Chapter 4 - Elasticity - Chapter 4 Elasticity The Basics...

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Chapter 4 Elasticity
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The Basics
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1. Define price elasticity of demand Explain what determines this elasticity 2. Calculate price elasticity of demand 3. Understand how changes in price affect total revenue Relate to price elasticity of demand 4. Define cross-price elasticity and income elasticity 5. Define price elasticity of supply Explain what determines this elasticity 6. Calculate the price elasticity of supply Learning Objectives
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Hypothesis Drug users steal to buy drugs Increase drug enforcement will decrease thef Analysis Increased enforcement reduces supply of drugs Price of drugs increases Quantity demanded decreases Thef goes down ONLY IF total expenditures on drugs decreases How responsive is quantity demanded to price? Drug Enforcement and Local Thef
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Price Elasticity of Demand Price elasticity of demand Percentage change in quantity demanded from 1% change in price Measure of responsiveness of quantity demanded to changes in price Example Price of beef decreases 1% Quantity of beef demanded increases 2% Price elasticity of demand is – 2 P Q
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Calculate Price Elasticity Symbol for elasticity is ε Lower case Greek letter epsilon For small percentage changes in price ε = Percentage change in quantity demanded Percentage change in price Price elasticity of demand is always negative Ignore the sign
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Elastic Demand If price elasticity is greater than 1, demand is elastic Percentage change in quantity is greater than percentage change in price Demand is responsive to price 3 3 Price Elasticity of Demand Inelastic Unit elastic Elastic 2 2 1 1 0 0
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Inelastic Demand If price elasticity is less than 1, demand is inelastic Percentage change in quantity is less than percentage change in price Quantity demanded is not very responsive to price 3 3 Price Elasticity of Demand Inelastic Unit elastic Elastic 2 2 1 1 0 0
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Unit Elastic Demand If price elasticity is 1, demand is unit elastic Price and quantity change by the same percentage 3 3 Price Elasticity of Demand Inelastic Unit elastic Elastic 2 2 1 1 0 0
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Example: Demand for Pizza Old New % Change Price $1.00 $0.97 -3% Quantity 400 404 1% ε = Percentage change in quantity demanded Percentage change in price ε = -1% 3% =-0.33 Demand is inelastic
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Example: Demand for Salt Old New % Change Price $1.00 $2.00 100% Quantity 400 400 0% ε = Percentage change in quantity demanded Percentage change in price ε = 0% 100% = 0 Demand is inelastic
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Determinants of Price Elasticity of Demand
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Examples of Elasticities Green peas 2.80 Restaurant meals 1.63 Beer 1.19 Coffee 0.25 Automobiles 1.35 Foreign air travel 0.77 Movies 0.87 Theater, opera 0.18
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