Microecon Chapter Seven Notes

Chapter Seven: Demand and Elasticity Elasticity: The Measure of Responsiveness Price Elasticity of Demand / Elasticity of Demand: The ration of the percentage change in quantity demanded to the percentage change in price that brings about the change in quantity demanded.  Economists measure the responsiveness of quantity demanded to price changes via a concept of elasticity Flat demand curves indicates that consumers respond sharply to a change in price  elastic or highly elastic  curve  Steep demand curve indicates that consumers respond hardly at all to a price change.  inelastic Demand is elastic if a rise by 10% in price reduces quantity by more than 10%   Slope is not an accurate measure of elasticity Elasticity = Percentages   Average of the two quantities - Two attributes of elasticity  Each change is measured as a percentage change  Each of the percentage changes is calculated in terms of the average values of the before and after quantities and prices - When price increases, demand decreases - Each percentage change is taken as an absolute value  Formula for Price Elasticity of Demand: Change in quantity demanded, expressed as a percentage of the average of the before and after quantities Corresponding percentage change in price

Price Elasticity of Demand and the Shapes of Demand C urves Perfectly Inelastic Demand Curves:  Change in Q P is always O. Consumer purchases don’t change even when price does.  Ex. Rubber bands, medicine Perfectly Elastic Demand Curves:  If price goes up, nobody demands it anymore Substitutes and compliments  (Seemingly Simple) Straight Line Demand Curves:  Slope is constant, by elasticity is not The price elasticity of demand grows steadily smaller as you move from left to right. That is because the quantity  keeps getting larger, so that a given numerical change in quantity becomes an ever smaller percentage change. But the price keeps going lower, so that a given numerical change in price becomes an ever larger percentage change. Unit Elastic Demand Curves:  Curve with elasticity greater than 1 = Elastic demand curve.  Elasticity < 1 = Inelastic Curve Elasticity = 1  Unit –Elastic  –Elastic   Luxury goods seem to be more elastic than necessities  Substitutes have high elasticities Price Elasticity of Demand, Its Effect on Total T otal Revenue and Total Expenditure  Demand elastic, price increase  TR decrease Unit-Elastic, p rice increase  TR same   Demand inelastic, price increase  TR increase Opposite when price falls   TR = P x Q  Elasticity percentage ration determines total revenue   Total Revenue = Area under that point

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When demand is unit elastic, total expenditure must be the same at every point Price cuts can also equal less money when elasticity is low

What Determines Demand Elasticity  Many things contribute to consumers sensitivity to price changes Nature of the Good  Necessities  low elasticity   Luxury goods  high elasticity  Availability of Close Substitutes Substitutes  Switch to the cheaper substitute  Demand is more elastic Narrowly defined commodities are more elastic than broadly defined commodities  Fraction of Income Absorbed   Inexpensive Inelastic  Expensive  More elastic Passage of Time  In the Short Run  Inelastic  Long Run  Elastic Income Elasticity Income Elasticity of Demand: The ration of percent change of quantity demanded to the percentage change of income Foreign travel is income elastic since mainly the rich travel abroad   Blue jeans aren’t income elastic because everyone wears them Price Elasticity of Supply The ratio of percent change of quantity supplied to percent change of price  Cross Elasticity of Demand Complements: Makes another good more valuable. Both increase quantity demanded. Substitutes: Makes another good less valuable. Cross Elasticity of Demand: Measures the ratio of percentage change of price of one good to the percentage change of  quantity demanded for another. Do not drop negative signs. Substitutes  Positive elasticity. Price increase, Demand increase   Complements  Negative elasticity. Price increase, Demand decrease Demand Shifters  Income change = Shifted curve  Substitutes and complements = Shifted curve  Price change = Movement  We expect a demand curve to shift to the right if consumer incomes rise, if tastes change in favor of the product, if substitute goods become more expensive, or if complementary goods become cheaper. We expect a demand curve to shift to the left if any o f these factors goes in the opposite direction The Time Period of the Demand Curve and Economic Decision Making  Demand during a particular time period Demand Curve  hypothetical prices and quantities 