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blanchard_ch04 - 9160335_CH04_p081-102.qxd 8:57 AM Page 81...

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What are the effects of a high gas price on buying plans? You can see some of the biggest effects at car dealers’ lots, where SUVs and other gas guzzlers remain unsold while sub-compacts and hybrids sell in greater quantities. But how big are these effects? When the price of gasoline doubles, as it has done over the past few years, by how much does the quan- tity of SUVs sold decrease, and by how much does the quantity of sub-compacts sold increase? And what about gasoline purchases? Do we keep filling our tanks and spending more on gas? Or do we find substitutes on such a large scale that we end up cutting our expenditure on gas? This chapter introduces you to elasticity: a tool that addresses these quantitative questions. At the end of the chapter, in Reading Between the Lines , we’ll use the concept of elasticity to explain what was happening in the markets for gasoline and automobiles in 2008. But we’ll explain and illustrate elasticity by studying another familiar market: the market for pizza. Elasticity 4 81 Define, calculate, and explain the factors that influence the price elasticity of demand Define, calculate, and explain the factors that influence the cross elasticity of demand and the income elasticity of demand Define, calculate, and explain the factors that influence the elasticity of supply After studying this chapter, you will be able to:
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Price Elasticity of Demand You know that when supply increases, the equilibrium price falls and the equilibrium quantity increases. But does the price fall by a large amount and the quantity increase by a little? Or does the price barely fall and the quantity increase by a large amount? The answer depends on the responsiveness of the quantity demanded to a change in price. You can see why by studying Fig. 4.1, which shows two possible scenarios in a local pizza market. Figure 4.1(a) shows one scenario, and Fig. 4.1(b) shows the other. In both cases, supply is initially S 0 . In part (a), the demand for pizza is shown by the demand curve D A . In part (b), the demand for pizza is shown by the demand curve D B . Initially, in both cases, the price is $20 a pizza and the equilibrium quantity is 10 pizzas an hour. Now a large pizza franchise opens up, and the sup- ply of pizza increases. The supply curve shifts right- ward to S 1 . In case (a), the price falls by an enormous $15 to $5 a pizza, and the quantity increases by only 3 to 13 pizzas an hour. In contrast, in case (b), the price falls by only $5 to $15 a pizza and the quantity increases by 7 to 17 pizzas an hour. The different outcomes arise from differing degrees of responsiveness of the quantity demanded to a change in price. But what do we mean by responsiveness? One possible answer is slope. The slope of demand curve D A is steeper than the slope of demand curve D B .
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