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Elasticity
CHAPTER OUTLINE
Price Elasticity of Demand
Slope and Elasticity
Types of Elasticity
Calculating Elasticities
Calculating Percentage Changes
Elasticity Is a Ratio of Percentages
The Midpoint Formula
Elasticity Changes Along a Straight-Line Demand Curve
Elasticity and Total Revenue
Availability of Substitutes
The Importance of Being Unimportant
The Time Dimension
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%A
elasticityofAwithrespecttoB
%B
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Changing the unit of measure from pounds to ounces changes the numerical value of the
demand slope dramatically, but the behavior of buyers in the two diagrams is identical.
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Types of Elasticity
FIGURE
5.2 shows
Perfectly
Inelastic and
Perfectly
Elasticcurve
Demand
Figure
5.2(a)
a perfectly
inelastic
demand
for Curves
insulin. Price elasticity of demand is
zero. Quantity demanded is fixed; it does not change at all when price changes.
Figure 5.2(b) shows a perfectly elastic demand curve facing a wheat farmer. A tiny price increase
drives the quantity demanded to zero. In essence, perfectly elastic demand implies that
individual producers can sell all they want at the going market price but cannot charge a higher
price.
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A warning:
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Calculating Elasticities
Calculating Percentage Changes
% changeinquantitydemanded
changeinquantitydemanded
x100%
Q
1
Q Q
x100%
Q
2
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Calculating Elasticities
Calculating Percentage Changes
changeinprice
%changeinprice
x100%
P
PART I Introduction to Economics
P P
x100%
P
2
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Calculating Elasticities
Elasticity Is a Ratio of Percentages
%changeinquantitydemanded
%changeinprice
priceelasticityofdemand
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Calculating Elasticities
The Midpoint Formula
changeinquantitydemanded
x100%
(Q Q )/2
Q Q
x100%
(Q Q )/2
2
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Calculating Elasticities
The Midpoint Formula
changeinprice
%changeinprice
x100%
(P P )/2
1
P P
x100%
(P P )/2
PART I Introduction to Economics
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Calculating Elasticities
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Calculating Elasticities
Elasticity Changes Along a Straight-Line Demand Curve
Quantity
Demanded
(Lunches per Month)
$11
10
9
8
7
6
5
4
3
2
1
0
0
2
4
6
8
10
12
14
16
18
20
22
FIGURE 5.3 Demand Curve for Lunch at the Office Dining Room
Calculating Elasticities
Elasticity and Total Revenue
In any market, P x Q is total revenue
(TR) received by producers:
TR = P x Q
total revenue = price x quantity
P QD
and
P QD
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Calculating Elasticities
Elasticity and Total Revenue
Because total revenue is the product of P and Q, whether
TR rises or falls in response to a price increase depends
on which is bigger: the percentage increase in price or the
percentage decrease in quantity demanded.
P x QD TR
P x QD TR
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Calculating Elasticities
Elasticity and Total Revenue
The opposite is true for a price cut. When demand is
elastic, a cut in price increases total revenues:
effect of price cut on a product
with elastic demand:
P x QD TR
P x QD TR
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E C O N O M I C S I N PRAC TI C E
Elasticities at a Delicatessen in the Short Run and Long Run
The graph shows the expected
relationship between long-run
and short-run demand for
Franks sandwiches.
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%changeinquantitysupplied
%changeinprice
elasticityofsupply
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CHAPTER 5 APPENDIX
Point Elasticity (Optional)
Q
Q
100
%Q
Q P1
Q1
Q
elasticity
%P P 100 P P Q1
P
P1
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CHAPTER 5 APPENDIX
Point Elasticity (Optional)
Q/P is the reciprocal of the slope of the curve.
Slope in the diagram is constant along the curve, and
it is negative. To calculate the reciprocal of the slope
to plug into the previous elasticity equation, we take
Q1B, or M1, and divide by minus the length of line
segment CQ1. Thus,
Q M 1
P CQ1
Q M 1
P P1
By substituting we get
M 1 P1 M 1 P1
M1
elasticity
P1 Q1 P1 M 2 M 2
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CHAPTER 5 APPENDIX
Point Elasticity (Optional)
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