# Elasticity and Its Application. Elasticity… u … is a measure of how much buyers and sellers respond to changes in market conditions u … allows us to.

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Elasticity and Its Application

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Elasticity… u … is a measure of how much buyers and sellers respond to changes in market conditions u … allows us to analyze supply and demand with greater precision.

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Price Elasticity of Demand

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uPrice elasticity of demand is the percentage change in quantity demanded given a percent change in the price.

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Determinants of Price Elasticity of Demand P-Proportion of income spent on the good A-Availability of Close Substitutes I-Importance (luxury vs. necessity) D-Delaying of good being possible or not

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Determinants of Price Elasticity of Demand Demand tends to be more elastic : uif you do not spend a lot on the good uthe larger the number of close substitutes uif the good is a luxury uthe longer the time period

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Computing the Price Elasticity of Demand The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.

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This is about to get ugly… Do not give up, get the notes, do the activity problems, and know it will make sense to you by the end Remember, no calculator

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Price Elasticity of Demand Using the Midpoint Formula The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change… ( ( ) )

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Price Elasticity of Demand Using the Midpoint Formula ( ( ) ) What do Q 2 and P 2 mean?

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Ranges of Elasticity Inelastic Demand uQuantity demanded does not respond strongly to price changes. uPrice elasticity of demand is less than one. Elastic Demand uQuantity demanded responds strongly to changes in price. uPrice elasticity of demand is greater than one.

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1 Necessity Luxury Inelastic Elastic 0 Price Elasticity of Demand *This means we are talking about absolute value

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Example 1: If the price of an ice cream cone increases from \$2.00 to \$2.20 and the amount you buy falls from 10 to 8 cones. Your elasticity of demand would be calculated via the midpoint formula as:

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Example 2: If the price of an ice cream cone increases from \$2.00 to \$2.20 and the amount you buy falls from 10 to 8 cones the your elasticity of demand, using the midpoint formula, would be calculated as:

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Computing the Price Elasticity of Demand \$5 4 Demand Quantity1000 Price 50 Example 3 What is the price elasticity from point A to B? A B

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Ranges of Elasticity uPerfectly Inelastic Quantity demanded does not respond to price changes. uPerfectly Elastic Quantity demanded changes infinitely with any change in price. uUnit Elastic Quantity demanded changes by the same percentage as the price.

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Perfectly Inelastic Demand – Elasticity equals 0 Quantity Price 4 \$5 Demand 100 2….leaves the quantity demanded unchanged. 1. An increase in price…

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Perfectly Elastic Demand – Elasticity equals infinity Quantity Price Demand \$4 1. At any price above \$4, quantity demanded is zero. 2. At exactly \$4, consumers will buy any quantity. 3. At a price below \$4, quantity demanded is infinite.

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Inelastic Demand – Elasticity is less than 1 Quantity Price 4 \$5 1. A 25% increase in price… Demand 100 90 2….leads to a 10% decrease in quantity.

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Unit Elastic Demand – Elasticity equals 1 Quantity Price 4 \$5 1. A 25% increase in price… Demand 100 80 2….leads to a 25% decrease in quantity.

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Elastic Demand – Elasticity is greater than 1 Quantity Price 4 \$5 1. A 25% increase in price… Demand 100 50 2….leads to a 50% decrease in quantity.

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Let’s figure this out (absolute value)

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Elasticity and Total Revenue uTotal revenue is the amount paid by buyers and received by sellers of a good. uComputed as the price of the good times the quantity sold. TR = P x Q

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\$4 Demand Quantity P 0 Price P x Q = \$400 (total revenue) 100 Q Elasticity and Total Revenue

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With an inelastic demand curve, an increase in price leads to a decrease in quantity that is proportionately smaller. Thus, total revenue increases. Inelastic Demand sees more TR with an increase in price; Elastic Demand lessens TR when prices increases

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Elasticity and Total Revenue: Inelastic Demand \$3 Quantity 0 Price 80 Revenue = \$240 Demand \$1 Demand Quantity 0 Revenue = \$100 100 Price An increase in price from \$1 to \$3… …leads to an increase in total revenue from\$100 to \$240

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