Ch. 5 Sec. 1

# Ch. 5 Sec. 1 - chapter 5 > Elasticity Section 1 Defining...

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>> Elasticity Section 1: Defining and Measuring Elasticity chapter 5 Luis Tellez, who is a trained economist, knew that to calculate the cut in oil output needed to achieve his price target, he would have to know the price elasticity of demand for oil. The Price Elasticity of Demand Figure 5-1 shows a hypothetical world demand curve for oil. At a price of \$20 per barrel, world consumers would demand 10 million barrels of oil per day (point A ); at a price of \$21 per barrel, the quantity demanded would fall to 9.9 million barrels (point B ). Figure 5-1, then, tells us the response of the quantity demanded to a particular change in the price. But how can we turn this into a measure of price responsiveness? The answer is to calculate the price elasticity of demand . The price elasticity of demand compares the percent change in the price to the per- cent change in quantity demanded as we move along the demand curve. As we’ll see later in this chapter, the reason economists use percent changes is to get a measure

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that doesn’t depend on the units in which a good is measured (say, gallons versus bar- rels of oil). But before we get to that, let’s look at how elasticity is calculated. To calculate the price elasticity of demand, we first calculate the percent change in the quantity demanded and the corresponding percent change in the price as we move along the demand curve. These are defined as follows: (5-1) % change in quantity demanded 100 and (5-2) % change in price 100 In Figure 5-1, we see that when the price rises from \$20 to \$21, the quantity demanded falls from 10 million to 9.9 million barrels, yielding a change in the quan- tity demanded of 0.1 million barrels. So the percent change in the quantity demand- ed is % change in quantity demanded 100 = 1% The initial price is \$20 and the change in the price is \$1, so the percent increase in price is % change in price 100 = 5% To calculate the price elasticity of demand, we find the ratio of the percent change
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Ch. 5 Sec. 1 - chapter 5 > Elasticity Section 1 Defining...

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