Chapter+5+Elasticity+and+Its+Application

Chapter 5: Elasticities & Its Application
CHAPTER 5 explores the **ELASTICITY**. Refer the Glossary for **bold** terms. Glossary

Price Elasticity of Demand  **Price Elasticity of Demand =** % ∆ in Q D / % ∆ in Price ; (where ∆ = change, Q D = Quantity Demanded) - As the price rises, the quantity demanded decreases and vice versa. Due to this concept, "% ∆ in Q D " and "% ∆ in Price" will always have different sign, which always results the price elasticity of demand into //negative// sign.

Based on the above formula, there are three responses. 1. //Elastic:// Q D greatly responds to change in Price ; numerator > denominator ; Elasticity > 1 2. //Inelastic:// Q D slightly responds to change in Price ; numerator < denominator ; Elasticity < 1 3. //Unit Elastic:// QD equally responds to change in Price ; numerator = denominator ; Elasticity = 1 * Note that //steeper// the slope of the demand, relatively more //inelastic// //Examples// of different responses. - Goods with close substitutes are //elastic// because consumers have more options of goods to choose from. So when the price increases, they can buy the substitutes of that good. - Luxuries are also //elastic// because consumers only enjoy luxuries when the price doesn't change immensely. - Necessities are //inelastic// because consumers will have to buy necessities regardless of their price. 1. CAN YOU GUESS WHICH IS ELASTIC AND INELASTIC? **vs. ** 

Total Revenue (TR) & Price Elasticity of Demand //RULES// 1. Inelastic demand: when price increases, total revenue increases as well 2. Elastic demand: when price increases, total revenue decreases 3. Unit Elastic demand: when price changes, total revenue stays the same

- Along the linear demand curve, the total revenue //decreases.// Look at the graph below.

//OBSERVATIONS// 1. Demand curve above point B is //elastic// because the elasticity is greater than 1. Using the Rule 2, as the price decreases, the total revenue increases. 2. Demand curve below point B is //inelastic// because the elasticity is less than 1. Using the Rule 1, as the price decreases, the total revenue decreases. Therefore, total revenue //decreases// along the linear demand curve.

Income Elasticity of Demand - Unlike the price elasticity of demand, the sign of income elasticity of demand isn't necessarily always negative. //Normal goods// (income ↑, quantity demanded ↑) have //positive// signs because increase / decrease in both income and quantity demanded will be positive. //Inferior goods// (income ↑, quantity demanded ↓) have //negative// signs because increase in income will be positive while decrease in quantity demanded is negative.
 * Income Elasticity of Demand =** % ∆ in Q D / % ∆ in Income

Cross-Price Elasticity of Demand - Like the income elasticity of demand, the sign of cross-price elasticity of demand can be positive or negative. Goods that are //substitutes// have //positive// sign because as the price of good Y increases, the quantity demanded of substitute good X will increase. Goods that are //complements// have //negative// sign because as the price of good Y decreases, the quantity demanded of complement good X will increase; consumers are more willing to buy the complements because the price of the core good decreased. 2. WHICH PAIR HAS A POSITIVE SIGN? WHICH PAIR HAS A NEGATIVE SIGN? / = ? /  = ?
 * Cross-Price Elasticity of Demand =** % ∆ in Q D of good X / % ∆ in Price of good Y

Price Elasticity of Supply Price elasticity of supply depends on the //flexibility of sellers to change the quantity of good produced//. For example, some goods such as beachfront lands, are inelastic because it is difficult to control the quantity of the land produced. However, other goods such as computers, are elastic because firms can produce them easily. Supply is more //elastic in the long run// because it is harder for the firms to change the quantity of good produced over the short period of time. Moreover, in long run, firms can build more factories, which will increase the quantity of good supplied.
 * Price Elasticity of Supply =** % ∆ in Q S / % ∆ in Price

Quiz ! 1~2. look above 3. Why are goods with substitutes more elastic? 4. The price decreased for a good with elastic demand. What happens to the total revenue?  Answers

by Sally B.