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Original Title: Unit-II Elasticity of Demand and Supply

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The price elasticity of demand is a measure of the extent to which the quantity demanded of a

good changes when the price of the good changes and all other influences on buyers plans

remain the same.

A. Percentage Change in Price

1. The midpoint method uses the average of the initial price and new price in the denominator

when calculating a percentage change. Because the average price is the same between two

prices regardless of whether the price falls or rises, the percentage change in price calculated

by the midpoint method is the same for a price rise and a price fall.

a. Using the midpoint formula, the percentage change in price equals

100 .

New price + Initial price 2

B. Percentage Change in Quantity Demanded

Use the midpoint method when calculating the percentage change in quantity.

100 .

New quantity Initial quantity 2

1. Minus Sign

Because a change in price causes an opposite change in quantity demanded, for the price

elasticity of demand we focus on the magnitude of the change by using the absolute value.

C. Elastic and Inelastic Demand

The price elasticity of demand falls into three categories:

1. Elastic demandwhen the percentage change in the quantity demanded exceeds the

percentage change in price (which means the elasticity is greater than 1).

2. Unit elastic demandwhen the percentage change in the quantity demanded equals the

percentage change in price (which means the elasticity equals 1).

3. Inelastic demandwhen the percentage change in the quantity demanded is less than the

percentage change in price (which means the elasticity is less than 1).

4. There are two extreme cases:

a. Perfectly elastic demandwhen the quantity demanded changes by a very large

percentage in response to an almost zero percentage change in price.

b. Perfectly inelastic demandwhen the quantity demanded remains constant as the price

changes.

D. Influences on the Price Elasticity of Demand

1. Substitution Effect

If good substitutes are readily available, demand is elastic. If good substitutes are hard to find,

demand is inelastic.

2. Three factors determine how easy substitutes are to find:

a. Luxury versus necessitythere are few substitutes for necessities (so demand is price

inelastic) and there are many substitutes for luxuries (so demand is price elastic).

b. Narrowness of definitionthe more narrowly defined the good is, the more elastic its

demand. The more broadly defined the good, the less elastic its demand.

c. Time elapsed since price changethe longer the time that has passed since the price

change, the more elastic is demand.

3. Income Effects

The larger the proportion of income spent on the good, the more elastic is demand because a

price change has a large, noticeable impact on the budget. The smaller the proportion of

income spent on the good, the less elastic is demand.

E. Computing the Price Elasticity of Demand

1. The formula used to calculate the price elasticity of demand is:

Percentage change in quantity demanded

Price elasticity of demand =

.

Percentage change in price

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a. If the price elasticity of demand is greater than 1 (the numerator is larger than the

denominator), demand is elastic.

b. If the price elasticity of demand is equal to 1 (the numerator equals the denominator),

demand is unit elastic.

c. If the price elasticity of demand is less than 1 (the numerator is less than the denominator),

demand is inelastic.

2. Slope and elasticity

The slope of a demand curve measures the responsiveness of quantity demanded to a change

in price, but it is not a units-free measure of this responsiveness and cannot be used to

compare the demand curves of different goods.

3. A units-free measure

The percentage change in price and the percentage change in quantity demanded (the

denominator and numerator of the elasticity formula) are independent of the units of

measurement. As a result, the elasticity formula produces a units-free measure of

responsiveness.

F. Elasticity Along a Linear Demand Curve

Along a straight-line demand curve, the slope is constant, but the elasticity changes.

1. At the midpoint of a linear demand curve, the elasticity equals 1 and demand is unit elastic.

2. Above the midpoint of a linear demand curve, elasticity is greater than 1 and demand is elastic.

3. Below the midpoint of a linear demand curve, elasticity is less than 1 and demand is inelastic.

G. Total Revenue and Price Elasticity of Demand

1. Total revenue from the sale of a good equals (the price of the good) (the quantity of the

good sold).

2. The total revenue test is a method of estimating the price elasticity of demand because the

impact of a change in price on total revenue depends on the elasticity of demand.

a. If elasticity is greater than 1, an increase in price decreases total revenue. Price and total

revenue change in opposite directions.

b. If elasticity equals 1, an increase in price does not change total revenue.

c. If elasticity is less than 1, an increase in price increases total revenue. Price and total

revenue change in the same direction.

H. Your Expenditure and Your Elasticity of Demand

When the price of a good increases, your expenditure on that good depends on the elasticity of

your demand for that good.

a. If your demand is elastic, your expenditure on the good decreases when the price rises.

b. If your demand is unit elastic, your expenditure on the good does not change when the price

rises.

c. If your demand is inelastic, your expenditure on the good increases when the price rises.

I. Applications of the Price Elasticity of Demand

1. Farm Prices and Total Revenue

a. Because the demand for agricultural products is inelastic, a crop failure that boosts the price

of an agricultural product increases the total revenue for all farmers taken together.

2. Addiction and Elasticity

a. Nonusers demand for addictive goods is elastic, so a tax that results in a moderately higher

price leads to a substantially smaller number of people trying a drug.

b. Addicts demand is inelastic, so a tax or legislation that results in even a substantial price

rise brings only a modest decrease in the quantity demanded and increases addicts

expenditure on these goods.

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The price elasticity of supply is a measure of the extent to which the quantity supplied of a

good changes when the price of the good changes and all other influences on sellers plans

remain the same.

A. Elastic and Inelastic Supply

1. The price elasticity of supply falls into three categories:

http://csetube.weebly.com/

a. Elastic supplywhen the percentage change in the quantity supplied exceeds the

percentage change in price.

b. Unit elastic supplywhen the percentage change in the quantity supplied equals the

percentage change in price.

c. Inelastic supplywhen the percentage change in the quantity supplied is less than the

percentage change in price.

2. There are two extreme cases of price elasticity of supply:

a. Perfectly elastic supplywhen the quantity supplied changes by a very large percentage

in response to an almost zero percentage change in price

b. Perfectly inelastic supplywhen the quantity supplied remains constant as the price

changes.

B. Influences on the Price Elasticity of Supply

1. Production possibilities

a. How rapidly the cost of increasing production rises and the time elapsed since the price

change influence the elasticity of supply. The more rapidly the production cost rises and the

less time elapsed since a price change, the more inelastic the supply.

2. Storage possibilities

a. Storable goods have a more elastic supply than goods that cannot be stored.

C. Computing the Elasticity of Supply

1. The formula used to calculate the price elasticity of supply is:

Percentage change in quantity supplied

Price elasticity of supply =

.

Percentage change in price

/

k

t

.

e

b

a. If the price elasticity of supply is greater than 1 (the numerator is larger than the

denominator), supply is elastic.

b. If the price elasticity of supply is equal to 1 (the numerator equals the denominator), supply

is unit elastic.

c. If the price elasticity of supply is less than 1 (the numerator is less than the denominator),

supply is inelastic.

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A. Cross Elasticity of Demand

The cross elasticity of demand is a measure of the extent to which the demand for a good

changes when the price of a substitute or complement changes, other things remaining the same.

1. The formula used to calculate the cross elasticity of demand is:

Percentage change in quantity demanded of a good

Cross elasticity of demand =

.

Percentage change in price of one

/

:

p

t

t

h

3. The cross elasticity of demand for a complement is negative.

B. Income Elasticity of Demand

The income elasticity of demand is a measure of the extent to which the demand for a good

changes when income changes, other things remaining the same.

1. The formula used to calculate the income elasticity of demand is:

Percentage change in quantity demanded

Income elasticity of demand =

.

Percentage change in income

2. For a normal good, the income elasticity of demand is positive.

3. When the income elasticity of demand is greater than 1, demand is income elastic. 4. When

the income elasticity of demand is between zero and 1, demand is income inelastic.

5. For an inferior good, the income elasticity of demand is less than 0.

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