xid-5590147_2 - Tuesday Sept 13 1 E lasticity...

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T uesday, Sept. 13 1. E lasticity - Responsiveness of quantity to change in price. a. Price elasticity of demand - % change in Qd / % change in P Calculation of price elasticity of demand: Use arc elasticity formula: e = (Q 2 - Q 1 )/(Q 1 + Q 2 )/2 (P 1 - P 2 )/(P 1 + P 2 )/2 : e can be >1 (elastic; relatively responsive), =1 (unitary elastic) < 1, (inelastic, relatively unresponsive) Elasticity - Illustration: Suppose P 1 = 25 Q 1 = 100 P 2 = 30 Q 2 = 90 e = (90-100)/((190)/2) (30-25)/((55)/2) e = (10)/(95) = .1053 = .579 (5)/(27.5) .1818 The elasticity coefficient is less than 1, so demand is relatively inelastic… - quantity demanded falls by a relatively small amount with respect to change in price - total revenue (total expenditure) rises (and falls) with price Explanation: The coefficient of elasticity, e, is equal to .579. Since it is less than one, it indicates that demand is inelastic, or relatively unresponsive to a change in price. The law of demand tells us that price and quantity are inversely related, so the coefficient will always be a negative number. To simplify things, economists have adopted the convention of dropping the negative sign (since it's understood) and simply report the absolute value of the coefficient. 1
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Since demand is inelastic, price and total revenue (price x quantity) change in the same direction: when price rises (as in the example) total revenue rises as well. When demand is elastic (when the coefficient is greater than one) total revenue would fall when price rises, and rise when it falls. How do you interpret the coefficient (in this case, .579)? It tells us the percent change in quantity demand when price changes by 1%. The coefficient of .579 means that, in this range of the demand curve, an increase in price of 1% will result in a fall in quantity demanded of .579% (slightly over 1/2 of 1 percent). When demand is elastic, price increase leads to decrease in total revenue.
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xid-5590147_2 - Tuesday Sept 13 1 E lasticity...

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