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# Chapter%205 - CHAPTER 5 ELASTICITY AND ITS APPLICATIONS 1...

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1 CHAPTER 5 CHAPTER 5 ELASTICITY AND ITS APPLICATIONS ELASTICITY AND ITS APPLICATIONS

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2 Main issues What is elasticity? What kinds of issues can elasticity help us understand? What is the price elasticity of demand? How is it related to the demand curve? What is the price elasticity of supply? How is it related to the supply curve? What are the income and cross-price elasticities of demand?
3 ELASTICITY   Basic idea: Elasticity measures how much one variable responds to changes in another variable. E.g how does the demand for gasoline respond to a change in the price of gasoline? Definition: Elasticity is a numerical measure of the responsiveness of Q d or Q s to one of its determinants.

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4 Price Elasticity of Demand Price elasticity of demand measures how much Q d responds to a change in P . Price elasticity of demand = Percentage change in Q d Percentage change in P It measures the price-sensitivity of buyers’ demand. 0
5 Example 0 P Q D Q 2 P 2 P 1 Q 1 P rises by 10% Q falls by 15%

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6 Price Elasticity of Demand Price elasticity of demand = Percentage change in Q d Percentage change in P 0 Price elasticity of demand = 15% 10% = 1.5 We will drop the minus sign and report all price elasticities as positive numbers
7 Calculating Percentage Changes 0 Standard method of computing the percentage (%) change: end value – start value start value x 100%

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8 Calculating Percentage Changes 0 P Q D \$250 8 B \$200 12 A
9 Calculating Percentage Changes 0 Problem : The standard method gives different answers depending on where you start. From A to B, P rises 25%, Q falls 33%, elasticity = 33/25 = 1.33 From B to A, P falls 20%, Q rises 50%, elasticity = 50/20 = 2.50 So, we instead use the midpoint method

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10 Calculating Percentage Changes Using the midpoint method, the % change in P equals 0 \$250 – \$200 \$225 x 100% The % change in Q equals 12 – 8 10 x 100% The price elasticity of demand equals = 22.6% = 40.0% 40/22.2 = 1.8
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## This note was uploaded on 01/27/2011 for the course ECON 1000 taught by Professor Ayhoo during the Spring '10 term at California Coast University.

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Chapter%205 - CHAPTER 5 ELASTICITY AND ITS APPLICATIONS 1...

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