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A.

B.

Elasticity of demand measures how much


the quantity demanded changes with a
given change in price of the item, change
in consumers income, or change in price
of a related product.
Price elasticity is a concept that also
relates to supply.

A.

B.

The law of demand tell us that consumers


will respond to a price decrease by buying
more of a product (other things remaining
constant), but it does not tell us how
much more.
The degree of responsiveness or
sensitivity of consumers to a change in
price is measured by the concept of price
elasticity of demand.
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If consumers are relatively responsive to


price changes, demand is said to be elastic.
2. If consumers are relatively unresponsive to
price changes, demand is said to be inelastic.
3. Note that with both elastic and inelastic
demand, consumers behave according to the
law of demand; that is, they are responsive
to price changes. The terms elastic or
inelastic
describe
the
degree
of
responsiveness.
1.

The quantitative measure of elasticity can


be found by using this formula:

Ed =

1.

Using the two price-quantity combinations


of a demand schedule, calculate the
percent change in quantity by dividing the
absolute change in quantity by one of the
two original quantities. Then calculate
the percentage change in price by dividing
the absolute change in price by one of the
two original prices.

2.

If we calculate the elasticity


using the other original quantity
and price, the resulting elasticity
would be different. To eliminate
this problem, economists use the
mid-point formula, which uses the
average of the quantities and the
prices as denominators.
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3.

Remember:
what is being
compared are the percentage
changes not the absolute changes.
That is because the absolute
changes depend on the choice of
units (a change in price of a
$10,000 car by $1 is very
different from a change in price
of $10 shirt by $1.
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Percentages also make it possible


to compare elasticities of demand
for different products.

4.

Because of the inverse relationship


between
price
and
quantity
demanded, the actual elasticity of
demand will be a negative number.
However, we will ignore the minus
sign and use the absolute value of
both percentage changes.
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The Coefficient of Elasticity:


If the coefficient of elasticity of
demand is a number greater than one
(Ed1), we say demand is elastic.
In other words, the quantity demanded
is relative responsive when Ed is
greater than 1, and relatively
unresponsive when Ed is les than 1.
A special case is if the coefficient
equals one, it is called unit elasticity.

5.

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NOTE: Inelastic demand does not mean that


consumers are completely unresponsive. This
extreme situation is called perfectly
inelastic demand, and would be very rare. In
this case, the demand curve would be
vertical, as the quantity demanded would not
change at all at any price.

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Likewise, an elastic demand does not mean


that consumers are completely responsive to
a price change. This extreme situation, in
which a small reduction in price would cause
buyers to increase their purchases to all
that is possible to obtain, is perfectly
elastic, and the demand curve would be
horizontal.

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So, the best formula for elasticity is:

Ed =

or
Ed =

1 2
(1+2)/2
12
(1+2)/2

(1+2)/2

(1+2)/2

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Get your calculator out!


On page 359, look at table 20.1. In your
notebook, compute the elasticity between
each two prices, using the midpoint formula.
Did you get the same numbers from the
table? Awesome! Youre ready to move on to
the next problem

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2.

Complete the following table:


PRICE

QUANTITY
DEMANDED

ELASTICITY
COEFFICIENT

CHARACTER OF
DEMAND

$1.00

300

.90

400

.80

500

.70

600

.60

700

.50

800

.40

900

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Graph the demand schedule shown below.


b) Determine the Ed between the prices.
c) Where is elastic demand found?
d) Where is the demand schedule inelastic?
a)

PRICE

QUANTITY DEMANDED

$5

5
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What can you conclude about the


relationship between the slope of the
demand curve and its elasticity? How are
they different?
f) Explain in a nontechnical way why demand
is elastic in the northwest segment and
inelastic in the southeast segment.
e)

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A.

Elasticity varies over a range of prices:


1. Demand is more elastic in the upper left

portion of the curve because when the initial


price is high and initial quantity is low, a unit
change in price is a low percentage while the
unit change in quantity is a high percentage
change.
The percent change in quantity
exceeds the percent change in price, making
demand elastic.

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2.

Demand is more inelastic in the lower


right portion of the curve because the
initial price is low and the initial quantity
is high, a unit change in price is a high
percentage change while a unit change in
quantity is a low percentage change. The
percentage change in quantity is less than
the percentage change in price, making
demand inelastic.
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It is impossible to judge the elasticity of a


single demand curve by its steepness or
flatness, since demand elasticity can
measure both elastic and inelastic at
different points on the same demand curve.

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It is impossible to judge the elasticity of a


single demand curve by its steepness or
flatness, since demand elasticity can
measure both elastic and inelastic at
different points on the same demand curve.

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PART 2:
TOTAL REVENUE AND
ELASTICITY

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The total-revenue test is the easiest way to


judge whether demand is inelastic or elastic.
This test can be used in place of the
elasticity formula, unless there is a need to
determine the elasticity coefficient.
1. Elastic demand and the total-revenue test:
Demand is elastic if a decrease in price results
in a rise in total revenue, or if an increase in
price results in a decline in total revenue (price
and revenue move in different directionsindirectly related).
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Inelastic demand and the total-revenue test:


Demand is inelastic if a decrease in price
results in a fall in total revenue, or if an
increase in price results in a rise in total
revenue (price and revenue move in the same
direction-directly related).
3. Unit elasticity and the total revenue test:
Demand has unit elasticity if total revenue
does not change when the price changes.
2.

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4.

5.

See the graphical representation of


the
relationship
between
the
relationship between total revenue and
price elasticity shown in the data from
the table on page 359 and the Figure
20.2 on page 360.
Table 20.2 on page 362 shows the
summary of the rules and concepts
related to elasticity of demand.
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There are several determinants of the price


elasticity of demand.
1. Substitutes for the product: Generally,
the more substitutes for the products,
the more elastic the demand.
2. The proportion of price relative to
income:
Generally, the larger the
expenditure is relative to ones budget,
the more elastic the demand, because
buyers notice the change in price more.
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3.

4.

Whether the product is a necessity or a


luxury: Generally, the less necessary the
item, the more elastic the demand.
The amount of time involved: Generally,
the longer the time period involved, the
more elastic the demand becomes.

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See the table 20.3 from page 363, which


presents some real-world elasticities. Use
the determinants and to see if the actual
elasticities are equivalent to what you would
predict, based on the characteristics of the
good.
Discuss your thoughts with your
neighbors.

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There are many practical applications of


elasticity:
1. Inelastic
demand
for
agricultural
products help explain why bumper crops
depress the prices and total revenues for
farmers.

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1.

Government looks at elasticity of demand


when levying excise taxes. Excise taxes
on products with inelastic demand will
raise the most revenue (in taxes) and
have the least impact on quantity
demanded for those products.

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3.

Demand for cocaine is highly inelastic and


presents problems for law enforcement.
Stricter enforcement reduces supply,
raises prices and revenues for sellers, and
provides more incentives for sellers to
remain in business.
Crime may also
increase as buyers have to find more
money to buy their drugs.

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Opponents of legalization think that


occasional users or dabblers have a
more elastic demand and would increase
their use at lower, legal prices.
2. Removal of the legal prohibitions might
make drug use more socially acceptable
and shift demand to the right.
3. The impact of minimum-wage laws will be
less harmful to employment if the
demand for minimum-wage workers is
inelastic.
1.

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PART 3:
PRICE ELASTICITY OF
SUPPLY

34

A.

The concept of price elasticity also


applies to supply. The elasticity formula
is the same as that for demand, but you
must substitute the word supplied for
the word demanded everywhere in the
formula.

Es =

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B.

The time period involved is very important


in price elasticity of supply because it will
determine how much flexibility a product
has to adjust his/her resources to a
change in the price.
The degree of
flexibility, and therefore the time period,
will be different in different industries.

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1.

The market period is so short that


elasticity of supply is inelastic; it could
be almost perfectly inelastic or vertical.
In this situation, it is virtually impossible
for producers to adjust their resources
and change the quantity supplied (for
example, think of adjustments on a farm
once the crop has been planted).

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2.

The short-run supply elasticity is more


elastic than the market period and will
depend on the ability of producers to
respond to price change.
Industrial
producers are able to make some output
changes by having workers work
overtime or by bringing on an extra
shift.

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3.

The long-run supply elasticity is the most


elastic, because more adjustments can be
made over time and quantity can be
changes more relative to a small change in
price. The producer has time to build a
new plant.

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A.

Cross elasticity of demand refers to the


effect of a change in a products price on
the quantity demanded for another
product. Numerically this is the formula:

EXY =
1.
2.
3.

If EXY is positive, then X and Y are substitutes.


If EXY is negative, then X and Y are complements.
Note: If EXY is zero, then X and Y are unrelated,
independent goods.
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1.

Income elasticity
the percentage
demanded that
percentage change
Ei=

of demand refers to
change in quantity
results from some
in consumer incomes.

If Ei is positive, then the good is normal.


If Ei is negative, then the good is inferior.
The goods that are income elastic will expand at a
higher rate as the economy grows.
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