Economics Chapter on Elasticity

Elasticity Overview

• Elasticity measures the responsiveness of buyers and sellers to market changes.
• Price elasticity of demand specifically gauges how quantity demanded changes in response to price variations.

Price Elasticity of Demand Calculation

• Price elasticity of demand formula:
  • Price Elasticity of Demand = (Percentage Change in Quantity Demanded) / (Percentage Change in Price)
• Use of midpoint formula provides consistent results irrespective of price change direction:
  • (Q2 − Q1) / [(Q2 + Q1) / 2] for quantity
  • (P2 − P1) / [(P2 + P1) / 2] for price

Determinants of Price Elasticity of Demand

• Demand elasticity increases with:
  • Availability of close substitutes.
  • Characterization of the good as a luxury rather than a necessity.
  • Wider market definitions.
  • Longer time horizons for consumers to adjust their purchasing behavior.

Demand Curve Types

• Inelastic Demand: Small changes in quantity demanded despite price changes (elasticity between 0 and 1).
• Elastic Demand: Significant changes in quantity with price changes (elasticity greater than 1).
• Perfectly Inelastic Demand: Quantity demanded remains constant regardless of price changes (elasticity equals 0).
• Perfectly Elastic Demand: Quantity changes infinitely with any price change (elasticity equals infinity).
• Unit Elastic Demand: Quantity changes by the same percentage as the price (elasticity equals 1).

Elasticity Implications

• The sensitivity of quantity demanded to price changes is indicated by the slope of the demand curve but is not identical to it.
• Own-price elasticity of demand varies with the good type, influencing how consumer response differs.

Total Revenue and Price Elasticity

• Total revenue (TR) is calculated as price (P) multiplied by quantity sold (Q): TR = P × Q.
• An increase in price can lead to increased total revenue when demand is inelastic, as the decrease in quantity demanded is proportionately smaller.

Other Demand Elasticities

• Income Elasticity of Demand: Measures responsiveness of quantity demanded to changes in consumer income.
  • Positive for normal goods (demand increases with income).
  • Negative for inferior goods (demand decreases with income).
  • Income inelastic for necessities (food, utilities), and elastic for luxuries (sports cars, expensive items).

Income Elasticity Calculation

• Income Elasticity of Demand = (Percentage Change in Quantity Demanded) / (Percentage Change in Income).
• Understanding the distinction between normal and inferior goods aids in predicting demand shifts based on income changes.

This quiz focuses on the elasticity of demand, a key concept in economics that measures how quantity demanded responds to price changes. Test your understanding of how supply and demand interact in various market conditions and the implications of elasticity for buyers and sellers.