Exam #2 Cheat Sheet

Exam #2 Cheat Sheet - 1 Elasticity a measure of the...

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Elasticity : a measure of the quantitative response of one variable to changes in another variable. For example, the price elasticity of demand for X measures how quantity demanded of X changes in response to change in price of X. Ex . We know from the law of demand that raising the price of X will reduce demand for X. But if price of X is raised 10 percent, will demand for X decline by 10 percent? 30 percent? or some other percent? Elasticity coefficient : enables us to quantify, measure and compare the elasticities of different products. Price elasticity of demand (E D ) measures the quantitative response of buyers of X to change in price of X. [If research revealed this would lead to only 2 percent decline in sales, then the firm would probably raise prices. But if research revealed, the 10 percent price increase would lead to 30 percent decline in sales, then the firm would not ^ prices.] Price elastic demand - Ex. 10 percent increase in price of gadgets leads to 20 percent decrease in gadgets sold. Revenue implications of price elastic demand P Q-sold Total revenue \$5 100 \$500 Raising price from \$5 to \$6 led to decrease in total revenue. \$6 80 \$480 Reason: percent decline in sales greater than percent increase in price Price Inelastic Demand- Ex. 10 percent increase in price of doodads leads to 3 percent decrease in doodads sold. Revenue implications of price inelastic demand P Q-sold Total revenue \$5 100 \$500 Raising price from \$5 to \$6 led to increase in total revenue. \$6 90 \$540 Reason: percent decline in sales smaller than percent increase in price Calculating price elasticity of demand (E D ). E D = (percentage change Q D )/ (percentage change P) Q D = quantity demanded = quantity that would be sold at the indicated price Midpoint formula for percentage change = change/midpoint Change = new – old Midpoint = (new + old)/2 Price is raised from \$14 to \$16. Solution. Old price = \$14. New price = \$16 Change in price = new price – old price = \$16 – \$14 = \$2 Midpoint price = (new + old)/2 = (\$16 + \$14)/2 = \$15 Percentage change price = change/midpoint (This is midpoint formula) = \$2/\$15 = 2/15 = .133 Calculation of price elasticity of demand problem Data Price Q D Old \$24 150 New \$30 110 Problem. Calculate the price elasticity of demand in the price region between \$24 and \$30. Solution. E D = (percentage change Q D )/ (percentage change P) percentage change Q D = (change Q D )/ (midpoint Q D ) change Q D = new – old = 110 – 150 = –40 ( midpoint Q D = (110 + 150)/2 = 260/2 = 130 percentage change Q D = -40/130 = -.308 (ignore minus sign) percentage change P = (change P)/ (midpoint P) change P = new – old = 30 – 24 = 6 midpoint P = (30 + 24)/2 = 54/2 = 27 percentage change P = 6/27 = .222 E D = (percentage change Q D )/ (percentage change P) = .308/.222 = 1.39 5 cases for values of E D , the coefficient of the price elasticity of demand 1. E D = 0 (perfectly inelastic demand) Price does not effect demand. (addict’s demand for cocaine) 2. E D between 0 and 1 (price inelastic demand) %age change in price -> smaller %age in quantity demand.

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