Prepared for MICROECONOMICS, Ms Bonfig Notes Adapted from Krugman, Wells and Graddy “Essentials of...
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Transcript of Prepared for MICROECONOMICS, Ms Bonfig Notes Adapted from Krugman, Wells and Graddy “Essentials of...
![Page 1: Prepared for MICROECONOMICS, Ms Bonfig Notes Adapted from Krugman, Wells and Graddy “Essentials of Economics” Third Edition, 2013 and notes from Dr. Julie.](https://reader035.fdocuments.in/reader035/viewer/2022062516/56649d9e5503460f94a87d9c/html5/thumbnails/1.jpg)
Chapter 5: Elasticity and Taxation
Prepared for MICROECONOMICS, Ms BonfigNotes Adapted from Krugman, Wells and Graddy “Essentials of Economics” Third Edition,
2013 and notes from Dr. Julie Mueller
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Elasticity – How do we respond to price?
Elasticity is a measure of “price responsiveness” If demand is elastic, the price elasticity of
demand is > 1 , or demand is responsive to change.
If demand is inelastic, the price elasticity of demand is < 1 , or demand is less responsive to price changes.
If demand is unitary elastic, the price elasticity of demand = 1 , or the change in demand is equal to the change in price.
Inelastic Unitary Elastic 1
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Defining and Measuring Elasticity The Price Elasticity of demand is
Where the % change in quantity demanded = X 100
And the % change in price = X 100
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Interpreting Elasticity…if P.E.D = 1.
Demand is…..
A. Unitary ElasticB. ElasticC. Inelastic
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Interpreting Elasticity…if P.E.D = 0.5
Demand is…..
A. Unitary ElasticB. ElasticC. Inelastic
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Interpreting Elasticity …if P.E.D = 2 .
Demand is…..
A. Unitary ElasticB. ElasticC. Inelastic
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Understanding “Perfectly Elastic” and “Perfectly Inelastic” Demand
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What Factors Influence Price Elasticity of Demand?
1. Availability of substitutes More substitutes = more elastic ; less substitutes = more inelastic
2. Whether the good is a necessity or a luxury
Luxury good = elastic ; necessity good = more inelastic
3. Share of income spent on the good Lower price = elastic ; higher price = inelastic
4. Time elapsed since the price change More time = elastic ; less time = inelastic
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Total Revenue and Elasticity
Total Revenue is the total value of sales of a good or service. TR = Price X Quantity Sold
When a seller raises a price, two things happen A price effect—each unit sells at a higher price, ⇒ revenue increases A quantity effect—fewer units are sold, ⇒ revenue decreases
Which impact dominates? Elastic demand: QUANTITY effect dominates, and an increase in price results in a decrease in revenue
Inelastic demand: PRICE effect dominates, and an increase in price result in an increase in revenue
Unitary elastic: The effects perfectly balance, and an increase in price has no change in revenue
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Total Revenue and Elasticity continued
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Demand Elasticity Practice Problem
1.Find the % change in the consumption of gasoline in the short run.
2.Find the % change in the consumption of gasoline in the long run.
3.Find the relevant numerical quantities for the horizontal axis by finding the amount demanded at $4.00 per gallon
4.Draw and label the demand curve.
Gasoline prices increased from about $3.00 per gallon in 2010 to about $4.00 per gallon in 2012. Economists have measured the short run elasticity of demand for gasoline to be about 0.25, and the long run elasticity of demand to be about 0.75. • What is the predicted change in
consumption of gasoline in the short run? • What is the predicted change in
consumption of gasoline in the long run? • Draw and label a demand curve that
reflects the long run elasticity, assuming that at $3.00 per gallon, motorists in the US consume 10 million barrels of gasoline per day.
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Demand Elasticity Practice Problem Answer
1. Find the % change in the consumption of gasoline in the short run. percent change in price = X 100 = $1/$3 = 33% = elasticity, so elasticity X % change in price = % change in quantity demanded % change in quantity demanded = 0.25 x 33% = 8.33%
2. Find the % change in the consumption of gasoline in the long run.
0.75 * 33% = 25%
3. Find the relevant numerical quantities for the horizontal axis by finding the amount demanded at $4.00 per gallon.
percent change in quantity demanded = X 100
Rearranging the formula, we see change in quantity demanded = % change in quantity demanded * initial /100= 25 * 10 /100 = 2.5 million barrels
So the new quantity demanded equals 10-2.5 = 7.5 million barrels at a price of $4.
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Demand Elasticity Practice Problem Answer
4. Draw and label the demand curve.
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Price Elasticity of Supply
The Price Elasticity of Supply is
Measures the responsiveness of quantity supplied to changes in price
Perfectly elastic supply: When even the smallest price changes will lead to drastic changes in the quantity supplied.
Perfectly inelastic supply: When the price elasticity is zero, such that changes in the price have no effect on the quantity supplied.
VS
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Interpreting the Price Elasticity of Supply
To be continued when we discusses taxes…