Chapter 5 outline - 21:05 Chapter5: a o o

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21:05 Chapter 5: Elasticity of Demand and Supply 5-1 Price Elasticity of Demand a. Calculating Price Elasticity of Demand o The price elasticity of demand  measures the percentage change in  quantity demanded divided by the percentage change in price o For price elasticity to be a clear and reliable measure, we should  get the same result between points  a  and  b  as we get between  points  b  and  a . o To ensure the consistency, we must take the average of the initial  price and the new price and use that as the base for computing the  percentage change in price. o The price elasticity formula  says if the price changes from p to p’,  other things constant, the quantity demanded changes from q to q’. o o Elasticity expresses a relationship between two amounts The percentage change in quantity demanded  The percentage change in price b. Categories of Price Elasticity of Demand o Ranges of elasticity can be divided into three categories: If the percentage change in quantity demanded is less than  the percentage change in price, the resulting elasticity has  an absolute value between 0 and 1.0. That portion of the demand curve is said to be  inelastic , meaning that quantity demanded is relatively  unresponsive to a change in price. If the percentage change in quantity demanded just equals  the percentage change in price, the resulting elasticity has  an absolute value of 1.0 That portion of a demand curve is unit-elastic . If the percentage change in quantity demanded exceeds the  percentage change in price, the resulting elasticity has an  absolute value exceeding 1.0 That portion of a demand curve is said to be elastic . c. Elasticity and Total Revenue
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o Knowledge of price elasticity of demand is especially valuable to  producers, because it indicates how a price change affects total  revenue. Total Revenue      is price multiplied by quantity demanded at  that price, or  TR= p x q According to the law of demand, a lower price increases quantity demanded, which  tends to increase total revenue.
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