Chapter+5+Elasticity+and+Its+Application.JAKS

= Chapter 5.   Elasticity and Its Application =

=**Definitions** =  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 quantity demanded divided by the percentage change in price 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 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

=**LEARNING OBJECTIVES:** =  1. Learn the fundamental concept of elasticity 2. Understand how this concept is applied to various parts of the economy

**I. Introduction**
 1. Elasticity is basically how much consumers respond to changes in quantity or price. 2. Price elasticity is percentage change in quantity demanded/supplied divided by percentage change in price. 3. Such elasticity is determined by the following factors: -if there's a close substitute, the good tends to be elastic. -if the good is necessity, good is inelastic whereas luxury goods are elastic. -if market is narrowly defined, then it's more elastic because it's easy to find close substitutes. -In longer period of time, curve tends to be elastic because people can respond to quantity/price with greater change. 4. If the absolute value of E derived from #2's formula is less than 1, it's inelastic. l E l > 1 -> elastic. l E l = 1 -> unit elastic. 5. Other way to get the elasticity (better, but complicated) is as follows:

[{(Q2 - Q1)} / {(Q2+Q1)/2}] / [{P2-P1}/{(P2+P1)}/2]

6. When it is perfectly inelastic, the demand curve is vertical. Perfectly elastic curve has horizontal slope because consumers will buy nothing above the given price. 7. Total revenue is Price times quantity (obvious, I hope) 8. When demand is inelastic, price and total revenue moves in same direction. 9. When demand is elastic, price and total revenue moves in opposite direction because increase in price brings larger loss in quantity. 10. When demand is unit elastic, total revenue DOES NOT change. 11. Even if the slope appears to be linear, it may actually contain different elasticities because slope is the ratio of changes whereas the elasticity is the ratio of "percentage changes". For easier understanding, think that in the higher price/lower quantity, elasticity is larger than 1 since percentage change in quantity is much larger. In lower price/higher quantity, elasticity is smaller since percentage change in quantity is smaller.

(http://opus1journal.org/images/glossary/elasticity.gif) 12. Income elasticity is used to see inferior goods/normal goods. It is % change in Q demanded / % change in income. Negative value means the good is inferior good. 13. Cross price elasticity is for substitutes or complements. It is % change in Q demanded of Good 1 / % change in price of good 2. If negative value, substitutes. If positive, complements. 14. Price elasticity for supply is largely the same. But, in the upper part of the curve, elasticity is small because firms have to incur more costs.

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=**THANK YOU **=

**Review Questions **
 Questions 1. Define two types of elasticity for demand and explain them. 2. Why is the price elasticity of supply not linearly-shaped?

Answer 1. Income elasticity is used to see inferior goods/normal goods. It is % change in Q demanded / % change in income. Negative value means the good is inferior good. Cross price elasticity is for substitutes or complements. It is % change in Q demanded of Good 1 / % change in price of good 2. If negative value, substitutes. If positive, complements. 2. It is because at high quantity, firms have to incur more costs, and thus, have trouble raising quantity without sharp increase in costs.