ECN 112 Chapter 5 Lecture Notes.doc - ECN 112 Chapter 5 Lecture Notes 5.1 The Price Elasticity of Demand The price elasticity of demand is a measure of

ECN 112 Chapter 5 Lecture Notes.doc - ECN 112 Chapter 5...

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ECN 112 Chapter 5 Lecture Notes 5.1 The Price Elasticity of Demand The price elasticity of demand is a measure of the extent to which the quantity demanded of a good changes when the price of the good changes and all other influences on buyers’ plans remain the same. A. Percentage Change in Price 1. The midpoint method uses the average of the initial price and new price in the denominator when calculating a percentage change. Because the average price is the same between two prices regardless of whether the price falls or rises, the percentage change in price calculated by the midpoint method is the same for a price rise and a price fall. a. Using the midpoint formula, the percentage change in price equals . 100 × 2 ÷ price Initial + price New price Initial price New B. Percentage Change in Quantity Demanded Use the midpoint method when calculating the percentage change in quantity. . 100 2 quantity Initial quantity New quantity Initial quantity New 1. Minus Sign Because a change in price causes an opposite change in quantity demanded, for the price elasticity of demand we focus on the magnitude of the change by using the absolute value. C. Elastic and Inelastic Demand The price elasticity of demand falls into three categories: 1. Elastic demand —when the percentage change in the quantity demanded exceeds the percentage change in price (which means the elasticity is greater than 1). 2. Unit elastic demand —when the percentage change in the quantity demanded equals the percentage change in price (which means the elasticity equals 1). 3. Inelastic demand —when the percentage change in the quantity demanded is less than the percentage change in price (which means the elasticity is less than 1). 4. There are two extreme cases: a. Perfectly elastic demand —when the quantity demanded changes by a very large percentage in response to an almost zero percentage change in price. b. Perfectly inelastic demand —when the quantity demanded remains constant as the price changes. D.Influences on the Price Elasticity of Demand 1. Substitution Effect If good substitutes are readily available, demand is elastic. If good substitutes are hard to find, demand is inelastic.
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