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Proportion of Income – the higher the price of the good relative to the consumers income, the more elastic Substitutability – if something else can be substituted then it is more elastic If total revenue moves in the opposite direction as price then demand is inelastic, if it doesn’t change then it is unit-elasticĭeterminants of Price Elasticity of Demand Price Elasticity and the Total-Revenue Curve Unit elasticity – An increase or decrease in price leaves total revenue the same This is because lowering the price will have a relatively small effect on quantity. If demand is inelastic – a price decrease will decrease total revenue and vice versa. If demand is elastic then a decrease in price will increase total revenue and vice versa Total Revenue test – TR is the total amount the seller receives from the sale of a product in a particular time period, TR = price * quantity The flatness/steepness of the demand curve is not a good way to judge elasticity because it is based on absolute (instead of relative) changes in price/quantity. This is because the original reference quantity is quite small in comparison to large values so a small change in price results in a larger percentage change.
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Graphical Analysis – Elasticity varies for price ranges, typically more elastic for the higher price ranges than towards the lower price ranges. You calculate Elasticity from the midpoint of the two prices (4.5 dollars)Įd = ( Change in quantities/(average quantities)) / (change in price/(average price)) If you calculate a 5-4 dollar change then going one way it is a 20% decrease the other way is a 25% increase. However there is a problem when deciding what price should be the reference point to calculate elasticity of demand. This only really occurs for a supplier in an extremely competitive market when they lower prices a little A good example is insulin or an addict for heroin. Unit elasticity – if a percentage change in price causes the same percentage change in demandĮxtreme Cases/Perfectly inelastic – in the case that a change in price causes NO CHANGE in demand, a good is known to be perfectly inelastic. Inelastic demand – If a specific percentage change in price causes a smaller change in quantity demanded then demand is inelastic Percentages – use them because they give you a better idea of relative pricesĮlimination of minus sign – b/c elasticity of demand is always negative, most people don’t bother writing it inĮlastic Demand – Demand is elastic if a specific percentage change results in a larger change in quantity demanded The price Elasticity of demand is the measure of how responsive the quantity demanded is to a change in priceĮd = (percentage change in quantity demanded)/(percentage change in price) Law of demand – dictates that consumers will buy more or less of something if the price is lowered/increased.
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Chapter 20 – Elasticity of Demand and Supply