Chapter 5 Notes - Chapter 5 Notes: Elasticity and Its...

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Chapter 5 Notes: Elasticity and Its Application The Elasticity of Demand Elasticity: a measure of the responsiveness of quantity demanded or quantity supplied to one of its detriments o Used to measure how much consumers respond to changes in certain variables The Price Elasticity of Demand and its Detriments Law of demand states that a fall in the price of a good raises the quantity demanded Price elasticity of demand measures how much quantity demanded responds to a change in price o Computed as the percentage change in quantity demanded divided by the percentage change in price o Demand for a good is elastic quantity demanded responds substantially to changes in the price o Demand is inelastic Quantity demanded responds only slightly to changes in price o Measures for any good how willing consumers are to move away from the good as its price rises o Reflects the many economic, social, psychological forces that shape consumer tastes Availability of Close Substitutes Goods with close substitutes tend to have more elastic demand o Easier for consumers to switch from that good to others o Butter and margarine are easily substitutable A small increase in the price of butter, assuming the price of margarine is fixed, causes the quantity of butter sold to fall by a lrge amount Necessities versus Luxuries Necessities tend to have inelastic demands o If price of the doctor rises people will still go Luxuries have elastic demands o When price of sailboats rises, the quantity of sailboats demanded falls substantially This is not always the case o Whether a good is a necessity or a luxury depends not on the intrinsic properties of the good but of the preferences of the buyer Definition of the Market Elasticity of demand in any market depends on how we draw boundaries of the market o Narrowly defined Markets tend to have more elastic demand than broadly defined markets Easier to find close substitutes for narrowly defined goods Food is inelastic because there are no substitutes for food Ice cream is elastic because it is easy to find other desserts Time Horizon Goods tend to have more elastic demand over longer time horizons
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When price of gas rises, the quantity of gas demanded falls only slightly in the first few months Over time people buy more fuel-efficient cars, switch to public transportation, and move close to where they work Within several years, the quantity of gas demanded falls substantially Computing the Price Elasticity of Demand How to measure price elasticity o Price elasticity = percentage change in quantity demanded/% change in price o Example: 10% increase in the price of ice cream cone causes the amount of ice cream you buy to fall by 20% You calculate your elasticity of demand as: Elasticity= 20/10=2 The change in the quantity demanded is proportionally twice as large as the change in price o Quantity demanded of a good is negatively related to price
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Chapter 5 Notes - Chapter 5 Notes: Elasticity and Its...

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