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Intro to Microeconomics 201

by: Sarah Gordon

Intro to Microeconomics 201 Econ 201

Marketplace > Indiana University > Economics > Econ 201 > Intro to Microeconomics 201
Sarah Gordon
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About this Document

Economics Notes and Examples from the second and third weeks of school.
Intro to Microeconomics
Hewei Shen
Class Notes
Microeconomics, Economics Microeconomics ECON 200 UW, supply and demand, Law, law of supply, law of demand, ECON201




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This 4 page Class Notes was uploaded by Sarah Gordon on Friday September 23, 2016. The Class Notes belongs to Econ 201 at Indiana University taught by Hewei Shen in Fall 2016. Since its upload, it has received 21 views. For similar materials see Intro to Microeconomics in Economics at Indiana University.


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Date Created: 09/23/16
E201 ­ Chapter 6 ­ Day 5 ­ September 12th, 2016    Warm Up Problem: How do people respond to change in the prices? If the price of  gasoline increases by 10%, we know that people will buy less gas, but will they buy much  less of gas? How much less?  People react differently, and for something that is a staple good, people HAVE to  pay for it, but how much less is the question. Intuitively we will know it depends on the  good.    The Price Elasticity of Demand and Its Measurement  ❖ Measuring Responsiveness to Price Changes  ➢ Look at the slope of the demand curve  ■ Example  ■ Probably not a good indication,​ because ​units matter  ❖ Price Elasticity of Demand  ➢ By looking at the p​ erc​entage change the units of the measurement do not  matter  ➢ Price Elasticity of Demand  ➢ Price elasticity of demand is always negative. Why?   ■ The demand curve is a downward slope, so whenever you do change  in quantity you are moving down the slope and will get a negative  number.  ➢ Instead, we look at the absolute value.  ■ Price elasticity of ­3 is LARGER than price elasticity of ­2  ➢ Demand price is ​price elastic ​if   |εd | ≻ 1   ■ 10% increase in price results in a greater than 10% decrease in  quantity demanded  ➢ Demand is ​price inelastic​ if |εd | ≺ 1  ■ Quantity demanded changes little in response to a price change  ➢ Demand is u ​ nit price elastic​ if |εd | = 1  ➢ CONCLUSION from Example #2  ■ More elastic = flatter slope; more inelastic = steeper slope  ❖ Percentage Changes and the Midpoint Formula  ➢ What is the problem of the previous method?  ■ What is the percentage change of quantity demanded when moving  from A to B? B to A?   ● We calculate 2 different elasticities depending on the  direction we move along the curve  ➢ Calculate percentage changes using the ​Midpoint Formula​****  ❖ Calculating Price Elasticity of Demand ­ Part 1  ➢ Doesn’t matter which direction we go on the slope with the midpoint  formula  ❖ Part 2  ❖ Observations about Elasticity  ​ ➢ Slope and Elasticity  ​ are related:  ■ IF two demand curves go through the same point, the one with the  higher slope also has the higher (more negative) elasticity  ​ ■ Perfectly inelastic: elasticity is ​zero  ​ ■ Perfectly elastic: elasticity is ​infinite (if slope is zero)  ❖ MIDNIGHT NEXT MONDAY  ❖   The Determinants of the Price Elasticity of Demand ❖ Why do some goods have a high price elasticity of demand, while others have a low price elasticity of demand? ➢ There are several characteristics of the good, of the market, etc. that determines this. ■ The availability of close substitutes ■ The passage of time ● Over time, people can adjust their buying habits more easily. ● Ex: if you eat a banana every morning, since you eat them everyday, it will be hard to switch to a new if the price goes up, it won’t really matter short term and you will still eat your banana, but if over long term, if it is so expensive, you will probably switch to a new fruit. ■ Whether the good is a luxury or a necessity ● BMW yeah comfortable and nicer (show off) but if it goes way up, you will not invest as much money into buying one and maybe go for a cheaper car ■ The definition of the market ● The more narrowly defined the market, the more substitutes are available, and hence demand is more elastic. ● Gas? Hard to find substitute...little or none ◆ But gas @ shell (company) there are lots of substitutes… ■ The share of a good in a consumer’s budget ● If a good is a small portion of your budget, you will likely not be very sensitive to its price. ❖ Elasticity and the Pricing Decision ➢ What scenario do we need to know about the price elasticity of demand? ■ IF​you are a ​business owner, you need to decide how to price your product. ● Total revenue:​ The total amount of funds received by a seller of a good or service. ● B​ siness owners with​ lastic goods should decrease their prices in order to gain more customers because their total revenue will increase because their gains in customers will be higher than their loss in price ​ ● Vice versa for ​inelastic goods ❖ Total Revenue along a Linear Demand Curve ➢ Elasticity is not a constant along a linear demand curve ➢ How do we understand this intuitively? ■ Middle between elastic and inelastic called ​unit elastic ❖ Estimating Price Elasticity of Demand ➢ We can see that knowing the price elasticity of demand would be very useful for a firm. But how can a firm know this information? ■ For a well-established product, economists can use historical data to estimate the demand curve. ■ To calculate the price elasticity of demand for a new product, firms often rely on market experiments. ■ Firms can try different prices and observe the change in quantity demanded that results. Other Demand Elasticities ❖ Cross - Price Elasticity of Demand ​ ➢ Measures the ​strength of substitute or complement relationships between goods: ■ =(percentage change in quantity demanded of good A)/(percentage change in quantity demanded of good B) ➢ What does the sign of it mean? ❖ Income Elasticity of Demand ​ ➢ Measures the s ​ trength of the effect of income on quantity demanded ❖ Price Elasticity of Supply ➢ Measures the responsivesnness of firms to a change in price ➢ It is very much analogous to price elasticity of demand: ■ PES=[(%change in Q(supplied))/(%change in price)] ➢ So the same sort of calculation methods apply (midpoint formula etc.) ❖ Determinants of the PRice Elasticity of Supply ➢ Depends on the ability and willingness of firms to alter the quantity they produce as price increases ➢ Unlike demand it is very difficult to change supply in a short period of time. ■ Ex: suppose the wholesale price of grapes doubles overnight… ● Farmers could do little to increase their quantity immediately; the initial price elasticity of supply would be close to 0. ● Over time farmers could plant more fields in grapes; so over the course of several years, the price elasticity of supply would ​rise ■ The most important determinant of price elasticity of supply is passage of time. ➢ Terminology for price elasticity of supply ■ elastic...Es>1 ■ inelastic...Es<1 ■


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