Chapter+Five

=Chapter 5 = = =  Elasticity and Its Application


 
 * //**Total Revenue**//: Price X Quantity Sold.
 * //**Elasticity**//: how quantity supplied and demanded responds to one of its determinants
 * //**Price elasticity of demand**//: how quantity demanded responds to change in the price. Calculated as % change in quantity demanded divided by the % change in price.
 * //**Total revenue**//: price times the quantity. Amount paid by buyers and received by sellers.
 * <span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;">//**Income elasticity of demand**//: how quantity demanded responds to change in income. Calculated as % change in quantity demanded divided by % change income.
 * <span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"><span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;">//**Cross-price elasticity of demand**//: how quantity demanded responds to change in price of substitute or complement

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<span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"> <span style="color: rgb(255, 6, 0);">I. The Elasticity of Demand <span style="color: rgb(255, 0, 221);">The Price Elasticity of Demand and Its Determinants <span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;">Like the law of demand, price elasticity of demand measures how the quantity changes as price go up or down. Demand can be elastic or inelastic. Elastic demand is when quantity increases or decreases quickly as price changes. Inelastic demand is when quantity stays relatively the same as price changes. Take for example, salt. Salt is an inelastic good and its quantity is unlikely change because it is crucial to daily lives. The price elasticity of demand measures how much consumers are willing to move away from the good as its price rises.

<span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"><span style="color: rgb(0, 6, 255);">• There are 4 determinants of price elasticity of demand: 1. Can the good be replaced? If a good can be easily replaced, it becomes much more elastic. For example, if Coca-cola’s price rises, then more people would buy Pepsi. This means that Coca-cola has elastic demand. If it cannot be replaced like salt, it has more inelastic demand. This is called availability of substitute. 2. Is it really necessary? Things that you need to survive mostly have inelastic demand, but luxuries such as BMW cars have elastic demand. 3. What is the definition of the market? If a good is narrowly defined it is easily to find substitute compared to broadly defined. For example, coke in general is not easily replaced, but Coca-Cola company coke can be replaces with Pepsi. 4. Is there time for me to adapt? Even if a good has inelastic demand, people can still adapt to not buy the good or replace it with technology if there is enough time.

<span style="color: rgb(255, 0, 221);">How to calculate the “price elasticity demand” <span style="color: rgb(235, 77, 15);"><span style="color: rgb(0, 6, 255);">• <span style="color: rgb(255, 56, 0);"><span style="color: rgb(241, 114, 70);"><span style="color: rgb(0, 255, 66);">To calculate the price elasticity, you need to know percentage change in quantity divide by the percentage change in price. Best way to calculate is the midpoint method. The midpoint method is used because unlike when you solve for slope, the result is different if the points are changed from A to B and B to A. So it is important to solve for average of the base before. Here is the formula: (Q1- Q2) / [Q1+ Q2 /2] divided by (P1-P2)/[(P1+P2)/2]

<span style="color: rgb(255, 0, 221);">How elastic is it? <span style="color: rgb(0, 6, 255);">• Demand curve can be elastic, inelastic, and unit elastic. A good is said to be elastic if elasticity calculated is greater than 1. It is inelastic if it is less than 1. It is said to be unit elastic if it is exactly one.

Following is different types of demand curve:

a. perfectly inelastic demand <span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"><span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"><span style="color: rgb(0, 6, 255);">Source:  www.csupomona.edu/ ~mrsafarzadeh/fig19.gif This graph shows inelastic demand curve. It looks like an "I" as in inelastic

<span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"><span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"><span style="color: rgb(0, 6, 255);">b. Unit elastic= 1



Source:  www.jcctm.edu.hk/.../ Basic_DD_SS/Image9.gif This shows unit elastic, which always equal 1

<span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"><span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"><span style="color: rgb(0, 6, 255);">c. perfectly elastic demand



Source: http://images.google.co.kr/imgres?imgurl=http://www.netmba.com perfectly elastic curve is horizontal

• Perfectly inelastic demand is a vertical line and the elasticity equals 0. Increase or decrease in price does not affect the quantity demanded. For example, seats in a concert. Let’s say that number of seats in the concert is limited 2000. VIP seats will cost more and seats located further may not cost as much. However, the quantity of seats is limited to 2000, so price may go down or up without changing the quantity. You can plug in 2000 for quantity in the formula and it would equal zero regardless of the price.

(Q1- Q2) / [Q1+ Q2 /2] divided by (P1-P2)/[(P1+P2)/2]

• Perfectly elastic demand is a horizontal line and the elasticity equals infinity. At one price, quantity increases or decrease. An example would be all-you-can-eat at $20 in a buffet. At $20, quantity varies.

<span style="color: rgb(255, 0, 221);">Total Revenue and the price elasticity of demand • <span style="color: rgb(121, 0, 255);">Total revenue is amount of price times quantity. Total revenue and price elasticity is related. Depending on how steep or flat the demand curve is, total revenue is can be maximized. When the demand curve is inelastic, increase in price increase the total revenue; also decrease in price decreases the total revenue. Unit elasticity usually maximizes the total revenue. When demand is elastic, decrease in price increases the total revenue and vise-versa. o Price and TR(total revenue) move in the same direction when demand is inelastic o Price and TR move in opposite direction when demand is elastic. o When demand is unit elastic, TR remains constant when the price changes.

<span style="color: rgb(255, 0, 221);">Linear Elasticity • <span style="color: rgb(218, 11, 97);">Demand curve may not have same elasticity along the entire curve. The slope of a linear curve may be constant, but elasticity changes. Reason for this is the slope is the rate of changes between two variables where is elasticity is the rate of change between two percentage changes • When linear demand curve’s slope equals 1, points with a low price and high quantity are inelastic and points with high price and low quantity are elastic. <span style="color: rgb(255, 0, 221);">Income Elasticity of Demand <span style="color: rgb(244, 92, 52);">• Income elasticity of demand is how quantity demanded changes as income changes. It is computed as % change in quantity demanded divided by % change in income. In income elasticity, normal goods have positive elasticity, but inferior goods have negative elasticity since people buy more inferior goods when income goes down. Necessities have small elasticity, while luxuries have large elasticity, since higher the income, more luxuries. Cross-price Elasticity of Demand • Cross-price elasticity of demand is how quantity demanded of good changes as price of related goods changes. It is computed as % change in quantity demand of good A divided by % change in the price of good B. Substitutes have positive elasticity since the definition of substitute is increase in price of a good causes increase in quantity of another good. On the other hand, complements are negative, since price of a good increase as quantity of a good decrease. If you can confuse with which one is negative think about the formula. (Q good a - Q good b) / [Q a + Q b /2] divided by (P a - P b )/[( P a + P b)/2] Source: http://images.google.co.kr/imgres?imgurl=http://instruct1.cit.cornell.edu/courses/econ101-dl/images/constant-elasticity-graph.gif&imgrefurl <span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"><span style="color: rgb(255, 6, 0);"> II. The Elasticity of Supply

<span style="color: rgb(255, 0, 221);">The Price Elasticity of Supply and Its Determinants The price elasticity of supply measures how quantity supplied responds to changes in price. It can be elastic or inelastic depending on how quickly it adjusts to changes in price. Elastic goods’ quantity responds quickly while inelastic goods’ quantity stays relatively the same. There are two determinants of price elasticity of supply.

1. Flexibility of seller. If sellers can quickly produce more goods as price rises, then the supply is elastic. Picasso’s drawing is inelastic supply because you cannot produce more of it.

2. Time. In a short run, the quantity supplied does not change very much because sellers cannot build new factories or close the old ones. In a long run, sellers adapt and quantity supplied changes more, than in a short time period.

Price elasticity of supply is computed as % change in quantity supplied divided by % change in price. Using midpoint method, it is :

(Q1- Q2) / [Q1+ Q2 /2] divided by (P1-P2)/[(P1+P2)/2]

<span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"><span style="color: rgb(255, 0, 221);">How elastic is it?

• Price elasticity of supply is basically like the price elasticity of demand, except that it appears like supply curve. Supply is inelastic if elasticity is less than 1 and it is perfectly inelastic when elasticity is 0, which appears a vertical line. Supply is elastic if it is greater than 1 and it is perfectly elastic when it’s infinite, which appears horizontal line. • Price elasticity of supply can vary within the curve. Elasticity may be very high at quantity low and very low at quantity high.

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<span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"><span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"> - Price elasticity of demand and price elasticity of supply measure how quantity responds to changes in price. Elasticity of demand depends; if a good is easily replaced or it is a luxury, then it has elastic demand. Opposite is true for goods that are not easily replaces or essential to life have inelastic demand. - Elasticity is calculated by midpoint formula. If Elasticity is less than 1, then it is inelastic. It is unit elastic if elasticity equals 1. Elastic if it is greater than 1 - Total revenue is total amount paid or received. TR increases as price rises for inelastic curves. TR decreases as price rises for elastic curves - Income elasticity of demand is how quantity changes in response to changes in consumers’ income. Important to know normal goods are positive and inferior good are negative. The cross-price elasticity is how quantity changes in response to related goods. Important to know that substitute are positive and complements are negative. - Price elasticity of supply is how quantity supplied changes as price rises or falls. Elasticity is affected by time horizon and flexibility of the sellers. - Price elasticity of supply is calculated by the midpoint formula. It is inelastic when elasticity is less than 1; elastic when it is greater than 1; unit when it is 1.

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<span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"><span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"> 1. While playing firework with her friends, Sara accidently destroy part of strawberry farm owned by her parents. Afraid of punishment, Sara and her friends goes to destroy the strawberry farms in all North Carolina (there are only strawberry farms present in North Carolina). Despite the fact this is morally wrong, what has she done?

2. Factory workers in New Hampshire wanted to drive out all the immigrants out of factory because immigrants are stealing their job. Do you think this is effective,considering elasticity of demand?

3. The cross-price elasticity of demand for yogurt and ice cream is negative a. true b. false c. need more information

4. There is no measure unit for elasticity a. true b. false c. need more information

Answers

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<span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"><span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"> media type="youtube" key="x5EKPX_atQo" width="425" height="350" Source: http://kr.youtube.com/watch?v=x5EKPX_atQo