Ch04-7e[1] - ELASTICITY 4 CHAPTER Tough Times in the...

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ELASTICITY 4 CHAPTER
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Tough Times in the Recording Industry More and more people are illegally downloading music rather than paying $12 for a CD. CD producers are loosing revenue and some of them are trying to combat the problem by slashing the price of a CD. Will this strategy work? Can lower priced CDs beat illegal downloads, bring greater revenue to the recording industry and artists, and help to promote the social interest? The concept of elasticity helps to answer these questions.
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Price Elasticity of Demand In Figure 4.1a, a change in supply brings a small increase in the quantity demanded and a large fall in price.
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Price Elasticity of Demand In Figure 4.1b, a change in supply brings a large increase in the quantity demanded and a small fall in price.
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Price Elasticity of Demand The contrast between the two outcomes in Figure 4.1 highlights the need for a measure of the responsiveness of the quantity demanded to a price change.
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Price Elasticity of Demand The price elasticity of demand is a units-free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buyers’ plans remain the same. Calculating Elasticity The price elasticity of demand is calculated by using the formula: Percentage change in quantity demanded Percentage change in price
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Price Elasticity of Demand To calculate the price elasticity of demand: We express the change in price as a percentage of the average price— the average of the initial and new price, and we express the change in the quantity demanded as a percentage of the average quantity demanded—the average of the initial and new quantity.
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Price Elasticity of Demand Figure 4.2 calculates the price elasticity of demand for pizza. The price initially is $20.50 and the quantity demanded is 9 pizzas an hour.
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Price Elasticity of Demand The price falls to $19.50 and the quantity demanded increases to 11 pizzas an hour. The price falls by $1 and the quantity demanded increases by 2 pizzas an hour.
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Price Elasticity of Demand The average price is $20 and the average quantity demanded is 10 pizzas an hour.
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Price Elasticity of Demand The percentage change in quantity demanded, % Q , is calculated as Q / Q ave , which is 2/10 = 1/5. The percentage change in price, % P , is calculated as P / P ave , which is $1/$20 = 1/20.
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Price Elasticity of Demand The price elasticity of demand is (1/5)/(1/20) = 20/5 = 4.
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Price Elasticity of Demand By using the average price and average quantity , we get the same elasticity value regardless of whether the price rises or falls. The ratio of two proportionate changes is the same as the ratio of two percentage changes. The measure is units free because it is a ratio of two percentage changes and the percentages cancel out.
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