Chapter%205 - ECON1200 Principles of Microeconomics Fall...

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ECON1200: Principles of Microeconomics Instructor: Ramsey Abu-Absi Fall 2009 Notes: Mankiw 5e Chapter 5 [email protected] Chapter 5 – Page 1 CHAPTER 5: Elasticity and its Application ( p.89) As a supplier, are you always better off increasing productivity so that you can sell more? This question can have surprising answers. In the previous chapter we learned that the upward sloping supply curve represents the behavior of sellers, and the downward sloping demand curve represents the behavior of buyers. The price of the good adjusts to bring the quantity supplied and the quantity demanded of the good into balance. To this we must add the concept of elasticity in order to understand whether increased productivity is more profitable for the supplier. Elasticity is a measure of the responsiveness of quantity demanded or quantity supplied to changes in market conditions. The Elasticity of Demand The discussion of demand in chapter 4 focused on how determinants of demand, such as price, income, prices of substitutes, and prices of complements affected the quantity demanded. However, only the direction of the change in demand was discussed. The concept of elasticity will allow us to determine the magnitude of the change as well. The Price Elasticity of Demand and its Determinants The law of demand states that a decrease in the price of a product raises the quantity demanded. Price elasticity of demand is a measure of how much the quantity demanded of a product responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price. Demand for a good is said to be elastic if quantity demanded is very responsive to changes in price. Demand is said to be inelastic if the quantity demanded is only slightly responsive to changes in the price. Price elasticity of demand depends on the many social, economic, and psychological forces that shape individual desires. However, there are some general rules about what can determine Price Elasticity of Demand: 1. Necessities versus Luxuries: Necessities tend to have inelastic demands, whereas luxuries have elastic demands. If a product is generally perceived as a necessity, the quantity demanded will not change dramatically if the price goes up. However, something viewed as a luxury would show a strong sensitivity to price changes. 2. Availability of Close Substitutes: A product that has close substitutes will generally exhibit elastic demand, because it is easy to switch from that product to a substitute if the price rises. 3. Definition of the Market: If a market is very narrowly defined, it will tend to exhibit more elastic demand, because if the market is very narrowly defined, it will be easier to find close substitutes. For example, if we examine a broadly defined market like the market for beverages, it will exhibit fairly inelastic demand because it is not easy to find acceptable substitutes for beverages. But if we examine the market for diet Dr. Pepper,
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Chapter%205 - ECON1200 Principles of Microeconomics Fall...

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