Ch. 5 Sec. 2

Ch. 5 Sec. 2 - chapter 5 > Elasticity Section 2:...

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>> Elasticity Section 2: Interpreting the Price Elasticity of Demand chapter 5 Mexico and other oil-producing countries believed they could succeed in driving up oil prices with only a small decrease in the quantity sold because the price elasticity of oil demand was low. But what does that mean? How low does a price elasticity have to be for us to classify it as low? How high does it have to be for us to consider it high? And what determines whether the price elasticity of demand is high or low, anyway? To answer these questions, we need to look more deeply at the price elasticity of demand. How Elastic Is Elastic? As a first step toward classifying price elasticities of demand, let’s look at the extreme cases. First, consider the demand for a good when people pay no attention to the price— say, shoelaces. Suppose that U.S. consumers will buy 1 billion pairs of shoelaces per
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year regardless of the price. In this case, the demand curve for shoelaces would look like the curve shown in panel (a) of Figure 5-2: it would be a vertical line at 1 billion pairs of shoelaces. Since the percent change in the quantity demanded is zero for any change in the price, the price elasticity of demand in this case is zero. The case of a zero price elasticity of demand is known as perfectly inelastic demand . The opposite extreme occurs when even a tiny rise in the price will cause the quantity demanded to drop to zero or even a tiny fall in the price will cause demand to get much larger. Panel (b) of Figure 5-2 shows the case of pink tennis balls; we suppose that tennis players really don’t care what color their balls are and that other colors, such as neon green and livid yellow, are available at $5 per dozen balls. In this case, consumers will buy no pink balls if they cost more than $5 per dozen but will buy only pink balls if they cost less than $5. The demand curve will therefore be a horizontal line at a price of $5 per dozen balls. As you move back and forth along this line, there is a change in the quantity demanded but no change in the price. Roughly speaking, when you divide a number by zero, you get infinity, so a horizontal demand curve implies an infinite price elasticity of demand. When the price elasticity of demand is infinite, economists say that demand is perfectly elastic . The price elasticity of demand for the vast majority of goods is somewhere between these two extreme cases. Economists use one main criterion for classifying these intermediate cases: they ask whether the price elasticity of demand is higher or lower than 1. When the price elasticity of demand is greater than 1, economists say that demand is elastic . When the price elasticity of demand is less than 1, they say that demand is inelastic . The borderline case is unit-elastic demand , where the price elasticity of demand is—surprise—exactly 1.
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This note was uploaded on 04/13/2010 for the course ECON 1110 taught by Professor Wissink during the Fall '06 term at Cornell.

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Ch. 5 Sec. 2 - chapter 5 > Elasticity Section 2:...

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