Chap_04 - Chapter 4: Elasticity Purpose: Elasticity is an...

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Chapter 4: Elasticity Purpose: Elasticity is an important concept in microeconomics. This chapter defines elasticity and provides many examples to show its importance in understanding how a market works. Emphasis is on the price elasticity of demand, but income elasticity of demand, cross elasticities, and the elasticity of supply are defined and considered. Length : 26 pages Time required to read: Two hours. More if the exercises are worked and the examples are considered. Number of lectures required for understanding: One 50 minute lecture period allows definition of the concept. A second lecture may be used to either expand/explain the examples in the chapter’s narrative or to introduce additional examples or problems. Summary : The chapter opens by posing questions relating to the illicit drug trade. Will an increase in the street price of drugs increase or decrease the quantity used? Will it increase or decrease the total expenditures on the illegal products? And more importantly, will an increase in the price of drugs set off an increase in the number of crimes against property? These question set off discussions of the responsiveness (sensitivity) of quantities purchased to changes in price. A graph (Figure 4.1) and a cartoon in the margin on page 92 help set the stage for definitions and discussions. Elasticity is defined in terms of percentage changes in the quantity demanded that come in response to specific percentage changes in price. “Elastic” (responsive) and “inelastic” (unresponsive) situations are explained before three determinants – s ubstitution possibilities, budget shares, and time -- are mentioned. Empirically estimated price elasticities are presented for several common consumer items. Policy implications of elasticity are shown through consideration of a tax on cigarettes and a tax on yachts. The former is hypothetical while the latter is based on actual experience.
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Graphs and formulae are used to explain the calculation of price elasticity. Differing elasticities along a single straight-line demand curve are explained as are the extreme cases of perfectly elastic and perfectly inelastic demands. Graphs show the important relationship between elasticity and total revenue. Income elasticity and cross elasticities are mentioned. The price elasticity of supply is defined and its determinants are listed as flexibility of inputs, mobility of inputs, substitute inputs, and time. The chapter ends with a reference to the limiting characteristics of a unique input such as the star player on a basketball team. Outline: 1. Introduction 2. Price Elasticity of Demand a. Price Elasticity Defined b. Determinants of Price Elasticity i. Substitution Possibilities ii. Budget Share iii. Time iv. Recap c. Some Representative Elasticity Estimates d. Using Price Elasticity of Demand 3. A Graphical Interpretation of Price Elasticity a. Price Elasticity Changes Along a Straight Line b. Two Special Cases c. Recap 4. Elasticity and Total Expenditure a. Income Elasticity and Cross-Price Elasticity of Demand
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Chap_04 - Chapter 4: Elasticity Purpose: Elasticity is an...

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