Quiz3Notes - Elasticity and its applications THE ELASTICITY...

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Elasticity and its applications 16/09/2007 14:07:00 THE ELASTICITY OF DEMAND Elasticity:   a measure of the responsiveness of quantity demanded or quantity  supplies to on of its determinants Consumers buy more when Income is higher Prices are lower Price of a substitute is higher Price of a complement is low  THE PRICE ELASTICITY OF DEMAND AND ITS DETERMINANTS Price elasticity of demand:  a measure of how much the quantity demanded of  a good responds to a change in the price of that good, computed as Percentage change in demand/ Percentage change in price o Elastic:  demand changes substantially with price. > 1 o Inelastic:  a straight line like an I, demand does not vary much with  price. <1 o Unit elastic:  quantity demanded moves the same amt proportionately  as price. 22% increase in price causes a 22% decrease in demand. = 1 o Elasticity is the result of the economic, social, and psychological forces  that shape consumer tastes o Goods with close substitutes are more elastic because it is easier to  find a replacement when prices increase, saving the consumer money o Necessities are have more inelastic demand because they are needed,  versus luxuries that are a treat, and not essential to survival
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o Narrowly defined markets tend to have more elastic demand bc it is  easier to find a close substitute. Food: broad, no good substitutes for  food. Vanilla ice cream: narrow, can buy chocolate instead o Elasticity is greater over longer time pds because comsumers can  adjust. Ex: gass prices increase, consumers can buy more fuel efficient  cars, and carpool, and work out ways to save o COMPUTING THE PRICE ELASTICITY OF DEMAND Midpoint method                       (Q – Q 1 )       ÷ (P – P 1 )                  [( Q 2  + Q 1 )/2]     [( P 2  + P 1 )/2]  Total Revenue and the Price Elasticity of Demand Total Revenue:  the amt paid by buyers and received by sellers of a good,  computed as the price times quantity sold If demand is inelastic, increase in price also means an increase in total  revenue If demand is elastic, an increase in price lowers the demand, and thus total  revenue ELASTICITY AND TOTAL REVENUE ALONG A LINEAR DEMAND CRUVE A linear demand curve has a constant slope:  ratio of changes in quantity  demanded and price While slops is linear, elasticity is not:  ratio of percentage changes in quantity  demanded and price-  these percentages become larger as the price  increases more or demand decreases, because the Q 2  is substantially farther 
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