HUBBARD_MICRO_SG_06

HUBBARD_MICRO_SG_06 - 6 Elasticity: The Responsiveness of...

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Chapter 6 Elasticity: The Responsiveness of Demand and Supply Chapter Summary Elasticity measures how much one variable responds to changes in another variable. The price elasticity of demand measures the responsiveness of the quantity demanded of a good or service to changes in its price. Price elasticity of demand is calculated by dividing the percentage change in quantity demanded by the percentage change in the product’s price. Demand can be either elastic, inelastic, or unit elastic. Demand curves slope downward. That means any increase in price (a positive change) will cause a decrease in quantity demanded (a negative change). Dividing a negative number by a positive number always equals a negative number. Price elasticity of demand is always negative. Because all economists know this, they often don’t bother writing the minus sign. If you ever encounter a price elasticity of demand that is positive, the first thing you should do is write a minus sign in front of the number. When we say that one price elasticity is “larger” than another, we mean larger in absolute value (that, is, when the negative value is turned into a positive value). There are five main determinants of the price elasticity of demand for a good: 1. Availability of close substitutes : The more substitutes for a good, the larger the price elasticity of demand. 2. The passage of time : Demand becomes more elastic as more time passes. 3. Luxuries versus necessities : The demand curve for a luxury is more elastic than the demand curve for a necessity. 4. The definition of the market : A narrowly defined good will have a more elastic demand than a broadly defined good. For example, the demand for one brand of toothpaste is more elastic than the demand for toothpaste as a product. 5. Share of the good in the consumer’s budget : The larger the share of the good in the consumer’s budget, the more elastic the demand for that good will be. Business owners should be aware of the price elasticity of demand for their product because of the effect of elasticity on the company’s total revenue. Total revenue equals price per unit multiplied by the number of units sold. If demand is elastic, then when price increases, total revenue decreases, and when price decreases, total revenue increases. (Price and total revenue move in opposite directions.) If demand is inelastic, an increase in price will increase total revenue and a decrease in price will decrease total revenue. (Price and total revenue move in the same direction.) There are two other measures of demand elasticity economists often use. The cross-price elasticity of demand equals the percentage change in the quantity demanded of one good divided by the percentage change in price of a related good. The sign of the cross-price elasticity is positive for two substitute goods
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CHAPTER 6 | Elasticity: The Responsiveness of Demand and Supply 148 and negative for two complements. The income elasticity of demand equals the percentage change in the quantity demanded for a good or service divided by the percentage change in income.
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HUBBARD_MICRO_SG_06 - 6 Elasticity: The Responsiveness of...

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