Chapter 5 notes .docx - Chapter 5 Elasticity and its application 5-1 The Elasticity of Demand Elasticity a measure of the responsiveness of quantity

# Chapter 5 notes .docx - Chapter 5 Elasticity and its...

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Chapter 5: Elasticity and its application 5-1 The Elasticity of Demand Elasticity : a measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants 5-1 A: The Price Elasticity of Demand and Its Determinants Law of demand states that a fall in the price of a good raises the quantity of demanded. Price elasticity of demand: a measure of how much the quantity demanded of a good responds to a change in the price of the good, computes ad the percentage change in quantity demanded divided by the percentage change in price Demand is elastic if the quantity demanded responds substantially to changes in price Demand is inelastic of the quantity demanded responds only slightly to changes in the price Availability of close substitutes: o Goods with close substitutions tend to have more elastic demand because of its easier for consumers to switch from that good to others Ex. Butter and margarine are easily substitutable. A small increase in the price of butter, assuming the price of margarine is held fixed, caused the quantity of butter sold to fall by a large amount. By contrast, because eggs are a food without a close substitute, the demand of eggs is less elastic than the demand for butter Necessities vs. luxuries: o Necessities tend to have inelastic demands, whereas luxuries have elastic demands. o Depends of the preferences of the buyer Ex. When the price of a visit to the dentist rises, people will not dramatically alter the number of times they go to the dentist, although they may go somewhat less often. By contrast, when the price of sailboats raises, the quantity of sailboats demanded fall substantially. The reason is that most people view dentist visits as a necessity and sailboats as a luxury. Definition of the market: o The elasticity of demand in any market depends of how we draw boundaries of the market. o Narrowly defined markets tend to have more elastic demand than broadly defined markets b/c it is easier to find close substitutions for narrowly defined goods Ex. Food, a broad category, has a fairly inelastic demand b/c there are no good substitutes for food. Ice cream, a more narrow category, has more elastic demand b/c it is easy to substitute other desserts for ice cream. Vanilla ice cream, a very narrow category, has a very elastic demand
because other flavours of ice cream are almost perfect substitutes for vanilla Time Horizon: o Goods tend to have more elastic demand over longer time horizons. Ex. When the price of gasoline rises, the quantity of gasoline demanded falls only slightly in the first few months. Over time, however, people buy more fuel-efficient cars, switch to public transportation, or move closer to where they work. Within several years, the quantity of gasoline demands falls substantially 5-1 B: Computing the price Elasticity of demand priceelasticityof demand = Percentage change quantity demanded Percentagechange price Or PED = Q 2 Q 1 ∕ midQ P 2 P 1 ∕ mid P Ex. Suppose that a 10 percent increase in the price of an ice-cream cone causes the amount of

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