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**Unformatted text preview: **Chapter 3: Elasticity Chapter 3: Elasticity Price elasticity demand supply Cross elasticity Income elasticity Basic idea Basic idea We know when P Qd Qs holding other factors constant but how much? but how much? if price doubles how much does Qd fall? by 10% by 50% by 300%? price elasticity tells us I. Price Elasticity of Demand I. Price Elasticity of Demand example mocha latte at Starbucks price rises from $3 to $5 per cup Qd falls from 15 to 5 cups per hr. equation equation % change in Qd % change in P % change in Qd % change in Qd new Qd - initial Qd average Qd x 100 midpoint method example example 5 cups - 15 cups (5+15)/2 cups x 100-10 cups 10 cups x 100 = -100% % change in P % change in P new P - initial P average P x 100 midpoint method example example $5 - $3 ($5+$3)/2 x 100 $2 $4 x 100 = 50% demand elasticity demand elasticity % change in Qd % change in P-100% 50% = -2 If price of latte increases 1%, Qd of latte decreases 2% demand elasticity demand elasticity a unit-free measure compare all goods & services changes for different points on the demand curve if price elasticity of demand if price elasticity of demand (absolute value) (absolute value) = 1 unit elastic % change Qd = % change P > 1 elastic % change Qd > %change P sensitive to P changes < 1 inelastic % change Qd < %change P not sensitive to P changes elastic demand elastic demand (>1) (>1) flatter curve P Q D small change in P big change in Qd inelastic demand inelastic demand (<1) (<1) steep curve P Q D big change in P small change in Qd perfectly inelastic demand perfectly inelastic demand vertical line P Q D change in P no change in Qd perfectly elastic demand perfectly elastic demand horizontal line P Q D any change in P Qd falls to zero effect on total revenue...

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