Chapter 5

# Chapter 5 - Chapter 5 Elasticity of Demand and Supply So...

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Chapter 5 Elasticity of Demand and Supply So far we have learned that a change in the price of good X changes the quantity demanded and the quantity supplied of that good. In this, an increase in the price of X decreases the quantity demanded and increases the quantity supplied of that good. For example, when the price of burger goes up, consumers reduce the quantity demanded of burger but the producers of burger increases the quantity supplied. Price Elasticity of Demand You have already learned that when price rises, the quantity demanded falls and when price falls, the quantity demanded rises. While it is useful to know the direction of movement of quantity as price changes, it is also important to know the magnitude of the change. A firm may decide to increase the price of a product if customers consume only slightly less at a higher price, but not to increase the price if customers consume much less at the higher price. This magnitude of change in quantity demanded with change in price is known as price elasticity of demand . Price Elasticity of Demand is nothing but a measure of the sensitivity or responsiveness of the quantity demanded due to a change in the price. It is the percentage change in quantity demanded divided by the percentage change in the price . Price Elasticity of Demand (denoted E D ) can be calculated as the following: Price Elasticity of Demand (E D ) = (Percentage Change in Quantity Demanded) (Percentage Change in Price) Examples General Example Suppose that when the price of good X changes from price (p) to (p’), other things being constant, the quantity demanded of X changes from quantity (q) to quantity (q’). The percentage change in quantity demanded= ((q’-q)/q) The percentage change in price = ((p’-p)/p) Price Elasticity of Demand (E D ) = ((q’-q)/q) / ((p’-p)/p)

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1. Say that when the price of a cup of coffee increases from 10 AED to 12 AED per cup, the quantity demanded for coffee decreased from 5 cups to 4. This change is depicted in the following figure. Find the price elasticity of demand for coffee for this change? Demand Curve for Coffee From the figure above, you can see that when the price of coffee goes down from 10 to 12, the quantity demanded decreases from 5 to 4, a move from point A to point B. So what is the price elasticity of demand when the price of coffee goes up from 10 to 12 – that is, what is the price elasticity of demand when we move from points A to point B in the figure above? Note here that q = 5, q’= 4, p = 10, and p’=12. Applying the formula for the price elasticity of demand for coffee we get: The percentage change in quantity demanded = ((q’-q)/q) = ((4-5)/5) = - 0.20 The percentage change in price = ((p’-p)/p) = ((12-10)/10) = 0.20 E D = (The percentage change in quantity demanded)/(The percentage change in price) = (-0.20)/(0.20) = -1.0 Interpretation : This numbers says that in response to the 20% increase in the price of coffee, the quantity demanded for coffee decreased by 20%.
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## This note was uploaded on 03/08/2011 for the course ECON 201 taught by Professor Azzam during the Spring '11 term at Alabama.

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Chapter 5 - Chapter 5 Elasticity of Demand and Supply So...

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