Lecture 3 elasticity (chapter 5) Flashcards
what does elasticity measure
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.
Price elasticity of demand (equation)
% change in quantity demanded / % change in price
- Suppose a 10% increase in the price of an ice-cream cone causes the amount of ice cream you buy to fall by 20%
o Price elasticity of demand = 20% / 10% = 2
The price elasticity 2 which means that the change in the quantity demanded is proportionately twice as large as the change in the price.
- If we do not know the percentage change, but only know the before and after prices and quantity demanded.
o Need to calculate the percentage change.
2 methods to calculate the price elasticity of demand
- Initial value as the base:
- Midpoint method-using mid=point or the average as the base to calculate percentage change (this will be the one we use in the calculation there after)
price elasticity of demand
- Price elasticity of demand =
(Q2 - Q1) / [(Q2 + Q1) / 2]
(P2 – P1) / [(P2 + P1) / 2]
- Using the previous example, with the midpoint method:
Price = $5 Quantity = 100
- From point A to Point B, the price rises by 40% and the quantity falls by 40%
- From point B to point A, the price falls by 40% and the quantity rises by 40%
- In both directions, PED = 1
initial value as the base
1. Initial value as the base: For example: Point A: Price = $4 Quantity = 120 Point B: Price = $6 Quantity = 80
- From point A to point B, the price rises by %50, and the quantity falls by 35%, PED = 0.66.
- From point B to point A, the price falls by 33%, and the quantity rises by 50%, PED = 1.5
when elasticity is greater greater than 1
demand is elastic
the quantity moves proportionately more than the price.
when the elasticity is less than 1
demand is inelastic
that quantity moves proportionately more than the price.
If the elasticity is exactly 1
the quantity moves the same amount proportionately as price, demand is said to have unit elasticity.
Even though the slope of a linear demand curve is constant, the elasticity is not.
that the slope is the ratio of changes in the two variables, whereas the elasticity is the ratio of percentage changes in the two variables
rearrange the elasticity formula
percentage change in quantity demanded = percentage change in price x Ed
Beer prices and highway deaths
Use the concept of price elasticity to predict the effects of a change in the price of beer on drinking and highway death among young adults.
- The price elasticity of demand for beer among young adults is about 1.30.
- If the state imposes a beer tax that increases the price of beer by 10%, we would predict that beer consumption will decrease by 13%
o % change in quantity demanded = % change in price*Ed = 10$ * 1.30 = 13% - the number of highway deaths among young adults is roughly proportional to their beer consumption, so the number of deaths will also decrease by 13%
Cigarette prices and teenagers
A policy to reduce smoking by teenagers.
A policy to reduce smoking by teenagers.
- Under the 1997 federal tobacco settlement, cigarette prices increased by about 62 cents per pack, a percentage increase of about 25%
- The demand for cigarettes by teenagers is elastic, with an elasticity of 1.3
- Therefore, a 25% price hike will reduce teen smoking by 32.5%
- % change in quantity demanded = 25%*1.30 = 32.5%
total revenue (in a market):
the amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold.
TR = P*Q
How does total revenue change as one moves along the demand curve?
- Effects of price changes on quantity demanded: PQD and PQD
When the price (P) declines, quantity demanded (QD) increase. The two factors, P and QD, move in opposite directions.
When demand is inelastic (a price elasticity less than 1),
price and total revenue move in the same direction.
When demand is elastic (a price elasticity greater than 1
price and total revenue move in opposite directions.
If demand is unit elastic (a price elasticity exactly equal to 1),
total revenue remains constant when the price changes.
Bus fares and deficits
In every large city in the united states. The public bus system runs a deficit. Here is the exchange between two city officials.
o Buster. “a fare increase is a great idea. We’ll collect more money from bus riders, so revenue will increase, and the deficit will shrink.
o Bessie: “wait a minute, buster. Haven’t you heard about the law of demand? The increase in the bus fare will decrease the number of passengers taking buses, so we’ll collect less money, not more, and the deficit will grow.
- Assume the price elasticity of demand for bus ridership in the typical city is 0.33. who is right?
Income elasticity of demand:
a measure of how much the quantity demanded of a good respond to change in consumers’ income, computed as the percentage change in quantity demanded divided by the percentage change in income.
Income elasticity of demand = % change in quantity demanded / percentage change in income.
Cross-price elasticity of demand:
a measure of how much the quantity demanded for one good responds to a change in the price of another good, computed as the % change in quantity demanded of the first good divided by the % change in the price of the second good
Income elasticity of demand
% change in quantity demanded of good 1 / % change in price of good 2
Price elasticity of supply
a measure of how much the quantity supplied of a good respond to a change in the price of that good, computed as the % change in quantity supplied divided by the % change in price.
- Supply of a good is said to be
o Elastic if the quantity supplied responds substantially to changes in the price
o Inelastic if the quantity supplied responds only slightly to changes in the price.
Elasticity of supply
% change in quantity supplied / % change in the wage rate
Elasticity of labour supply
% change in quantity of labour supplied / % change in the wage rate
Factors that affect the elasticity of supply
- In most markets, a key determinant of the price elasticity of supply is the time period being considered.
- Supply is usually more elastic in the long run than in the short run.
Two methods of reducing drug use
- Reducing drugs entering the country
- Educate people on drugs
o Drug interdiction reduces the supply of drugs – which raises the price - And reduces the quantity sold
o Drug education reduces the demand for drugs – which lowers the price – reduces the quantity sold.
