, Sailboats: Luxury. 3. Definition of the Market Elasticity of demand in any market depends on how we draw the boundaries of the market. Narrowly defined markets have more elastic demand than broadly defined markets because it is easier to find close subs for narrowly defines goods.
ex: food: broad category: Inelastic demand because there are no good subs for food. 4. Time Horizons Goods have more elastic demand over longer time horizons. When price of gas rises, quantity of demanded falls only slightly in first few months. Over time, people buy more fuel efficient cars, take oc transpo, move closer to work. Quantity of gas demanded FALLS SUBSTANTIALLY.
Computing the Price Elasticity Of Demand Price Elasticity of Demand= % Qd/ %P Percentage change in quantity demanded / Percentage change in price ex: 10% increase in price of ice cream cone causes the amount of ice cream you buy to decrease by 20%. Elasticity of Demand: 20% / 10% = 2 It means that change in quantity demanded is proportionally TWICE as large as change in Price. Quantity of a good is NEGATIVELY related to its price: Percentage Change in QUANTITY will always have an opposite sign as Percent Change in PRICE. percentage change in Price is POSITIVE 10 PERCENT= INCREASE, percentage change in Quantity is NEGATIVE 20 PERCENT = DECREASE. Therefore PED can be negative. But we can take absolute values of prices: larger price elasticity implies greater responsiveness of a quantity demanded to price.
Midpoint Method: A better way to Calculate Percentage Changes and Elasticities •
Trying to calculate PED between two points on demand curve : The elasticity of point A to point B is different than vice versa
•
To avoid this problem we use midpoint method for calculating elasticities.
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Change/ Initial
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computes percentage change by dividing change by the midpoint (average) of the initial and final levels.
•
ex: midpoint of 4 and 6 is 5 dollars. =(64)/5 X 100= 40. change from 4 to 6 is 40% increase. change from 6 to 4 is 40% fall. ( does not matter direction of change). In both directions PED equals 1.
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PED: (Q2Q1)/ [(Q2+Q1)/2] (P2P1)/[(P2+P1)/2]
•
To calculate elasticities.
The Variety Of Demand Curves •
PED1 (absolute Value) Elastic: Movie Tickets, Cheesburgers, Candy: Price increases, revenue decreases.
•
PED=1 (absolute Value) Unit Elasticity: equal change
PED: measure show much quantity demanded responds to changes in its price, its closely related to the slope of demand curve. FLATTER DEMAND CURVE THAT PASSES THRU GIVEN POINT= > THE PED STEEPER DEMAND CURVE THAT PASSES THRU GIVEN POINT=
Elasticity of Demand Elasticity: a measure of the responsiveness of quantity demanded or QS to one of its determinants. Price of Elasticity of Demand and its determinants Law of demand: Fall price in good raises Qd. Price elasticity: A measure of how much the Qd of a good responds to a change in QD divided by the percentage change in price. Demand of good is ELASTIC if Qd responds substantially to changes in price. Demand of good is INELASTIC if Qd responds only slightly to changes in price. Price elasticity of demand for any good, measure HOW WILLING consumers are to move away from the good as its prices rises. reflects the economic, social, psychological forces that shape consumer tastes.
General Rules about Price Elasticity of Demand 1. Availability of Close Substitutes: Goods with close substitutes have more elastic demand b/c it is easier for consumers to
switch
from that good to others. Ex: Butter and Margarine. Butter price slightly rises, Margarine stays fixed= decrease in consumption for butter. Eggs are food without substitute the demand for eggs is less elastic than the demand for butter. 2. Necessities versus Luxuries Necessities have inelastic demands whereas luxuries have elastic demands. dentists: necessity, Sailboats: Luxury. 3. Definition of the Market Elasticity of demand in any market depends on how we draw the boundaries of the market. Narrowly defined markets have more elastic demand than broadly defined markets because it is easier to find close subs for narrowly defines goods.
ex: food: broad category: Inelastic demand because there are no good subs for food. 4. Time Horizons Goods have more elastic demand over longer time horizons. When price of gas rises, quantity of demanded falls only slightly in first few months. Over time, people buy more fuel efficient cars, take oc transpo, move closer to work. Quantity of gas demanded FALLS SUBSTANTIALLY.
Computing the Price Elasticity Of Demand Price Elasticity of Demand= % Qd/ %P Percentage change in quantity demanded / Percentage change in price ex: 10% increase in price of ice cream cone causes the amount of ice cream you buy to decrease by 20%. Elasticity of Demand: 20% / 10% = 2 It means that change in quantity demanded is proportionally TWICE as large as change in Price. Quantity of a good is NEGATIVELY related to its price: Percentage Change in QUANTITY will always have an opposite sign as Percent Change in PRICE. percentage change in Price is POSITIVE 10 PERCENT= INCREASE, percentage change in Quantity is NEGATIVE 20 PERCENT = DECREASE. Therefore PED can be negative. But we can take absolute values of prices: larger price elasticity implies greater responsiveness of a quantity demanded to price.
Midpoint Method: A better way to Calculate Percentage Changes and Elasticities •
Trying to calculate PED between two points on demand curve : The elasticity of point A to point B is different than vice versa
•
To avoid this problem we use midpoint method for calculating elasticities.
•
Change/ Initial
•
computes percentage change by dividing change by the midpoint (average) of the initial and final levels.
•
ex: midpoint of 4 and 6 is 5 dollars. =(64)/5 X 100= 40. change from 4 to 6 is 40% increase. change from 6 to 4 is 40% fall. ( does not matter direction of change). In both directions PED equals 1.
•
PED: (Q2Q1)/ [(Q2+Q1)/2] (P2P1)/[(P2+P1)/2]
•
To calculate elasticities.
The Variety Of Demand Curves •
PED1 (absolute Value) Elastic: Movie Tickets, Cheesburgers, Candy: Price increases, revenue decreases.
•
PED=1 (absolute Value) Unit Elasticity: equal change
PED: measure show much quantity demanded responds to changes in its price, its closely related to the slope of demand curve. FLATTER DEMAND CURVE THAT PASSES THRU GIVEN POINT= > THE PED STEEPER DEMAND CURVE THAT PASSES THRU GIVEN POINT=
