Principles of economics 2nd by mankiw chapter 05

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Elasticity and Its Application Chapter Copyright © 2001 by Harcourt, Inc All rights reserved.   Requests for permission to make copies of any part of the work should be mailed to: Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida 32887-6777 Elasticity … is a measure of how much buyers and sellers respond to changes in market conditions  … allows us to analyze supply and demand with greater precision  Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Price Elasticity of Demand  Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price  It is a measure of how much the quantity demanded of a good responds to a change in the price of that good Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Determinants of Price Elasticity of Demand  Necessities versus Luxuries  Availability of Close Substitutes  Definition  Time of the Market Horizon Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Determinants of Price Elasticity of Demand Demand tends to be more elastic : if the good is a luxury  the longer the time period  the larger the number of close substitutes  the more narrowly defined the market  Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc 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 Percentage Change in Quantity Demanded Price Elasticity of Demand = Percentage Change in Price Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Computing the Price Elasticity of Demand Price elasticity of demand  Percentage change in quatity demanded Percentage change in price Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to cones then your elasticity of demand would be calculated as: (10  ) 100 20 percent 10  2 ( 2.20  2.00 ) 100 10 percent 2.00 Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Computing the 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 (Q2  Q1 )/[(Q  Q1 )/2] PriceElasticityof Demand= (P2  P1 )/[(P  P1 )/2] Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Computing the Price Elasticity of Demand (Q2  Q1 )/[(Q  Q1 )/2] PriceElasticityof Demand= (P2  P1 )/[(P  P1 )/2] Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to cones the your elasticity of demand, using the midpoint formula, would be calculated as: (10  8) 22 percent (10  8) /  2.32 (2.20  2.00) 9.5 percent (2.00  2.20) / Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Ranges of Elasticity Inelastic Demand   Quantity demanded does not respond strongly to price changes Price elasticity of demand is less than one Elastic Demand   Quantity demanded responds strongly to changes in price Price elasticity of demand is greater than one Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Perfectly Inelastic Demand - Elasticity equals Price Demand $5 An increase in price Quantity 100 .leaves the quantity demanded unchanged Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Inelastic Demand - Elasticity is less than Price A 22% $5 increase in price Demand Quantity 90 100 .leads to a 11% decrease in quantity Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Unit Elastic Demand - Elasticity equals Price A 22% $5 increase in price Demand Quantity 80 100 .leads to a 22% decrease in quantity Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Elastic Demand - Elasticity is greater than Price $5 A 22% increase in price Demand Quantity 50 100 .leads to a 67% decrease in quantity Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Perfectly Elastic Demand - Elasticity equals infinity Price At any price above $4, quantity demanded is zero Demand $4 At exactly $4, consumers will buy any quantity At a price below $4, quantity demanded is infinite Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Quantity Elasticity and Total Revenue Price $4 P x Q = $400 (total revenue) P Q Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Demand 100 Quantity Elasticity and Total Revenue: Inelastic Demand Price Price An increase in price from $1 to $3 …leads to an increase in total revenue from$100 to $240 $3 Revenue = $240 $1 Demand Revenue = $100 100 Quantity Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Demand 80 Quantity Elasticity and Total Revenue: Elastic Demand Price An increase in price from $4 to $5 …leads to a decrease in total revenue from$200 to $100 Price $5 $4 Demand Demand Revenue = $200 50 Quantity Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Revenue = $100 20 Quantity Perfectly Inelastic Supply - Elasticity equals Price Supply $5 An increase in price Quantity 100 .leaves the quantity supplied unchanged Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Inelastic Supply - Elasticity is less than Price Supply A 22% $5 increase in price Quantity 100 110 .leads to a 10% increase in quantity Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Unit Elastic Supply - Elasticity equals Price Supply A 22% $5 increase in price Quantity 100 125 .leads to a 22% increase in quantity Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Elastic Supply - Elasticity is greater than Price Supply A 22% $5 increase in price 100 200 Quantity .leads to a 67% increase in quantity Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Perfectly Elastic Supply - Elasticity equals infinity Price At any price above $4, quantity supplied is infinite Supply $4 At exactly $4, producers will supply any quantity At a price below $4, quantity supplied is zero Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Quantity Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc An Increase in Supply in the Market for Wheat Price of Wheat S1 $3 Demand 100 Quantity of Wheat Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc An Increase in Supply in the Market for Wheat Price of Wheat When demand is inelastic, an increase in supply S1 S2 .leads $3 to a large fall in price Demand 100 110 Quantity of Wheat .and a proportionately smaller increase in quantity sold As a result, revenue falls from $300 to $220 ... quantity demanded of a good responds to a change in the price of that good Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Determinants of Price Elasticity of Demand  Necessities... Availability of Close Substitutes  Definition  Time of the Market Horizon Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Determinants of Price Elasticity of Demand Demand... copyright © 2001 by Harcourt, Inc Quantity Elasticity and Total Revenue Total revenue is the amount paid by buyers and received by sellers of a good  Computed as the price of the good times
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