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Unformatted text preview: Chapter 6: Extensions of Demand and Supply Analysis Price elasticity of demand How much the quantity demanded changes with a given change in price of item, change in consumers income, or change in price of related product Ed = Percentage change in quantity demanded of X Percentage change of price of product X Midpoint formula Averages two prices and two quantities because percentages differ when going up or going down for same prices. Ed = change in quantity / change in price_ sum of quantities/2 sum of prices/2 Elastic demand If a specific percentage change in price results in a larger percentage of quantity demanded, then Ed will be greater than 1 Inelastic demand If a specific percentage change in price produces a smaller percentage change in quantity demanded, then Ed will be less than 1 Unit elasticity Percentage change in price and resulting percentage change in quantity demanded are the same Perfectly inelastic demand Price change results in no change whatsoever in quantity demanded, Ed = 0 and the graph is a line parallel to the vertical axis Perfectly elastic demand Small price reduction causes buyers to increase their purchases from zero to all they can obtain and Ed is infinite, the graph is a line parallel to the horizontal axis Total revenue (TR) Total amount the seller receives from the sale of a product in a particular time period (TR = P x Q) Total-revenue test Note what happens to total revenue when price changes: if total revenue changes in the opposite direction from price, demand is elastic. If total revenue changes in the same direction as price, demand is inelastic. If total revenue does not change when price changes, demand is unit-elastic. Price elasticity of supply How responsive producers are to price changes. Es is almost like Ed except it is quantity supplied than quantity demanded Market period The period that occurs when the time immediately after a change in market price is too short for producers to respond with a change in quantity, so the supply curve is perfectly inelastic Short run Period of time too short to change plant capacity, but long enough to use fixed plant more or less intensively and so it is more elastic than the market period Long run A time period long enough for firms to adjust their plant sizes are for new firms to enter (or existing firms to leave) the industry, so it is the most elastic (more adjustments can be made over time and quantity can be changed more relative to a small change in price) Cross elasticity of demand Measures how sensitive consumer purchases of one product are to a change in the price of some other product: Exy = percentage change in quantity demanded of X Percentage change in price of product Y If Exy is positive (move in same direction), then X and Y are substitute goods. Bigger Exy = greater substitutability....
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