*Step+5.+Elasticity+and+Its+Application+-Clair

=CHAPTER 5 - ELASTICITY AND ITS APPLICATION = = = 

[[image:400179962_17e9a4851d.jpg width="324" height="244" align="center"]] yes, we're going to learn about rubber bands! NOT
- elasticity - price elasticity of demand - total revenue - income elasticity of demand - cross-price elasticity of demand - price elasticity of supply
 * __ Key terms __

- what does price elasticity of demand and price elasticity of supply measure and how do you calculate it? - when is demand more elastic? when is it inelastic? How about supply? - what does different elasticity (greater than one, less than one) mean? - what is total revenue, and its relation to elasticity? - how do you calculate income elasticity of demand and cross-price elasticity of demand?
 * __ What we will learn :__

= __**INTRODUCTION**__ =

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**__ THE ELASTICITY OF DEMAND __** · ** Elasticity ** – measures how much consumers respond to changes (size of the change) · **__ The Price Elasticity of Demand and Its Determinants __** o ** Price elasticity of demand ** – measures how much the quantity demanded responds to a change in price (how willing consumers are to move away from the good as its price rises) o ** Elastic ** – quantity demanded responds substantially to changes in the price o ** Inelastic ** – quantity demanded responds only slightly to changes in the price o ** What determines the price elasticity of demand ** … § // Availability of close substitutes // – the closer the substitutes are, the more elastic demand § // Necessities versus luxuries // – necessities have inelastic demands § // Definition of the Market // – elasticity of demand in any market depends on how we draw the boundaries of the market. Narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes · Food – inelastic (no substitutes) · Vanilla Ice cream – elastic (other flavors available § // Time Horizon // – goods have more elastic demand over longer time horizons  · **__ Computing the Price Elasticity of Demand __**
 * __ Topics __

Price elasticity of demand = (% ∆Q)/(% ∆P)

The larger the price elasticity of demand, the greater responsiveness of quantity demanded to price. · **__ The Midpoint Method: a Better Way to Calculate Percentage Changes and Elasticities __** o Midpoint method –

Price elasticitiy of demand = (Q2 – Q1)/[(Q2 + Q1)/2] _ (P2 – P1)/[(P2 + P1)/2] · **__ The Variety of Demand Curves __** o Elastic: demand > 1 o Inelastic: demand < 1 o Unit elasticity: elasticity = 1 o The flatter the demand curve that passes through a given point, the greater the price elasticity of demand o The steeper, the smaller the price elasticity of demand · **__ Total Revenue and the Price Elasticity of Demand __** o ** 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 o ** P x Q ** o Inelastic: increase in price causes in increase in total revenue (price and total revenue move in the same direction) o Elastic: increase in price causes decrease in total revenue (price and total revenue move in opposite direction o Unit elastic = total revenue remains constant when the price changes · **__ Elasticity and Total Revenue along a Linear Demand Curve __** o straight line – elasticity changes even though the slope is constant o why? Because the slope is the ratio of changes in the 2 variables, whereas the elasticity is the ratio of percentage changes in the two variables o Other demand elasticities  § __ The 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  · Income elasticity of demand = Percentage change in quantity demanded / 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 god · Cross-price elasticity of demand = (percentage change in quantity of demanded of good 1)/(percentage change in the price of good 2) · **__ The Price Elasticity of Supply and its Determinants __** o ** 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 o ** Elastic ** – quantity supplied responds substantially to changes in the price o ** Inelastic ** – quantity supplied responds only slightly to changes in the price o ** Depends on ** … § Flexibility of sellers to change the amount of the good they produce § Time period (more elastic in the long run) because it takes time to make major changes in the way they produce · **__ Computing the Price Elasticity of Supply __** Price elasticity of supply = (%∆ Q supplied)/ (%∆ price) · **__ The variety of supply curves __** o In some markets, the elasticity of supply varies over supply curve o As the quantity supplied rise, firms begin to reach capacity o For low levels of supply – elasticity is great
 * __ THE ELASTICITY OF SUPPLY __**

__CONCLUSION__

The tools of supply and demand are essential in many different kinds of market. They are also helpful in measuring elasticity. :)

__SOURCE__ http://www.studyguide4cfa.com/2009/04/price-elasticity-of-demand.html