Chapter+5+(Elasticity+and+its+Application)


 * Chapter 5**
 * Elasticity and its Application**


 * What is Elasticity ?**
 * Measurement of the 'responsiveness' of demanded and supplied Q to one of its determinants.

The Price of Demand measures how much a good responds to a change is price. This measures how willing consumers are to move away from the good as its price rises. A demand for a good is ‘elastic ’ if the quantity demanded responds to changes in the price.
 * The Price of Demand and its Determinants**

Goods with closer substitutes have more elastic demand. This is because it is easy for consumers to switch from that good to others.
 * __General rules of determining the Price Elasticity of Demand:__**
 * **Availability of Close Substitutes **

Necessities have inelastic demand vs. Luxuries have elastic demands. For example, people would not change the number of times they go to visit the doctor. But they would alter the number of sailboats they demand if the price of sailboats go up because it is a luxury, not a necessity. Narrowly defined markets tend to have more elastic demand than broadly defined markets. This is because it is easier to find substitutes that are close for narrowly defined goods.
 * **Necessities vs. Luxuries**
 * **Definition of the Market**

Goods tend to have more elastic demand over longer time horizons. For example, When the price of gasoline rises, the Q of gasoline demanded falls only a little over a few months. However, over a long period of time, people buy more fuel-efficient cars, move houses closer to work and start changing methods of transportation. So within a few years, the Q of gasoline demanded decreases.
 * **Time Horizon**

Price elasticity of demand= (Percentage Change in quantity demanded)/ (Percentage change in price) For example, if a 10 % increase in a price of ice-cream cones causes the amount of ice-cream bought to fall by 20%, the price elasticity of demand would be: Price elasticity of demand= (20%)/ (10%)= 2 We follow the practices of dropping the minus sign and finding the price elasticity as positive numbers: ‘Absolute value’.
 * Computing the Price Elasticity of Demand**

Look at these numbers Point A: Price=$54, Quantity=$120 Point B: Price=$6, Quantity=$80 When calculating the price elasticity using the equation from above, we see that the elasticity from point A to point B is difference from the elasticity found from point B to point A. In order to avoid this problem, we use the midpoint method in order to calculate elasticity. Price Elasticity of demand: (Q2-Q1)/[Q2+Q1]/2] divided by (P2-P1)/[(P2+P1)/2] This method means: finding the percentage change by dividing the change by the midpoint (average) of the initial and final levels.
 * The Midpoint Method**

Demand is elastic when the elasticity is greater than 1. This means the quantity moves more in proportion than the price.
 * The Variety of Demand Curves**

Demand is inelastic when elasticity is less than 1. This means, the quantity moves the same amount proportionately less than the price.

If the elasticity is 1, the demand is said to have “unit elasticity”. This means the quantity moves in the same amount proportionately as price.



__Remember these rules:__
 * The flatter the demand curve that passes through a given point, the greater the price elasticity of demand.
 * The steeper the demand curve that passes through a given point, the smaller the price elasticity of demand.
 * When there is zero elasticity, demand is perfectly inelastic, and the demand curve would be vertical. So the quantity demanded would be the same.
 * But as the elasticity increases, the demand curve gets flatter.
 * A demand curve would show perfect elasticity when it is horizontal, and the price elasticity of demand approaches infinity. This shows that very small changes in the price lead to very late changes in quantity demanded.


 * Total Revenue and the Price of Elasticity of Demand**

Total revenue is computed as: (price of the good) x (the quantity sold). Total Revenue: P x Q
 * Total Revenue**: the amount paid by buyers and received by sellers of a good.

If demand is inelastic, the increase in price would lead to an increase in total revenue. If demand is elastic, the increase in the price causes a decrease in total revenue.

__Remember these rules:__
 * When demand is inelastic, price and total revenue move in the same direction.
 * When demand is elastic, price and total revenue move in opposite directions.
 * If demand is unit elastic, total revenue remains constant when the price changes.

The slope of a linear demand curve is constant, but its elasticity is not. At points with a low price and high quantity, the demand curve in inelastic. At points with a high price and low quantity, the demand curve is elastic.
 * Elasticity and Total Revenue along a Linear Demand Curve**

The income of Elasticity of Demand: Measurement of how the quantity demanded changes as consumer income changes. Income Elasticity of Demand= (% change in quantity demanded)/ (% change in income)
 * Other Demand Elasticity**

Higher income raises the quantity demanded. With normal goods, quantity demanded and incomes move in the same direction. NORMAL GOODS have positive income elasticity. Goods like bus rides are <span style="color: rgb(118, 203, 244);">INFERIOR GOODS. Higher income lowers the quantity demanded. Because the quantity demanded and income move in opposite directions, inferior goods have negative income elasticity. <span style="color: rgb(25, 173, 240);">NECESSITIES have smaller income elasticity because consumers want to buy some of these goods. <span style="color: rgb(22, 175, 243);">LUXURIES, such as caviar and diamonds, tend to have large income elasticity because consumers feel they can live without these goods, if their income is low.

This measure: how much the quantity demanded of one good responds to a change in the price of another good. <span style="background-color: rgb(250, 242, 252); color: rgb(183, 36, 240);">Cross-Price of Elasticity of Demand: <span style="color: rgb(155, 67, 219);">(% change in quantity demanded of good 1)/ (% change in price of good 2) Whether the cross-price elasticity is a positive or negative #, depends on whether the goods are substitutes (like hamburgers and hot dogs) or complements (like computers and software).
 * The Cross-Price of Elasticity of Demand**


 * Elasticity of Supply**

This is a measure of how much the quantity supplied of a good responds to a change in the price of that good. <span style="color: rgb(140, 58, 212);">Price Elasticity of Supply= <span style="color: rgb(91, 62, 224);">(% change in quantity supplied)/ (% change in price)

A key determinant of the price elasticity of supply is the __time horizon.__ Supply is more elastic after a long period because over a short period, firms cannot easily change the size of their factories to make more good or less. But over a longer period, firms can build new factories or close old ones. So, the Q supplied would respond to the P changes.
 * Determinants of Price Elasticity of Supply**


 * Variety of Supply Curves**
 * In the case of zero elasticity, a supply is perfectly inelastic, and the supply curve is vertical. So the quantity supplied is the same regardless of price change.
 * However, as the elasticity curve gets flatter, the quantity supplied responds more to the changes in price.
 * When the curve is horizontal, this means the curve is perfectly elastic and that very small changes lead to huge changes in the quantity supplied.

Part 1 Price Elasticity media type="youtube" key="MNiEHvw6TTg" height="344" width="425"

Part 2 Price Elasticity media type="youtube" key="DB6rmbAegvE" height="344" width="425"


 * Questions and Answers**

Q1. What is Elasticity? Q2. What are some rules of determining the Price Elasticity of Demand? Q3. How do you find the Price Elasticity of demand? Q4. How do you find the total revenue? Q5. Draw perfectly inelastic demand curve and perfectly elastic curve.

A1. A measure of the responsiveness of Q demanded or Q supplied to one of its determinants. A2. Availability of Close substitutes, Necessities vs. Luxuries, Definition of the market, Time horizon A3. Price Elasticity of demand: (Q2-Q1)/[Q2+Q1]/2] divided by (P2-P1)/[(P2+P1)/2] A4. P x Q A5. Look above for answer.


 * Sources:**

Book: __The Principles of Microeconomics__ by N. Gregory Mankiw of Havard University

Sites: http://en.wikipedia.org/wiki/Price_elasticity_of_demand [|http://en.wikipedia.org/wiki/Elasticity_(economics]) http://economics.about.com/cs/micfrohelp/a/priceelasticity.htm

[|http://kr.mnsu.edu/~renner/supdem.htm]