Elasticity

# Elasticity - Elasticity 1 2 The Problem with Rate Change...

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1 Elasticity

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3 The Problem with Rate Change • Rate of change of quantity demanded compared to the change in price is not a good measure of price sensitivity – Doesn’t tell whether a change in price or a change in quantity demanded is a relatively large or relatively small change • Relative means compared to value of price or quantity before change

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4 The Elasticity Approach Elasticity approach improves on the problems with rate of change – By comparing percentage change in quantity demanded with percentage change in price Price elasticity of demand (E D ) for a good is percentage change in quantity demanded divided by percentage change in price Will virtually always be a negative number Tells us percentage change in quantity demanded for each 1% increase in price Price elasticity of demand tells us percentage change in quantity demanded caused by a 1% rise in price as we move along a demand curve from one point to another
5 Calculating Price Elasticity of Demand When calculating elasticity base value for percentage changes in price or quantity is always midway between initial value and new value – When price changes from any value P 0 to any other value P 1 , we define the percentage change in price as – When quantity demanded changes from Q 0 to Q 1 , percentage change is calculated as

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6 Figure 3: Calculating Price Elasticity of Demand Quantity of Laptops C Price per Laptop 100,000 200,000 300,000 400,000 500,000 600,000 \$3,500 3,000 2,500 2,000 1,500 1,000 B A D D
7 An Example: Calculating Price Elasticity of Demand • Now let’s calculate an elasticity of demand for laptop computers using data in Figure 3 from point A to point B • Use percentage changes for price and quantity to calculate price elasticity of demand (E D )

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8 An Example: Calculating Price Elasticity of Demand Now let’s calculate an elasticity of demand for laptop computers using data in Figure 3 from point C to point D • Use percentage changes for price and quantity to calculate price elasticity of demand (E D )
9 Elasticity and Straight-Line Demand Curves As we move upward and leftward along a straight-line demand curve – Same absolute increment in price will correspond to smaller and smaller percentage increments in price Because base price used to calculate percentage changes keeps rising As we move upward and leftward along a straight-line demand curve – Same absolute decrease in quantity corresponds to larger and larger percentage decreases in quantity As we move upward and leftward by equal distances, percentage change in quantity rises and Percentage change in price falls Elasticity of demand varies along a straight-line demand curve – Demand becomes more elastic as we move upward and leftward

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10 Figure 4: Elasticity and Straight-Line Demand Curves Quantity Price and since equal quantity decreases (horizontal arrows) are larger and larger percentage decreases . . . Since equal dollar increases (vertical
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Elasticity - Elasticity 1 2 The Problem with Rate Change...

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