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3-Elasticity - Elasticity and Its Applications(Chapter 5...

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Elasticity and Its Applications (Chapter 5) Principles of Microeconomics Mankiw et al. 5th Cdn Edition Introduction to Microeconomics (ECO 1104F) University of Ottawa – Spring 2011
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3. Elasticity 2 Look for the answers to these questions: 1. What is elasticity? What kinds of issues can elasticity help us understand? 2. What is the price elasticity of demand? How is it related to the demand curve? How is it related to revenue & expenditure? 3. What is the price elasticity of supply? How is it related to the supply curve? 4. What are the income and cross-price elasticities of demand?
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3. Elasticity 3 Elasticity Measures how much one variable responds to changes in another variable. One type of elasticity measures how much the quantity demanded for your websites will fall if you raise your price. Elasticity a numerical measure of the responsiveness of Qd (quantity demanded) or Qs (quantity supplied) to one of their determinants.
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Price Elasticity of Demand Price elasticity of demand measures how much Qd or Qs respond to a change in one of their determinants. Loosely speaking, it measures the price- sensitivity of buyers’ demand. s to a change in P . Price elasticity of demand = Percentage change in Qd Percentage change in P
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Price Elasticity of Demand Price elasticity of demand equals P Q D Q 2 P 2 P 1 Q 1 P rises by 10% Q falls by 15% 15% 10% = 1.5 Price elasticity of demand = Percentage change in Qd Percentage change in P Example:
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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 positive numbers. P Q D Q 2 P 2 P 1 Q 1 Price elasticity of demand = Percentage change in Qd Percentage change in P
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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%
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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
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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 & end values, also the average of those values. It doesn’t matter which value you use as the “start” and which as the “end” – you get the same answer either way!
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Percentage Changes Using the midpoint method, the % change in P equals $250 – $200 $225 x 100% = 22.2% The % change in Q equals 12 – 8 10 x 100% = 40.0% The price elasticity of demand equals 40/22.2 = 1.8
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Calculating Price Elasticity Use the following information to calculate the price elasticity of demand for hotel rooms: if P = $70, Q d = 5000 if P = $90, Q d = 3000 11 % change in Q d = (5000 – 3000)/4000 = 50% % change in P = ($90 – $70)/$80 = 25% The price elasticity of demand = 50% / 25% = 2
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Barrels of Oil Before After Price $9.50 $10.50
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