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Notes for Test 2

# Notes for Test 2 - nd Chapter6(183195)2 Half 09:09:00 Price...

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Chapter 6 (183-195) 2 nd  Half  28/09/2010 09:09:00 Price elasticity of Demand (Ed) The responsiveness of Qd to a change in P Ed= % ∆ Qd = always (-) from law of demand % ∆ P o typically reported in absolute value |Ed| (the “|” symbolizes absolute value) o 0 < |Ed| < 1 Inelastic (Qd not very responsive to ∆ in P) o |Ed| > 1 Elastic (Qd responsive to ∆ in P) o |Ed| = 1 Unit elastic (Qd ∆’s by exact % ∆ as ∆ in P) o |Ed| = 0 Perfectly Inelastic (Qd not at all responsive to ∆ in P) o |Ed| = ∞ Perfectly elastic (Qd incredibly responsive to ∆ P |Ed| >1 elastic o consumer very responsive to P o luxury goods, donuts, candy |Ed| < 1 Inelastic o consumers not responsive o necessary, gasoline, TP, utilities, food, healthcare, medication P of butterfingers decreases by 20% and Qd increases by 25% o Ed = % ∆ Qd = 25 = |-1.25| > 1 elastic o % ∆ P -20 P of insulin increases by 15% Qd decreases by 2.5%

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o Ed = -2.5 = |-1.667| < 1 inelastic o 15 Gum (see graph 6.1) o mid point formula: Ed = q 2 – q 1 divided by P 2 – P 1 (q 1 + q 2 / 2) (P 1 + P 2 / 2) see next to graph for rest of the equations see 6.2 for inelastic vs. elastic graphs see 6.3 for perfectly inelastic vs. perfectly inelastic graphs o if you are a firm you would want to sell inelastic goods What determines Ed 1) * Availability of close substitutes * 2) Necessities vs. Luxuries 3) Definition of the market o narrowly defined markets will be more elastic corn vs. all veggies; t-shits vs. clothes 4) Time horizon o over longer periods of time demand for goods become increasingly elastic as you can find more substitutes gasoline (inelastic in the short run) buy bus pass/ bike with time 5) Share of consumers budget o small share items tend to be elastic
o large share items tend to be inelastic Firms and Ed Total revenue (Tr): the total amount of funds received by a seller of a g/s o If Ed < 1, and we increase P Tr increases For inelastic goods, P and Tr are positively related o If Ed > 1, and we increase the P Tr decreases For elastic goods, P and Tr are negatively related See graph 6.4 See graph 6.5 o If increase in P, loss two customers o See NB for equations |Ep| = % ∆ Qd % ∆ P < 1 inelastic > 1 elastic Ep and TR firms Inelastic (P, TR (+) related) Elastic (P, TR (-) related) See graph 6.6

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o Ed = holding PINTE constant Other elasticities: Income elasticity of Demand (EI) a measure of how much the Qd of a good responds to a ∆ in income o Two types of goods: normal and inferior o E I : % ∆ Qd o % ∆ I o cannot do absolute value for this o < 0 inferior good o > 0 normal good example: Joan’s income increases from \$1,500 to \$2,000 a month as a result her Qd of snickers increases from 20 to 27 a month snickers are a normal good because as income increased, her Qd fro snickers increased EI = q 2 – q 1 divided by I 2 – I 1 (q 2 + q 1 / 2) (I 2 + I 1 / 2) = 27-20 divided by 2,000-1,500 (27 + 20 / 2) (2,000+1,500/2) cross price elasticity= a measure of how the Qd of a good responds to a ∆ in another goods price o E
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Notes for Test 2 - nd Chapter6(183195)2 Half 09:09:00 Price...

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