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Unformatted text preview: 1 CHAPTER 5: ELASTICITY AND ITS APPLICATIONS (EXAMPLES, GRAPHS, and EXERCISES are covered in class) A) The Price Elasticity of Demand : Definition : The price elasticity of demand is a measure of the responsiveness of the quantities demanded by consumers to a change in the price of the product . The greater the elasticity of demand, the more responsive consumers are to a change in price. The price elasticity of demand is always negative by definition . For this reason, economists often report it in absolute values and exclusively focus on its magnitude; that is, on whether or not it exceeds 1 . When consumers are elastic, the price elasticity of demand is greater than 1 in absolute value. What are some of the determinants of this elasticity? i. The type of good , i.e. whether it is a NECESSITY or a LUXURY. We are very elastic with respect to luxuries since they are not absolutely necessary. Hence, if their price increases, we are more likely to stop purchasing the product. This is not the case for a necessity good, since it is something we need, such as gas to drive to school or work. ii. Availability of close substitutes : The more substitutes there are for a particular product, say butter, the more elastic we will be when it comes to purchasing butter if its price goes up. iii. How broadly defined is the produc t: When the product is very broadly defined, say LIQUIDS, we are likely to be very inelastic when it comes to purchasing that product even if its price goes up. (If we dont consume liquids, we die.) However, if the product is narrowly defined, say CHERRY COKE, then we are likely to be much more elastic....
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