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Unformatted text preview: 5 Elasticity and Its Application Goals In this chapter you will ■ Learn the meaning of the elasticity of demand ■ Examine what determines the elasticity of demand ■ Learn the meaning of the elasticity of supply ■ Examine what determines the elasticity of supply ■ Apply the concept of elasticity in three very different markets Outcomes After accomplishing these goals, you should be able to ■ Calculate the price and income elasticity of demand ■ Distinguish between the price elasticity of demand for necessities and luxuries ■ Calculate the price elasticity of supply ■ Distinguish between an inelastic and elastic supply curve ■ Demonstrate the impact of the price elasticity of demand on total revenue Chapter Overview Context and Purpose Chapter 5 is the second chapter of a three-chapter sequence that deals with supply and demand and how markets work. Chapter 4 introduced supply and demand. Chapter 5 shows how much buyers and sellers respond to changes in market conditions. Chapter 6 will address the impact of government policies on competitive markets. The purpose of Chapter 5 is to add precision to our supply and demand model. We introduce the concept of elasticity, which measures the responsiveness of buyers and sellers to changes in economic variables such as prices and income. The concept of elasticity allows us to make quantitative observations about the impact of changes in supply and demand on equilibrium prices and quantities. Chapter Review Introduction In Chapter 4, we learned that an increase in price reduces the quantity demanded and increases the quantity supplied in a market. In this chapter, we will develop the concept of elasticity so that we can address how much the quantity demanded and the quantity supplied responds to changes in market conditions such as price. The Elasticity of Demand To measure the response of demand to its determinants, we use the concept of elasticity . Price elasticity of demand measures how much the quantity demanded 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. If the quantity demanded changes substantially from a change in price, demand is elastic . If the quantity demanded changes little from a change in price, demand is inelastic . Whether a demand curve tends to be price elastic or inelastic depends on the following: • Availability of close substitutes: The demand for goods with close substitutes is more sensitive to changes in prices and, thus, is more price elastic. • Necessities versus luxuries: The demand for necessities is inelastic while the demand for luxuries is elastic. Since one cannot do without a necessity, an increase in the price has little impact on the quantity demanded. However, an increase in price greatly reduces the quantity demanded of a luxury....
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This note was uploaded on 02/08/2011 for the course ECONOMICS 101 taught by Professor June during the Spring '08 term at Rutgers.
- Spring '08