Econ 5

Front 1

• Elasticity

Back 1

how economists measure responsiveness
o Concept that can be used to quantify the response in one variable when another variable changes
o Elasticity of A with respect to B= %change A/% change B


• Understanding the responsiveness of consumers and producers in markets to price changes
• We know a price change will cause a shift, but how BIG of a shift?
• Measuring the magnitude of market responses to price changes

Front 2

• Price elasticity of demand

Back 2

how does demand for a product respond when its price changes?

Front 3

• Price elasticity of supply

Back 3

how does supply respond when prices change

Front 4

• Cross price elasticity of demand

Back 4

how the price of one good affects the demand for another good

Front 5

• Slope is not a useful measure of responsiveness

Back 5

the slope of a demand curve doesn’t tell you much other than the overall negative relationship
o Ex: if you change the units on the X axis from pounds to ounces, you decrease the magnitude of the slope even though you’re not changing anything about the actual behavior
o Numerical value of the slope depends on the units used to measure the variables on the axes
• So you use percentages to fix this problem
• Percentages don’t change as units change

Front 6

• Price elasticity of demand

Back 6

ratio of the percentage of change in quantity demanded to the percentage change in price
o Price elasticity of demand= %change in quantity demanded/%change in price
o Measures the responsiveness of quantity demanded to changes in price
o Positive changes are increases, negative changes are decreases
• Law of demand implies that price elasticity of demand is nearly always negative

Front 7

• Elasticity of 0

Back 7

indicates that the quantity demanded does not respond at all to a price change

Front 8

• Perfectly inelastic demand

Back 8

demand in which quantity demanded does not respond at all to a change in price
o Ex: demand for insulin, people will still need their medicine whether or not the price changes

Front 9

• Perfectly elastic demand

Back 9

demand in which quantity drops to zero at the slightest increase in price
o Ex: two competing ice cream stores, one store raises its price, all buyers go to the other store, the first store goes out of business

Front 10

• Elastic

Back 10

when an elasticity is over -1.0 in absolute value

o Percentage change in quantity is larger in absolute value than the percentage change in price
o Consumers are responding a lot to the price change

Front 11

• Elastic demand

Back 11

a demand relationship in which the percentage change in quantity demanded is larger than the percentage change in price in absolute value (demand elasticity with an absolute value greater than 1)

Front 12

• Inelastic

Back 12

when elasticity is less than 1 in absolute value
o Consumers are responding less to changes in price
o Ex: demand for oil is inelastic b/c even with a price increase it is hard to substitute oil with other products

Front 13

• Inelastic demand

Back 13

o Demand that responds somewhat, but not a great deal, to changes in price. Inelastic demand always has a numerical value between zero and -1

Front 14

• Unitary elasticity

Back 14

o A demand relationship in which the percentage change in quantity of a product demanded is the same as the percentage change in price in absolute value (a demand elasticity of -1)
o Percentage change in price exactly equals percentage change in demand

Front 15

• Calculating percent change in demand

Back 15

o %change in quantity demand= (Q2-Q1)/Q1 X 100
o take change in demand, divide by original demand, times by 100
o but usually you use the midpoint formula

Front 16

• Calculating percent change in price

Back 16

o % change in price= (P2-P1)/P1 X 100
o take change in price, divide by original price, times by 100
o but usually you use the midpoint formula

Front 17

• Midpoint formula

Back 17

o Ex: price of steak goes from $3-$2 causing demand to go from 5-10 pounds. Afterwards price of steak goes from $2-$3 causing demand to go from 10-5 pounds.
o If you calculate the percentage decrease in quantity demand using Q1=10 and Q2=5 you get 50% but the percentage increase calculated before was 100% (when Q1=5 and Q2=10)
o You need to use the midpoint formula, which uses the midpoint as the “base” (Q1)
o Look in handwritten notes for midpoint formula
o MOST OF THE TIME YOU’RE USING THE MIDPOINT FORMULA

Front 18

• Elasticity changes from point to point along a demand curve even when the slope of the demand curve doesn’t change

Back 18

o Demand becomes less elastic as price is reduced
o As you move down the demand curve, price elasticity falls
o Ex: if mcdonalds kept lowering the price of a burger, eventually a smaller amount of new customers will be lured in to buying burgers, there are only so many consumers out there
o At high prices there is a higher potential demand, so quantity is likely to respond well to price cuts
o At low prices, everyone who is likely to buy the product already has, so there aren’t many new customers who will be attracted to buy the product – quantity won’t respond as well to price cuts

Front 19

• Elasticity and total revenue

Back 19

knowing the value of price elasticity allows us to see what happens to a firm’s revenue as it raises and cuts its prices
o If demand is inelastic, raising prices will raise revenues
• Ex: raising the price of gas will raise revenues b/c people will still buy the gas
o If demand is elastic, raising prices will reduce revenues
• Ex: raising the price of bananas will cause the companies to lose money because people will just buy more oranges instead
o Oil producers will succeed and banana producers will fail as they raise prices b/c oil is inelastic demand and banana is elastic demand

Front 20

• Total revenue=price times quantity

Back 20

o TR= P X Q

Front 21

• Effect of price increase on a product with inelastic demand

Back 21

o Big increase price
o Small decrease demand
o Increase total revenue

Front 22

• Effect of price increase on a product with elastic demand

Back 22

o Small price increase
o Big demand decrease
o Decrease total revenue

Front 23

• Effect of price cut on a product with elastic demand

Back 23

o Small price decrease
o Big demand increase
o Increase total revenue

Front 24

• Effect of price cut on a product with inelastic demand

Back 24

o Big price decrease
o Small demand increase
o Decrease total revenue

Front 25

• Availability of Substitutes affects demand elasticity

Back 25

o If substitutes are available, the demand elasticity will be more elastic
o Ex: if banana and apples are substitutes, the demand elasticity of both goods will be very elastic because they act as substitutes

Front 26

• Unimportant goods and elasticity

Back 26

o If an item represents a small portion of our budget, we pay less attention to its price
o Ex: if gum doubles its price from 10 cents to 20 cents, we’re still going to buy it even though it doubled in price
o So demand for gum is inelastic

Front 27

• Elasticity in the short run and long run

Back 27

o Elasticity of demand in the short run may be different from the elasticity of demand in the long run
o Ex: if gas prices rise, I’m still going to fill my tank once a week, but if gas prices continue to rise I’m switching to a hybrid car so I’ll use less gas
o In the longer run, demand is likely to become more elastic and responsive as households make adjustments over time and producers develop substitute goods

Front 28

• Income elasticity of demand

Back 28

o Measures the responsiveness of demand to changes in income
o %change in quantity demanded/% change in income
o income elasticities can be positive or negative
• income elasticity for jewelry is positive
• income elasticity for spam is negative

Front 29

• cross price elasticity of demand

Back 29

o a measure of the response of the quantity of one good demanded to a change in the price of another good
o %change in quantity of Y demanded/%change in price of X
o positive cross price elasticity→ increase in the price of X causes the demand for Y to rise
• implies that the goods are substitutes
o negative cross price elasticity→ increase in the price of X causes a decrease in the demand for Y
• implies that the goods are compliments

Front 30

• elasticity of supply

Back 30

o a measure of the response of quantity of a good supplied to a change in price of that good. Likely to be positive in output markets
o %change in quantity supplied/%change in price
o a higher price usually leads to an increase in supply
o elasticity of supply measures how easily producers can adapt to a price increase and bring increased quantities to market
o ex: it’s easy to manufacture more pens (high elasticity), but it’s harder to drill more oil (low elasticity)

Front 31

• elasticity of labor supply

Back 31

a measure of the response of labor supplied to a change in the price of labor
o %change quantity of labor supplied/%change in wage rate
o applies to input markets
o sometimes an increase in wages will lead to a reduction in quantity of labor supplied
• ex: I’m going to work less if I make more money per hour because I won’t have to work as much to make money
•