Elasticity and its Applications

In this chapter, look for the answers to these questions: •What is elasticity? What kinds of issues can elasticity help us understand? •What is the price elasticity of demand? How is it related to the demand curve? How is it related to revenue & expenditure? •What is the price elasticity of supply? How is it related to the supply curve? •What are the income and cross-price elasticities of demand?

You design websites for local businesses. You charge $200 per website, and currently sell 12 websites per month. Your costs are rising (including the opportunity cost of your time), so you consider raising the price to $250. The law of demand says that you won’t sell as many websites if you raise your price. How many fewer websites? How much will your revenue fall, or might it increase? A scenario… 2

Price Elasticity of Demand Price elasticity of demandmeasures how much Qdresponds to a change in P. Price elasticity of demand = Percentage change in Qd Percentage change in PLoosely speaking, it measures the price-sensitivity of buyers’ demand.

Price Elasticity of Demand Price elasticity of demand equals P Q D Q2 P2 P1 Q1 Prises by 10% Qfalls by 15% 15%10%= 1.5 Price elasticity of demand = Percentage change in Qd Percentage change in PExample:

Price Elasticity of Demand Along a Dcurve, Pand Qmove in opposite directions, which would make price elasticity negative. We will drop the minus sign and report all price elasticities as positive numbers. P Q D Q2 P2 P1 Q1 Price elasticity of demand = Percentage change in Qd Percentage change in P

Calculating Percentage Changes P Q D $2508B $20012A Demand for your websites Standard method of computing the percentage (%) change: end value – start value start value x 100% Going from A to B, the % change in Pequals ($250–$200)/$200 = 25%

Calculating Percentage Changes P Q D $2508B $20012A Demand for your websites Problem:The standard method gives different answers depending on where you start. From A to B, Prises 25%, Qfalls 33%, elasticity = 33/25 = 1.33 From B to A, Pfalls 20%, Qrises 50%, elasticity = 50/20 = 2.50

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