Lesson 6 - Elasticity Flashcards
Elasticity
measure of how much buyers/sellers respond to changes in market
price elasticity of demand
1) measures how much quantity demanded responds to change in price
2) considered elastic if quantity demanded responds SUBSTANTIALLY to price change
3) considered inelastic if quantity demanded responds SLIGHTLY to price change
Rules of thumb for elasticity of demand
1) availability of close substitutes = goods with substitutes more elastic since consumers can easily switch
2) necessities/luxuries = necessities inelastic, luxuries elastic
3) defining market broadly/narrowly = narrowly defined markets more elastic since easier to find close substitutes for narrowly defined goods
4) time horizons = demand more elastic over longer periods of time
Example of elasticity changing bc of narrowly defined or broadly defined markets
1) broadly defined –> less elastic –> something like food is inelastic since you need it to survive
2) narrowly defined –> more elastic –> something like ice cream is more elastic since you can substitute another desert for ice cream
Calculating price elasticity of demand
% change in price
ex: 10% increase in ice cream cone –> 20% fewer cones bought
20
—- = 2
10
SO, change in quantity demanded is twice as large as change in price
Midpoint Method
1) Bases change on midpoint btwn 2 points
2) Useful when comparing elasticity across multiple points
(Q2+Q1).5
————————————
P2 - P1
————
(P2+P1).5
Elasticity of Demand curve
1) Greater than 1 –> elastic
2) Equals 1 –> unit elastic
3) Less than 1 –> inelastic
Flatter curve –> MORE elastic
Types of Demand Curves Based on Elasticity
1) Perfectly inelastic = vertical line
2) perfectly elastic = horizontal line
3) rest –> flatter –> more elastic
Inelastic curves look more like an I
Total Revenue
1) P * Q
2) Price of a good * # goods sold
Elasticity and Total Revenue
1) Inelastic –> Increase in price increases total revenue (extra revenue from selling at higher price offsets decline in revenue from selling fewer units) AND decreases in price decreases total revenue
2) Elastic –> Increase in price reduces total revenue
3) Unit elastic = total revenue constant when price changes
How does elasticity change on a demand curve
1) Low prices + High quantities –> inelastic (adding 1 dollar would seem like a large percentage change BUT because quantity % change isn’t much, overall low percentage change)
2) High prices + low quantities –> elastic ($1 increase in price is a small percentage change in price, but the reduction in quantity demanded is a large percentage change)
price of elasticity of demand CHANGES through a linear demand curve
Income elasticity of demand
1) Measures how quantity demanded changes as consumer income changes
Percentage change in income
2) Positive = normal goods
3) Negative = inferior goods
4) Zero for perfectly inelastic, life saving drug
Normal Good’s elasticity
1) Food –> inelastic (low elasticity) –> % spent on food decreases with increasing income
2) luxuries –> elastic –> consumers buy more when their income rises
Cross-Price elasticity of demand
1) Measures how quantity demanded of one good responds to change in price of another
% change in quantity demanded of good 2
