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Chapter 3: Elasticity
1
Chapter
3
Elasticity
CHAPTER SUMMARY
The elasticity of demand measures the responsiveness of demand to changes in a
factor that affects demand.
Elasticities can be estimated for price, income, prices of
related products, and advertising expenditures.
The ownprice elasticity is the ratio of
the percentage change in quantity demanded to the percentage change in price, and is
a negative number.
Demand is price elastic if a 1% increase in price leads to more
than a 1% drop in quantity demanded, and inelastic if it leads to less than a 1% drop in
quantity demanded.
The ownprice elasticity can be used to forecast the effects of price changes on
quantity demanded and buyer expenditure.
Elasticities can be used to forecast the
effects on demand of simultaneous changes in multiple factors.
All elasticities vary with
adjustment time.
The longrun demand is generally more elastic than the shortrun
demand in the case of nondurables, but not necessarily for durables.
Elasticities can be estimated from records of past experience or test markets by
the statistical technique of multiple regression.
KEY CONCEPTS
elasticity of demand
income elasticity
cross section
ownprice elasticity
crossprice elasticity
dependent variable
arc approach
advertising elasticity
independent variable
point approach
short run
multiple regression
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© 2001, I.P.L. Png and C.W.J. Cheng
2
2. Describe the arc approach and the point approach when deriving the ownprice
elasticity of demand and discuss the properties of ownprice elasticity.
3. Discuss the intuitive determinants of price elasticity.
4. Introduce the relationship between ownprice elasticity and total revenue when
there is a price change for an elastic and inelastic item.
5. Describe the application of income elasticity, crossprice elasticity, and advertising
elasticity, as well as forecasting the effects of multiple factors on demand.
6. Explain the importance of time on elasticity.
7. Discuss the statistical estimation of elasticities.
NOTES
1.
Elasticity of demand
.
(a)
Definition
 the responsiveness of demand to changes (increase or decrease)
in an underlying factor (e.g., price of the product itself, income, prices of
related products, advertising).
(b)
Changes in any of these factors will lead to a movement along or shift of the
demand curve.
(c)
There is an elasticity corresponding to every factor (i.e., measuring the
responsiveness of demand to changes in each factor) that affects demand.
(d)
Elasticities depend on the time available for adjustment.
(e)
With elasticities, managers can forecast the effect of single or multiple changes
in the factors underlying demand.
(f)
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This note was uploaded on 12/21/2011 for the course ECON 3014 taught by Professor Michaelshaw during the Spring '11 term at HKU.
 Spring '11
 Michaelshaw

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