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Econ 2106 – Principles of Microeconomics Dr. Jon Mansfield Micro Lecture 2

1. Elasticity - sensitivity, responsiveness • • • Can Be Calculated for Any Variable in the Demand Function. Examples: Price, Income, Advertising, etc. Compare Percentage Changes to Avoid a Units Problem in Measurement

Definition:

e p = ( % ∆ Q) /( % ∆ P)

=

(∆ Q / Q) / (∆ P / P)

=

(∆ Q / ∆ P) ( P / Q)

Arc Elasticity Discrete Range e p = (( Q2 - Q1) / Q) / ((P2 - P1) / P) e p = [ (Q2 - Q1) / (Q1 + Q2) / 2] / [ (P2 - P1) / (P1 + P2) / 2]

Point Elasticity Point on the Demand Curve e p = (∆Q / ∆P ) ( P / Q ) Linear demand curve (price form): P = a + bQ b = (∆P / ∆Q ) and (1 / b) = (∆Q / ∆P ) e p = (∆Q / ∆P ) ( P / Q)

e p = [ (Q2 - Q1) / (Q1 + Q2)] / [ (P2 - P1) / (P1 + P2)]

e p = (1 / b) [P / (P - a) / b] = [P / (P - a)]

Values |ep| > 1 |ep| < 1 |ep| = 1 Elastic Inelastic Unit Elastic %∆Q>%∆P %∆Q<%∆P %∆Q=%∆P

You should be able to work through the derivation of both elasticity formulas.

Q P TR MR MRc Arc elasticity e p = [ (Q2 .Q (or Q = 12 .Q 2 AR = TR / Q = [(P)(Q)] / Q = P MR = (∆TR) / (∆Q) = (TR2 . Jon Mansfield .P1) / (P1 + P2)] Point elasticity e p = [P / (P .TR1) / (Q2 .P) TR = (P)(Q) = (12 .Q1) / (Q1 + Q2)] / [ (P2 .a)] 0 1 2 3 4 5 6 7 8 9 10 11 12 12 11 10 9 8 7 6 5 4 3 2 1 0 0 11 20 27 32 35 36 35 32 27 20 11 0 11 9 7 5 3 1 -1 -3 -5 -7 -9 -11 12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 -23 -11 As the price decreases from 12.Elasticity 2 2. what happens with both types of elasticities? Econ 2106 – Principles of Microeconomics Dr. Downward-sloping Linear Demand Curve Demand Function Total Revenue Function (TR) Average Revenue Function (AR) Marginal Revenue Function (MR) MR using calculus (MRc) P = 12 .2Q Calculate the elasticities using the formulas.Q)(Q) = 12Q .Q 1) MRc = ∆TR / ∆Q = 12 .

P$ 12 P = 12 .Q MR = 12 .Elasticity 3 Based on the information and table above. graph the Demand and Marginal Revenue functions on one diagram and the Total Revenue function directly beneath.2Q 6 D Q 6 TR $ 40 TR = 12Q . Jon Mansfield .Q 2 12 Q 6 12 Econ 2106 – Principles of Microeconomics Dr.

Jon Mansfield . Price Elasticity and Total Revenue: The Price Effect and Quantity Effect of a Price Change. P P1 P2 A area A B Demand area B C D Q1 Q2 Q 4.Elasticity 4 3. What is the significance of vertical and horizontal demand curves? D D ep = 0 ep = ∞ Econ 2106 – Principles of Microeconomics Dr.

How sensitive is the amount demanded to a change in price? This is primarily determined by: Elastic • • • • number of substitute goods importance in consumer’s budget product durability time period under consideration 6.Elasticity 5 5. Other Elasticities Income Elasticity of Demand e I = (% ∆ QX) / (% ∆ I) (= (∆ Q X / ∆ I) (I / QX)) e I > 0 Normal Good e I < 0 Inferior Good Cross Elasticity of Demand e C = (%∆ QX) / (% ∆ PY) (= (∆ Q X / ∆ P Y) (P Y / QX)) e C > 0 Substitute Goods e C < 0 Complementary Goods Econ 2106 – Principles of Microeconomics Dr. Jon Mansfield .

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