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2023Ch6SumMcBr - Elasticity Chapter 6 Outline What is...

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Elasticity Chapter 6
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Outline What is elasticity? Price elasticity of demand Classifications Arc elasticity and the mid-point formula Total revenue test Marginal revenue test Determinants of price elasticity of demand Cross elasticity of demand Income elasticity of demand Price elasticity of supply Determinants of price elasticity of supply Applications
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What is elasticity? Elasticity is a concept that measures a reaction or a response to a change in a market variable. For example, the law of demand states that when price decreases, quantity demanded increases. Elasticity would measure how much quantity demanded increases. For the most part, consumers of a product would either react by buying a relatively large amount more, or a relatively small amount more. If consumers react by buying a relatively large amount more (compared to the price change), economists would say that demand is relatively elastic. If consumers buy a relatively small amount more, demand would be relatively inelastic. Thus, in general, “elastic” would measure large responses, and “inelastic” would measure small responses.
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Price elasticity of demand How consumers react to price increases and decreases is known as price elasticity of demand. If the price of a product decreases, for example, consumers may choose to buy a great deal more, or not much more at all. Likewise, if the price increases, quantity demanded may decrease by large amounts or small amounts. Since quantities and prices are usually completely different amounts, elasticity is always measured through percentage changes and not absolute changes. Thus, for price elasticity of demand we would compare the percentage change in quantity demanded to the percentage change in price, as opposed to the absolute changes. For instance, if the price fell from $10 to $9, we would not measure the change as $1, but as a percentage change.
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Classifications of elasticity The basic formula for price elasticity of demand is: % in quantity demanded divided by % in price, with representing change. Comparing the % in quantity demanded to the % in price, there are five possibilities, or classifications, of elasticity. One possibility is when the % in quantity demanded is greater than the % in price, such as when the price falls by 10% and (as a result) quantity demanded increases by 20%. This case would be classified as relatively elastic. Since the numerical response (coefficient) is always treated as a positive number for price elasticity of demand, you could say that relatively elastic demand is when Ed>1, with Ed representing the elasticity of demand coefficient.
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Classifications (continued) A second possibility is when the % in quantity demanded is less than the % in price, such as when the price falls by 10% and quantity demanded increases by only 2%. This case would be classified as relatively inelastic with Ed<1.
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