CHAPTER_6

# CHAPTER_6 - CHAPTER 6 Extensions of Demand and Supply...

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CHAPTER 6) Extensions of Demand and Supply Analysis Price Elasticity of Demand o Price elasticity of demand: the responsiveness (or sensitivity) of consumers to a price change Elastic - Highly responsive to price changes for meals (quantity) Inelastic – consumers pay much less attention to price changes (toothpaste) o The Price-Elasticity Coefficient and Formula Ed = % change in quantity demanded of product X % change in price of product X = change in quantity demanded of X ÷ change in quantity demanded of X Original quantity demanded of X original price of X o Using Averages Midpoint formula – averages the two prices and the two quantities as the reference points for computing the percentages Ed = change in quantity ÷ change in price Sum of quantities/2 sum of prices/2 o Using Percentages If we use absolute changes, the choice of units will arbitrarily affect our impression of buyer responsiveness. By using percentages, we can correctly compare consumer responsiveness to changes in the prices of different products o Elimination of Minus Sign Law of demand – price and quantity demanded are inversely related Thus, the price-elasticity coefficient of demand Ed will always be a negative number Economists usually ignore the minus sign and simply present the absolute value of the elasticity coefficient to avoid an ambiguity that might otherwise arise. The ambiguity does not arise with supply because price and quantity supplied are positively related. o Interpretations of Ed Elastic Demand Demand is elastic if a specific percentage change in price results in a larger percentage change in quantity demanded (Ed > 1) Inelastic Demand If a specific percentage change in price produces a smaller percentage change in quantity demanded, demand is inelastic (Ed <1) Unit Elasticity A percentage change in price and the resulting percentage change in quantity demanded are the same. It is termed unit elasticity (Ed = 1) Extreme Cases Perfectly inelastic – where a price change results in no change whatsoever in the quantity demanded o Coefficient is zero – there’s no response to a change in price o Parallel to the vertical axes o Ex. An acute diabetic’s demand for insulin Perfectly elastic o Where a small price reduction causes buyers to increase their purchases from zero to all they can obtain o The coefficient is infinite o Line parallel to the horizontal axis 1

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o Ex. Raspberry grower that is selling its product in a purely competitive market o The Total-Revenue Test Total revenue (TR) – the total amount the seller receives from the sale of a product in a particular time period TR = P x Q ; P = product price, Q = the quantity demanded and sold Shown by the rectangle composed of the price and quantity on a graph, areas under the demand curve Total revenue and the price elasticity of demand are related Total-revenue test – to find out whether it is elastic or inelastic
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CHAPTER_6 - CHAPTER 6 Extensions of Demand and Supply...

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