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EC Week 4 Chapter 5 Book Notes

by: Danielle Linska

EC Week 4 Chapter 5 Book Notes EC 201

Marketplace > Michigan State University > EC 201 > EC Week 4 Chapter 5 Book Notes
Danielle Linska

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About this Document

These book notes cover Demand Elasticity, Supply Elasticity, and their applications.
Intro to Microeconomics
C. Liedholm
Class Notes
Econ, Economics, supply and demand, elasticity, elasticity of demand
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This 4 page Class Notes was uploaded by Danielle Linska on Sunday September 18, 2016. The Class Notes belongs to EC 201 at Michigan State University taught by C. Liedholm in Fall 2016. Since its upload, it has received 29 views.


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Date Created: 09/18/16
9/18/16  Chapter  5  Book  Notes   Wednesday,  September   14,  2016 3:13  PM Yellow  is  important  facts   Green  is  definitions   Bold  is  also  important Elasticity  and  Its  Application   I. The  Elasticity  of  Demand The  Price  Elasticity  of  Demand  and  Its  Determinants • Elasticity -­‐a  measure  of  the  responsiveness  of  quantity  demanded  or   quantity  supplied  to  a  change  in  one  of  its  determinants. • The  law  of  demand  states  that  the  fall  in  the  price  of  a  good  raises  the   quantity  demanded   • The  Price  Elasticity  of  Deman-da    measure  of  how  much  the  quantity   demanded  of  a  good  responds  to  a  change  in  the  price  of  that  good,   computed  as  the  percentage  change  in  quantity  demanded  divided  by  the   percentage  change  in  price ○ Demand  is  said  to elastic  when  the  quantity  demanded  responds   substantially  to  changes  in  price.   ○ Demand  is  said  to inelastic  when  the  quantity  demanded  responds   only  slightly  to  changes  in  the  price Availability  of  Close  Substitutes • Goods  with  close  substitutes  tend  to  have  more  elastic  demand ○ Easy  to  switch  back  and  forth Necessities  versus  Luxuries • Necessities  tend  to  have  inelastic  demands,  where  as  luxuries  tend  to  have   elastic  demands ○ Ex.  When  price  of  going  to  doctor  increases,  people  will  not  reduce  the   number  of  times  they  go  to  the  doctor.  When  price  of  yachts  increase,   people  will  reduce  the  number  of  times  they  buy  a  yacht • Whether  a  good  is  a  luxury  or  a  necessity  depends  on  the  preference  of  the   buyer.   Definition  of  the  Market • Narrowly  defined  markets  tend  to  have  more  elastic  demand  than  broadly   people  will  reduce  the  number  of  times  they  buy  a  yacht • Whether  a  good  is  a  luxury  or  a  necessity  depends  on  the  preference  of  the   buyer.   Definition  of  the  Market • Narrowly  defined  markets  tend  to  have  more  elastic  demand  than  broadly   defined  markets  because  it  is  easier  to  find  close  substitutes  for  narrowly   defined  goods. ○ Ex.  Food  has  a  fairly  inelastic  demand  because  there  are  no  good   substitutes  for  "food".   ○ Ex.  Ice  cream  has  elastic  demand  because  there  are  many  flavors  of  ice   cream Time  Horizon   • Goods  tend  to  have  more  elastic  demand  over  longer  periods  of  time   because  people  soon  work  to  eliminate  the  good  that  has  a  substitute. Computing  the  Price  Elasticity  o▯▯▯▯▯▯▯▯▯▯▯▯▯▯▯▯ ▯▯▯▯▯▯▯▯▯▯ ▯▯▯▯▯▯▯▯ • Price  elasticity  of  demand  =   ▯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯▯ ▯▯▯▯▯▯▯▯▯▯ ▯▯▯▯▯▯ ▯▯▯▯▯▯▯ The  Midpoint  Method:  A  Better  Way  to  Calculate  Percentage  Changes  and   Elasticities   • Standard  procedure:  divide  the  change  by  the  initial  level ▯▯▯▯▯ ▯⎯⎯⎯⎯⎯ ▯ • Price  elasticity  of  demand  = ▯▯▯▯▯⎯⎯⎯⎯⎯⎯⎯) ▯▯⎯⎯⎯⎯▯ ▯▯ ▯ The  Variety  of  Demand  Curves • Economists  classify  demand  curves  according  to  their  elasticity • Demand  is  considered  elastic  when  the  elasticity  is  greater  than  1 ○ Which  means  the  quantity  move  proportionally  more  than  the  price • Demand  is  considered  inelastic  when  the  elasticity  is  less  than  1   ○ Which  mean  the  quantity  moves  proportionally  less  than  the  price. • If  the  elasticity  is   exactly  1,  then  the  demand  is  said  to  have   unit  elasticity   • Elasticity  is  closely  related  to  the  slope  of  the  demand  curve ○ The  flatter  the  demand  curve,  the  greater  the  price  elasticity  of   demand ○ The  steeper,  the  smaller  the  price  elasticity  of  demand • In  a  zero  elasticity  case,  the  demand  is   perfectly  inelastic. Quantity  demanded  stays  the  same ○ • Inelastic  curves  look  like  the  letter  "I" Total  Revenue  and  the  Price  Elasticity  of  Demand • Total  revenue-­‐  the  amount  paid  by  buyers  and  received  by  sellers  of  a  good,   • In  a  zero  elasticity  case,  the  demand  is   perfectly  inelastic. ○ Quantity  demanded  stays  the  same • Inelastic  curves  look  like  the  letter  "I" Total  Revenue  and  the  Price  Elasticity  of  Demand • Total  revenue-­‐  the  amount  paid  by  buyers  and  received  by  sellers  of  a  good,   computed  as  the  price  of  the  good  times  the  quantity  sold • An  increase  in  price  raises  P  x  Q  because  the  fall  in  Q  is  proportionally   smaller  than  the  rise  in  P. ○ The  extra  revenue  from  selling  units  at  a  higher  price  more  than   offsets  the  decline  in  revenue  from  selling  fewer  units. • When  demand  isi  nelastic  (a  price  elastically  less  than  1),  price  and  total   revenue  move  in  the  same  direction   • When  demand  ise   lastic  (a  price  elastically  greater  than  1),  price  and  total   revenue  move  in  opposite  directions   • If  demand  is  unit  elastic  (a  price  elastically  equal  to  1),  total  revenue   remains  the  constant  when  the  price  changes Elasticity  and  Total  Revenue  along  a  Linear  Demand  Curve • Slope  =  "rise  over  run" ○ The  change  in  price  (rise)  over  the  change  in  quantity  (run)   • The  linear  demand  curve  illustrates  that  the  price  elasticity  of  demand  need   not  be  the  same  at  all  points  on  a  demand  curve.   Other  Demand  Elasticities The  Income  Elasticity  of  Demand   • Income  elasticity  of  demand  -­‐ a  measure  of  how  much  the  quantity   demanded  of  a  good  responds  to  a  change  in  consumers'  income,  computed   as  the  percentage  change  in  quantity  demanded  divided  by  the  percentage   change  in  income. • Income  elasticity  of  demand  =   ▯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯▯ ▯▯▯▯▯▯▯▯▯▯▯▯▯▯▯▯ ▯▯▯▯▯▯▯▯ • Normal  goods  have  positive  income  elasticities ○ Elasticities  vary  substantially  in  size • Inferior  goods  have  negative  elasticities The  Cross-­‐Price  Elasticity  of  Demand   • Cross-­‐price  elasticity  of  demand  -­‐a  measure  of  how  much  the  quantity   demanded  of  one  good  responds  to  a  change  in  the  price  of  another  good,   computed  as  the  percentage  change  in  quantity  demanded  of  the  first  good   divided  by  the  percentage  change  in  the  price  of  the  second  good • Cross  price  elasticity  of  demand  =   ▯▯▯▯▯▯▯▯▯▯  ▯▯▯▯▯▯  ▯▯  ▯▯▯▯▯▯▯▯  ▯▯▯▯▯▯▯▯  ▯▯  ▯▯▯▯  ▯ ▯⎯⎯⎯⎯⎯⎯▯▯▯▯▯▯▯▯▯▯  ▯▯▯▯▯▯  ▯▯  ▯▯▯  ▯▯▯▯▯  ▯▯  ▯▯▯▯  ▯ demanded  of  one  good  responds  to  a  change  in  the  price  of  another  good,   computed  as  the  percentage  change  in  quantity  demanded  of  the  first  good   divided  by  the  percentage  change  in  the  price  of  the  second  good • Cross  price  elasticity  of  demand  =   ▯▯▯▯▯▯▯▯▯▯  ▯▯▯▯▯▯  ▯▯  ▯▯▯▯▯▯▯▯  ▯▯▯▯▯▯▯▯  ▯▯  ▯▯▯▯  ▯ ▯⎯⎯⎯⎯⎯⎯▯▯▯▯▯▯▯▯▯▯  ▯▯▯▯▯▯  ▯▯  ▯▯▯  ▯▯▯▯▯  ▯▯  ▯▯▯▯  ▯ II. The  Elasticity  of  Supply The  Price  Elasticity  of  Supply  and  Its  Determinants   • Price  elasticity  of  supply  -­‐ measure  of  how  much  the  quantity  supplied  of  a   good  responds  to  a  change  in  the  price  of  that  good,  computed  as  the   percentage  change  in  quantity  supplied  divided  by  the  percentage  change  in   any  price. • Supply  of  a  good  is  said  to  be  elastic  if  the  quantity  supplied  responds   substantially  to  changes  in  the  price   • Supply  of  a  good  is  said  to  be  inelastic  if  the  quantity  supplied  responds  only   slightly  to  changes  in  the  price.   • The  price  elasticity  of  supply  depends  on  the  flexibility  of  sellers  to  change   the  amount  of  the  good  they  produce.   • Key  determinants  of  the  price  elasticity  of  supply  is  the  time  period  being   considered.   ○ Supply  is  usually  more  elastic  in  the  long  run  than  in  the  short  run.   Computing  the  Price  Elasticity  of  Supply     ▯▯▯▯▯▯▯▯▯▯ ▯▯▯▯▯▯ ▯▯▯▯▯▯▯▯▯▯ ▯▯▯▯▯▯▯▯ • Price  elasticity  of  supply  = ▯▯▯▯▯▯▯▯▯▯▯▯▯▯▯▯ ▯▯▯▯▯▯▯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯ ▯ The  Variety  of  Supply  Curves • The  price  elasticity  of  supply  measures  the  responsiveness  of  quantity   supplied  to  the  price,  it  is  reflected  in  the  appearance  of  the  supply  curve..   • As  elasticity  rises,  the  supply  curve  gets  flatter


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