Chapter+5-+Elasticity+and+Its+Application



 The price elasticity of demand and supply plays an important role in understanding the market. Let’s take a look at elasticity in more detail.

**Words to keep in mind: **
 * Elasticity** - A measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants.
 * Price Elasticity of Demand** - A 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 the quantity demanded divided by the percentage change in price.
 * 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.
 * 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.
 * 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.
 * Price Elasticity of Supply** - A 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 price.

**THE PRICE ELASTICITY OF DEMAND** **& DETERMINANTS**  The Price elasticity of demand - measures how much the quantity demanded responds to a change in price. - **Elastic demand** for a good is if the quantity demanded responds substantially to changes in the price.

//Here is an example of an elastic demand://

This shows that these people are not going to buy the food in the market because the price increased. We use the term elastic demand when the price of goods increases, and people respond to it by not buying them.

- **Inelastic demand** for a good is if the quantity demanded responds only slightly to changes in the price.

//Here is an example of an inelastic demand://



When this letter says "my demand for you is inelastic," it shows that the demand for that person does not change. Since inelastic demand is how the demand does not change even though the price goes up, this picture shows that when someone loves another, no matter how they change, their love for them, in this case demand, is inelastic.

- The price elasticity of demand for any good measures how willing consumers are to move away from the good as its price rises.

- Goods with close substitutes have more elastic demand since it is easier for consumers to switch from that good to others.
 * Availability of Close Substitutes**

- To determine rather a good is a necessity or a luxury, it all depends on the preferences of the buyer. - **Necessities** are something necessary for living or indispensable food. - Example, food, shelter, water, hospitality, and so on. - Necessities have inelastic demands. - **Luxuries** are somethings like material object, service that are needed of the sumptuous living. Things that are shown to others as elegant, delicate, and refinement of living. - Example: diamond, car, and so on. - Luxuries have elastic demands.
 * Necessities versus Luxuries**

- 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.
 * Definition of the Market**

- Goods have more elastic demand than longer time horizons. - Example: Gasoline. - When the gasoline prices rise, the demand goes down. Later on, more people would buy less fuel-efficient cars, and turn to public transportation.
 * Time Horizon**

In order to calculate the **Price Elasticity of Demand**, use this formula:

- If the percentage change will //always// have the opposite sign as the percentage change in price, the quantity demanded of a good is //negatively related// to its price,

In order to calculate the Midpoint between the two points on the demand curve, use this formula.



**Variety of Demand Curves**

- We call it **//unit elasticity//** if the quantity moves the same amount proportionately as price. - The graphs are shown like this:



- We call a curve **//perfectly inelastic//** if the curve is vertical. - This shows that very small change in the price leads to a huge change in quantity demanded. - If the elasticity rise, the demand curve gets flatter, just like this:



- We call a curve **//perfectly elastic//** if the curve is horizontal, as the price elasticity of demand approaches infinity. - This shows that very small change in the price leads to a no change in quantity demanded. - The perfectly elastic curve look like this:

- We call a curve **//inelastic in demand//** if the elasticity is less than 1. - The information can be found by using the price elasticity of demand. - The total revenue moves in the same direction.



- We call a curve //**unit elastic demand**// when the elasticity equals 1. - We can calculate the elasticity by using the price elasticity of demand equation. - The total revenue remains constant although the price changes.

- We call a curve **//elastic in demand//** when the elasticity is greater than 1. - The total revenue move in opposite directions.

- We call a curve //**perfectly elastic demand**// when the elasticity equals infinity.

- Although the slope of a linear demand curve is constant, the elasticity is not. - Reason: The slope of a linear demand curve is the ratio of changes in the two variables. - However, the elasticity is the ratio of percentage changes in the two variables.

//- How do we determine if the elasticity is elastic or inelastic by looking at a graph?// - At low price and large quantity, the demand curve is inelastic. - At high price and low quantity, the demand curve is elastic.

- The income elasticity of demand measures how the quantity demanded changes as consumer income changes. - Normal goods are goods that are bought when higher income raises the quantity demanded.
 * INCOME ELASTICITY OF DEMAND**

**TOTAL REVENUE**

- The total revenue is the amount paid by buyers and received by sellers of the good. - The total revenue can be calculated by doing **P X Q**.

Here is an example:

- If the price increases, then the total revenue would increase. - The total revenue increases when the price raises, since the fall in quantity demanded would be smaller than the rise in price.

- Demand is inelastic (a price elasticity less than 1), price and total revenue move in the same direction. - Thus, the total revenue rises as price rises. - Demand is elastic (a price elasticity greater than 1). price and total revenue move in opposite directions. - Demand s unit elastic (a price elasticity exactly equal to 1), total revenue remains constant.

- Although the slope of a linear demand curve is constant, the elasticity is not. - The slope is the ratio of changes in the two variables, and the elasticity is the ratio of percentage changes in the two variable. - With a low price and high quantity, demand curve in inelastic. - With high price and low quantity, demand curve is elastic.

In order to determine the elasticity on a curve:



- **Income Elasticity of Demand** is how the quantity demanded changes as consumer income changes. - We can use this formula to calculate the income elasticity of demand.

- For normal goods, higher income raises the quantity demanded. - For inferior goods, higher income lowers the quantity demanded. - Since quantity demanded and income move indirectly, inferior goods have negative income elasticities.

- Necessities have small income elasticities since consumers choose to buy these goods. - Luxuries have large income elasticities since consumers believe they can survive without those goods when they have low income.

- We can calculate by using this formula:
 * Cross-price elasticity of demand** is a measure of how the quantity demanded of one good changes as the price of another good changes.

- The positivity and negativity of the cross-price elasticities depends on the substitutes and complements of the goods.

**PRICE ELASTICITY OF SUPPLY**

- The price elasticity of supply is the measures how much the quantity supplied responds to changes in the price. - Supply is //elastic// if the quantity supplied responds substantially to changes in the price. - Supply is inelastic if the quantity supplied responds only slightly to changes in the price.

What does the price elasticity of supply depend on? - The price elasticity of supply depends on the flexibility of sellers to change the amount of the good they produce.

- Supply is more elastic in the long run than in the short run. - Short Run - the quantity supplied is not very responsive to the price. - Long Run - the quantity supplied respond substantially to price changes.

- We can use this formula to calculate the price elasticity of supply:  //Here are some elasticity of supply curves depending on the elasticities:// 

**Perfectly Inelastic Supply**: Perfectly Inelastic Supply - As elasticity rises, the supply curve gets flatter, the quantity supplied responds more to changes in the price, thus perfectly inelastic (supply curve is vertical).


 * Inelastic Supply**: Elasticity is less than 1


 * Unit Elastic Supply:** Elasticity Equals 1


 * Elastic Supply**: Elasticity is greater than 1


 * Perfectly Elastic Supply**: Elasticity Equals Infinity

- Price elasticity gets closer to infinity the supply curves becomes horizontal. - Small changes in the price lead to very large changes in the quantity supplied.



 This chapter covers the different situations where the elasticity change in our economy. Usually, when the price increases demand goes down which is an elastic example. Other special cases, when the price increases, demand stays unchanged which is inelastic. Also, there are different types of curves in a elasticity demand curve and in a elasticity supply curve.

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