4.1 Price Elasticity of Demand

Question 1

When would we consider demand to be elastic?

Answer 1

Loosely speaking, demand is said to be elastic when quantity demanded is quite responsive to changes in price.

Question 2

When would we consider demand to be inelastic?

Answer 2

When quantity demanded is relatively unresponsive to changes in price, demand is said to be inelastic.

Question 3

What conditions must be fulfilled in order for us to be able to compare the responsiveness to price changes between two different graphs?

Answer 3

First, both curves were drawn on the same scale. Second, the initial equilibrium prices and quantities were the same in both parts of the figure. Let’s see why these conditions matter.

Question 4

Why is it important to draw both figures on the same scale?

Answer 4

First, by drawing both figures on the same scale, we saw that the demand curve that looked steeper actually did have the larger absolute slope.

If we had drawn the two curves on different scales, we could have concluded nothing about which demand curve actually had the greater slope.

Question 5

What dose the slope of a demand curve tell us?

Answer 5

The slope of a demand curve tells us the amount by which price must change to cause a unit change in quantity demanded.

Question 6

Why is it important to start from the same price-quantity equilibrium?

Answer 6

Because we started from the same price–quantity equilibrium in both parts of the figure, we did not need to distinguish between percentage changes and absolute changes. If the initial prices and quantities are the same in both cases, the larger absolute change is also the larger percentage change. However, when we want to deal with different initial price–quantity equilibria, we need to decide whether we are interested in absolute or percentage changes.

Question 7

Why is it important to know the initial quantity demanded when figuring out the significance of the present quantity demanded?

Answer 7

knowing the change in the quantity demanded is not very revealing unless the initial quantity demanded is also known. An increase of 7500 kilograms is quite a significant change if the quantity formerly bought was 15 000 kilograms, but it is insignificant if the quantity formerly bought was 10 million kilograms.

Question 8

What is the definition of “Price elasticity of demand”?

Answer 8

price elasticity of demand (η)(η)

A measure of the responsiveness of quantity demanded to a change in the product’s own price.

Question 9

What are different names for the Price elasticity of demand?

Answer 9

This measure is called the price elasticity of demand or simply demand elasticity. Because the variable causing the change in quantity demanded is the product’s own price, the term own-price elasticity of demand is also used.

Question 10

What are demand elasticities computed using? Why do we use this?

Answer 10

Demand elasticities are computed by using changes in price and quantity measured in terms of the average values of each. Averages are used to avoid the ambiguity caused by the fact that when a price or quantity changes, the change is a different percentage of the original value than the new value.

Using average values for price and quantity means that the measured elasticity of demand between any two points on the demand curve, call them A and B, is independent of whether the movement is from A to B or from B to A.

Question 11

What is it mean when we say that elasticity is “Unit free”?

Answer 11

Notice that elasticity is unit free—even though prices are measured in dollars and quantity of cheese is measured in kilograms, the elasticity of demand has no units.

Question 12

What effect dose an increase in price have on a demand curve?

Answer 12

Because demand curves have negative slopes, an increase in price is associated with a decrease in quantity demanded, and vice versa.

Question 13

Why is demand elasticity always a positive number?

Answer 13

Because the percentage changes in price and quantity have opposite signs, demand elasticity is actually a negative number. However, economists usually focus on the absolute value of the changes (and thus ignore the sign) and so treat elasticity as a positive number, as we have done in the illustrative calculations in Table 4-3. Thus, the more responsive the quantity demanded to a change in price, the greater the elasticity and the larger is η.

Question 14

What is the range of the numerical value of demand elasticity?

Answer 14

The numerical value of demand elasticity can vary from zero to infinity.

Question 15

What dose it mean when elasticity is zero?

Answer 15

First consider the extreme cases. Elasticity is zero when a change in price leads to no change in quantity demanded. This is the case of a vertical demand curve, and it is quite rare because it indicates that consumers do not alter their consumption at all when price changes.

Question 16

What dose it mean when the demand elasticity is infinite?

Answer 16

At the other extreme, when even a very small change in price leads to an enormous change in quantity demanded, elasticity is a very large number. In these situations, the demand curve is very flat, almost horizontal. (In the rare limiting case, the demand curve is perfectly horizontal and elasticity is infinite.)

Question 17

What is inelastic demand?

Answer 17

inelastic demand
Following a given percentage change in price, there Is a smaller percentage change in quantity demanded; elasticity is less than 1.

When the percentage change in quantity demanded is less than the percentage change in price (η<1),(η<1), there is said to be inelastic demand. For example, if price rises by 10 percent, quantity demanded falls by less than 10 percent.

Question 18

What is elastic demand?

Answer 18

elastic demand
Following a given percentage change in price, there is a greater percentage change in quantity demanded; elasticity is greater than 1.

When the percentage change in quantity demanded is greater than the percentage change in price (η>1),(η>1), there is said to be elastic demand For example, if price rises by 10 percent, quantity demanded falls by more than 10 percent.

Question 19

When is demand “Unit elastic”?

Answer 19

The dividing line between these two cases occurs when the percentage change in quantity demanded is exactly equal to the percentage change in price, and so elasticity is equal to 1. For example, if price rises by 10 percent, quantity demanded falls by exactly 10 percent. Here we say that demand is unit elastic.

Question 20

What is the Elasticity of demand mostly determined by?

Answer 20

Elasticity of demand is mostly determined by the availability of substitutes, the importance in consumers’ budgets, and the time period under consideration.

Question 21

How dose the availability of substitutes affect

Answer 21

A change in the price of these products, with the prices of the substitutes remaining constant, can be expected to cause much substitution. A fall in the price of broccoli leads consumers to buy more broccoli and less of other green vegetables, and a rise in price leads consumers to buy less broccoli as they substitute toward other green vegetables.

Question 22

How dose product definition affect our analysis.

Answer 22

A related point concerns product definition. Products defined more broadly, such as all foods or all clothing or all methods of transportation, have many fewer satisfactory substitutes than do products defined much more narrowly.

Question 23

What is the different in terms of products with close substitutes and products with no cluse substitutes in terms of product elasticity.

Answer 23

Products with close substitutes tend to have elastic demands; products with no close substitutes tend to have inelastic demands. Narrowly defined products have more elastic demands than do more broadly defined products.

Question 24

Importance of the Product in Consumers’ Budgets

Answer 24

Other things being equal, demand for items that represent a small fraction of consumers’ budgets tend to be less elastic than the demand for items that represent a larger fraction of consumers’ budgets.

Question 25

How dose time frame affect elasticity of demand?

Answer 25

The response to a price change, and thus the measured price elasticity of demand, will tend to be greater the longer the time span.

Question 26

What are short-run/long run demand curves?

Answer 26

For products for which substitutes only develop over time, it is helpful to identify two kinds of demand curves. A short-run demand curve shows the immediate response of quantity demanded to a change in price. The long-run demand curve shows the response of quantity demanded to a change in price after enough time has passed to develop or switch to substitute products.

Question 27

What does the supply increase do on a short-run demand curve? Long run?

Answer 27

In the short run, the supply increase leads to a movement down the relatively inelastic short-run demand curve; it thus causes a large fall in price but only a small increase in quantity.

In the long run, demand is more elastic; thus long-run equilibrium has price and quantity above those that prevailed in short-run equilibrium.

Question 28

What is the equation for Total expenditure on the demand curve?

Answer 28

To see the relationship between the elasticity of demand and total expenditure, we begin by noting that total expenditure at any point on the demand curve is equal to price times quantity:

Question 29

What does the change in total expenditure depend on?

Answer 29

Because price and quantity move in opposite directions along a demand curve, the change in total expenditure is ambiguous if all we know about the demand curve is that it has a negative slope. The change in total expenditure depends on the relative changes in the price and quantity.

Question 30

How does expenditure change in the three different elasticity scenarios?

Answer 30

If the quantity demanded rises by more than 10 percent (elastic demand), then the quantity change will dominate and total expenditure will rise. In contrast, if the quantity demanded increases by less than 10 percent (inelastic demand), then the price change will dominate and total expenditure will fall. If the quantity demanded increases by exactly 10 percent (unit elastic demand), then the two percentage changes exactly offset each other and total expenditure will remain unchanged.