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Unformatted text preview: Chapter 5: Elasticity and its Application In this chapter look for the answers to these questions# 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? How is it related to revenue &amp; expenditure? What is the price elasticity of supply? How is it related to the supply curve? What are the income and crossprice elasticities of demand? You design websites for local businesses. You charge $200 per website, and currently sell 12 websites per month. Your costs are rising (including the opportunity cost of your time), so you consider raising the price to $250. The law of demand says that you wont sell as many websites if you raise your price. How many fewer websites? How much will your revenue fall, or might it increase? $ scenario ,3&amp;ST0(0TY &amp;N) 0TS &amp;PP30(&amp;T0ON Elasticity Basic idea: Elasticity measures how much one variable responds to changes in another variable. One type of elasticity measures how much demand for your websites will fall if you raise your price. Definition: Elasticity is a numerical measure of the responsiveness of Q d or Q s to one of its determinants. ,3&amp;ST0(0TY &amp;N) 0TS &amp;PP30(&amp;T0ON 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 Loosely speaking, it measures the price sensitivity of buyers demand. ,3&amp;ST0(0TY &amp;N) 0TS &amp;PP30(&amp;T0ON Price Elasticity of Demand Price elasticity of demand equals P Q D Q ! P ! P Q P rises by 10% Q falls by 15% 15% 10% = 1.5 Price elasticity of demand = Percentage change in Q d Percentage change in P Example: ,3&amp;ST0(0TY &amp;N) 0TS &amp;PP30(&amp;T0ON Price Elasticity of Demand Along a D curve, P and Q move in opposite directions, which would make price elasticity negative. We will drop the minus sign and report all price elasticities as nonnegative numbers. P Q D Q ! P ! P Q Price elasticity of demand = Percentage change in Q d Percentage change in P ,3&amp;ST0(0TY &amp;N) 0TS &amp;PP30(&amp;T0ON Calculating Percentage Changes P Q D $250 8 B $200 12 A Demand for your websites Standard method of computing the percentage (%) change: end value start value start value x 100% Going from A to B, the % change in P equals ($250$200)/$200 = 25% ,3&amp;ST0(0TY &amp;N) 0TS &amp;PP30(&amp;T0ON Calculating Percentage Changes P Q D $250 8 B $200 12 A Demand for your websites 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 ,3&amp;ST0(0TY &amp;N) 0TS &amp;PP30(&amp;T0ON Calculating Percentage Changes So, we instead use the midpoint method : end value start value midpoint x 100% The midpoint is the number halfway between the start &amp; end values, the average of those values....
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This note was uploaded on 03/22/2011 for the course ECON 200 taught by Professor Ta during the Spring '07 term at University of Washington.
 Spring '07
 TA
 Price Elasticity

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