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Notes - Chapter 4

# Notes - Chapter 4 - I Elasticity 1 War on Drugs 1 Many...

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I. Elasticity 1. War on Drugs 1. Many illegal drug users commit crimes to finance their addictions 2. War on drugs aims to reduce the supply of drugs P(\$/oz) 80 ---------------------- | | 50 ---------------------|--------- | | | | | | 40 50 Q (Number of Ounces) Initial Total Expenditure = 50,000 x \$50 = \$2.5 mil. New Total Expenditure = 40,000 x \$80 = \$3.2 mil. Total expenditure increased because of reduced supply. If crimes are based on total expenditure, they will likely increase. %change = New – Old / Old x 100 %Change Price = 80-50/50 x 100 = 60% %Change Quantity = 40-50/50 x 100 = -20% 1. The Price Elasticity of Demand – A measure of the responsiveness of quantity demanded of a good to a change in its price Formally, the percentage change in quantity demanded that results from a 1% change in it's price. Price Elasticity of Demand = %Change Qd %Change Price (%Change in P must be small) Ex: If the price of good x falls by 2%, and the Qd increases by 10% .... E = 10% -2% = -5

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Elasticity Ratings - 0 – 1 --> Inelastic 1 --> Unit Elastic >1 --> Elastic Inelastic - %Change Qd < %change Price Unit Elastic - %change Qd = %change Price Qd and P are changing at the same rate Elastic - %change Qd > %change P Example: Originally P = 400, Q = 10,000 Then P = 380, Q = 12,000 %changeQ = 12,000 – 10,000 / 10,000 x 100 = 20% %change P = 380 – 400 / 400 x 100 = 5% E = 20% / 5% = 4 (Elastic) Interpretation - A 1% decrease in price would increase Qd by 4% A 1% increase in price would decrease Qd by 4% 1. Determinents of Price Elasticity of Demand: 1. Availability of Substitutes 1. More available substitutes --> more elastic demand 2. Less Available substitutes --> less elastic demand Examples: Salt – demand is very inelastic Appendectomies – inelastic demand A specific Brand of Salt - perfect substitutes available – very elastic 2. Budget Share 1. Larger portion of budget --> More elastic demand 2. Smaller portion of budget --> inelastic demand 1. Examples
1. Pack of gum 1. Very small portion of budget 2. Inelastic Demand 2. Cars 1. Very large portioin of budget 2. Elastic demand 3. Time 1. Substituting one product for another takes time. The more time we have to adjust to price changes, the more easily we can find substitutes. 1. Longer Period of time --> More elasticity 2. Shorter Period of time --> Less elastic 4. Elasticity Examples 1. Salt 0.1 --> Few subs 2. Water 0.2 --> Few Substitutes 3. Coffee 0.25 --> Few substitutes 4. Housing 1.0 --> Few subs, large share of budget 5. Restaurant meal --> Lots of subs 6. Air Travel --> Lots of substitutes 7. In 1990, congress imposed a tax on US made luxury yachts costing more than 100,000 1.

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Notes - Chapter 4 - I Elasticity 1 War on Drugs 1 Many...

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