Ch 5 reading notes PDF

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Dr. Kevin C. Moore's class. In depth reading notes from the the textbook....

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Chapter 5 reading:  Elasticity is a measure of how much buyers and sellers respond to changes in market conditions- used to measure how much consumers respond to changes in variables  Consumers usually buy more of a good when its price is lower, when their incomes are higher, when the price of its substitutes are higher, or when the price of its complements are lower (qualitative because discussing the direction)  The price elasticity of demand measure how much the quantity of demand responds to a change in price o Demand for a good is said to be elastic if the quantity demanded responds substantially to changes in the price… and said to be inelastic if quantity demanded responds only slightly o This is measuring how willing consumers are to buy less of the good as its price rises o There is no universal rule for what determines a demand curve’s elasticity… but there are some rules of thumb about what influences the price elasticity of demand  Availability of close substitutes: goods with close substitutes tend to have more elastic demand because it’s easier for consumers to switch from that good to others  Necessities versus luxuries: necessities tend to have inelastic demands (don’t dramatically reduce the necessity), whereas luxuries have elastic demands.  Narrowly defined markets tend to have more elastic demand than broadly defined markets because it’s easier to find close substitutes for narrowly defined goods  Ex: food (a broad market) is fairly inelastic because there are no substitutes for food  Ex: ice cream (a narrow market) is more elastic because there are substitutes (vanilla for chocolate)  Time Horizon: goods tend to have more elastic demand over long time horizons o Computing the price elasticity of demand: percentage change in quantity demanded / percentage change in price  Ex: 10% increase in price of ice cream so amount of ice cream you buy falls by 20% --> 20%/10%= 2 is the price elasticity of demand (change is quantity demanded is twice as large as the change in price) o The midpoint method is a better way to calculate elasticities: divide the change by the initial value (midpoint)  $5 is the midpoint between $4 and $6… so the change from $4 to $6 is considered a 40% rise because (6-4)/5 x 100= 40%  This can be used between two points as well  Demand is considered elastic when the elasticity is greater than 1, and inelastic is elasticity is less than 1

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o This means the quantity moves proportionately less than the price o If elasticity is exactly 1, the percentage chance in quality equals the percentage change in price, and the demand is said to have unit elasticity o The flatter the demand curve that passes through a given point, the greater the price elasticity (steeper= smaller price elasticity) o Demand perfectly inelastic= demand perfectly elastic= as prices rise the demand curve gets flatter= When studying changes in supply or demand one variable is total revenue: the amount paid by buyers and received by sellers of a good (P x Q) o How total revenue changes as one moves along the demand curve depends on price elasticity of demand o Demand is inelastic (price elasticity less than 1) = increase in price causes increase in total revenue (move in same direction o Demand is elastic (price elasticity greater than 1) = price and total revenue move in opposite direction (price increase= total revenue decrease) o Demand is unit elastic (price elasticity equals 1) = total revenue remains constant when the price changes Even if the slope of a linear demand curve is constant the elasticity is not o At points with a low price and high quantity, the demand curve is inelastic… at points with a high price and low quantity, the demand curve is elastic o Price is low= consumers buy a lot In addition to price elasticity of demand, economists use other elasticities to describe the behavior of buyers in a market: o Income elasticity of demand measures how the quantity demanded changes as consumer income changes percentage of income quantity / percentage change in income = income elasticity of demand  Normal goods have positive income elasticities o The cross-price elasticity of demand measure how the quantity demanded of one good responds to a change in the price of another good % change in quantity demanded of good 1 / % change in price of good 2 The price elasticity of supply measures how much the quantity supplied responds to changes in the price o Supply of a good is elastic if the quantity supplied responds substantially to changes in the price o Supply is said to be inelastic if the quantity supplied responds only slightly to changes in the price o Price elasticity of supply depends on the flexibility of sellers to change the amount of the good they produce % change in quantity supplied / % change in price = price elasticity of supply The variety of supply curves: o Perfectly inelastic is vertical straight line o Perfectly elastic is horizontal straight line

o As elasticity rises, the supply curve gets flatter, showing that the quantity supplied responds more to changes in the price...