5 - 12/2/2007 Ch. 5 Elasticity Copyright 2006 Nelson, a...

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12/2/2007 1 Copyright © 2006 Nelson, a division of Thomson Canada Ltd. Ch. 5 Elasticity Copyright © 2006 Nelson, a division of Thomson Canada Ltd. Elasticity s allows us to analyze supply and demand with greater precision. s is a measure of how much buyers and sellers respond to changes in market conditions. s measures how responsive Qd or Qs is to changes in price, income or prices of related goods. Copyright © 2006 Nelson, a division of Thomson Canada Ltd. Elasticity of Demand s Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good. s Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price.
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12/2/2007 2 Copyright © 2006 Nelson, a division of Thomson Canada Ltd. s The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price. s Price elasticity = percentage change in Qd percentage change in P = % t in Qd % t in P Copyright © 2006 Nelson, a division of Thomson Canada Ltd. Types of Price Elasticity s People respond to changes in price differently depending on various factors. s Are there a large number of substitutes? s Is the good a luxury or a necessity? s How narrowly defined is the market? s What about the time period? Copyright © 2006 Nelson, a division of Thomson Canada Ltd. Calculating price elasticity s When we calculate elasticity, we calculate a numeric value called the coefficient of elasticity . s We can tell how responsive Qd is to a change in price by the value of the coefficient. s We’ll denote the coefficient for price elasticity by Ep (p for price).
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12/2/2007 3 Copyright © 2006 Nelson, a division of Thomson Canada Ltd. s If we are given percentage changes in price and the corresponding changes in Qd, we use the formula Ep = % t in Qd % t in P s For example, The price of milk increases by 2% and Qd decreases by .5% Ep = -.5/2 = -.25 Copyright © 2006 Nelson, a division of Thomson Canada Ltd. s Another formula we use is the midpoint formula . s The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change. s We use it when we are given two prices and their corresponding Qd values. Copyright © 2006 Nelson, a division of Thomson Canada Ltd. s The midpoint formula is: Ep = (Q 2 – Q 1 ) / ([Q 2 + Q 1 ] / 2) (P 2 – P 1 ) / ([P 2 + P 1 ] / 2) s Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand would be calculated as:
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12/2/2007 4 Copyright © 2006 Nelson, a division of Thomson Canada Ltd. s
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5 - 12/2/2007 Ch. 5 Elasticity Copyright 2006 Nelson, a...

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