chapter 7 notes - Elasticity of Demand and Supply CHAPTER...

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Elasticity of Demand and Supply CHAPTER SEVEN ELASTICITY OF DEMAND AND SUPPLY LECTURE NOTES I. Introduction A. Elasticity of demand measures how much the quantity demanded changes with a given change in price of the item, change in consumers’ income, or change in price of related product. B. Price elasticity is a concept that also relates to supply. C. The chapter explores both elasticity of supply and of demand and applications of the concept. II. Price Elasticity of Demand A. The law of demand tells us that consumers will respond to a price decrease by buying more of a product (other things remaining constant), but it does not tell us how much more. B. The degree of responsiveness or sensitivity of consumers to a change in price is measured by the concept of price elasticity of demand. 1. If consumers are relatively responsive to price changes, demand is said to be elastic. 2. If consumers are relatively unresponsive to price changes, demand is said to be inelastic. 3. Note that with both elastic and inelastic demand, consumers behave according to the law of demand; that is, they are responsive to price changes. The terms elastic or inelastic describe the degree of responsiveness. A precise definition of what we mean by “responsive” or “unresponsive” follows. 4. CONSIDER THIS … A Bit of a Stretch The Ace bandage stretches a lot when force is applied (elastic); the rubber tie-down (not to be confused with a rubber band) stretches little when force is applied (inelastic). C. Price elasticity formula. Quantitative measure of elasticity, E d = percentage change in quantity/percentage change in price. 1. Using two price-quantity combinations of a demand schedule, calculate the percentage change in quantity by dividing the absolute change in quantity by one of the two original quantities. Then calculate the percentage change in price by dividing the absolute change in price by one of the two original prices. 2. Estimate the elasticity of this region of the demand schedule by comparing the percentage change in quantity and the percentage change in price. Do not use the ratio formula at this time. Emphasize that it is the two percentage changes that are being compared when determining elasticity. 4. Show that if the other original quantity and price were used as the denominator that the percentage changes would be different. Explain that a way to deal with this problem is to use the average of the two quantities and the average of the two prices. 5. Emphasis: The percentages changes are compared, not the absolute changes. a. Absolute changes depend on choice of units. For example, a change in the price of a $10,000 car by $1 and is very different than a change in the price a of $1 can of beer by $1. The auto’s price is rising by a fraction of a percent while the beer price is rising 100 percent.
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