Ch. 5 - Elasticity We look for the answers to these...

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Elasticity See Material in Mankiw Ch. 5 We 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 & expenditure? What is the price elasticity of supply? How is it related to the supply curve? What are the income and cross-price elasticities of demand? Elasticity Frequently we need to know how sensitive quantity demanded or supplied is to changes in one of its determinants. Why not just look at the slope of the demand or supply curve? The slope depends on the units of measurement. We need a measure that is invariant of the units chosen. Elasticity For Example: An increase of 20 cents in the price of steak leads to a decrease of 2 pounds per year of steak purchases. An increase of 20 cents in the price of oranges leads to a decrease in orange purchases of .5 dozen per year. Which of these goods is more responsive to price changes? Problem: commodities are measured in different units.
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Elasticity Basic idea: Elasticity measures how much one variable responds to changes in another variable. Definition: Elasticity is a numerical measure of the responsiveness of Q d or Q s to one of its determinants. 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. 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 Q d Percentage change in P Example: 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 non-negative numbers. P Q D Q 2 P 2 P 1 Q 1 Price elasticity of demand = Percentage change in Q d 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% Calculating Percentage Changes; A Problem 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 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.
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This note was uploaded on 02/14/2012 for the course NUBITRY 3304 taught by Professor Various during the Spring '01 term at Albertus Magnus.

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Ch. 5 - Elasticity We look for the answers to these...

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