20 C HAPTE R Elasticity of Demand & Supply From Ch. 3 make sure you know the following: • Define demand and supply and state the laws of demand and supply. • Determine equilibrium price and quantity from supply and demand graphs and schedules. • From law of demand, a consumer will buy more when price declines, or P↓ → Qd ↑ • But how much more or less? • Will you buy more of 2 different goods as their P decline by 1 KD? • We use the concept of elasticity • Elasticity of demand measures: how much the Qd changes with a given change in P of the good, change in consumers’ income (I), or change in price of related product, or: %∆Qd to %∆P, or %∆I, or %∆Pof related goods • Price elasticity is a concept that also relates to supply. II. Price Elasticity of Demand - The degree of responsiveness or sensitivity of consumers to a change in price is measured by the concept of price elasticity of demand. 1. If consumers are relatively responsive to price changes, demand is said to be elastic. 2. If consumers are relatively unresponsive to price changes, demand is said to be inelastic. 3. Note that with both elastic and inelastic demand, consumers behave according to the law of demand: they are responsive to price changes. Price elasticity formula: change in quantity/percentage change in price. Or εd = %∆Qd / %∆P Or: εd = (Qd2-Qd1) / ( P2-P1 ) Q d1 P1 • Using two price-quantity combinations of a demand schedule, calculate the percentage change in quantity by dividing the absolute change in quantity by one of the two original quantities. Then calculate the percentage change in price by dividing the absolute change in price by one of the two original prices. PRICE ELASTICITY OF DEMAND Measures Responsiveness to Price Changes P The percentage change in quantity The percentage change in price .01 P2 P1 Q2 Q1 .02 D Elasticity is .5 Q PRICE ELASTICITY OF DEMAND Commonly Expressed as… P The percentage change in quantity The percentage change in price P2 P1 Q2 Q1 %Q d % P D Elasticity is .5 Q PRICE ELASTICITY OF DEMAND The Price-Elasticity Coefficient and Formula εd = Percentage change in quantity demanded of product X Percentage change in price of product X Or equivalently… εd = Percentage change in quantity demanded of X Original quantity demanded of X Change in price of X Original price of X Elimination of the Minus Sign PRICE ELASTICITY OF DEMAND Interpretations of Ed Elastic Demand εd = .04 .02 =2 Inelastic Demand εd = εd = .01 .02 .02 .02 = .5 Unit Elasticity =1 Percentages also make it possible to compare elasticities of demand for different products. Because of the inverse relationship between price and quantity demanded, the actual elasticity of demand will be a negative number. However, we ignore the minus sign and use the absolute value of both percentage changes. • If the coefficient of elasticity of demand is > 1, we say demand is elastic; • The quantity demanded is “relatively responsive” when εd is >1. • If the coefficient is < 1, demand is inelastic. • Demand is “relatively unresponsive” when εd 0, then X and Y are substitutes. 2. If εxy < 0, then X and Y are complements. 3. If εxy = 0, then X and Y are unrelated, independent products. Income elasticity of demand The percentage change in quantity demanded that results from some percentage change in consumer incomes. εI = %∆Qx / %∆I 1. If εI >0, this is a normal good. 2. If εI >0, this is an inferior good. LAST WORD: Elasticity and Pricing Power: Why Different Consumers Pay Different Prices A. Sellers often charge different prices for goods based on differences in price elasticity of demand. B. The ability to charge different prices depends on some market power; that is, some ability to control price (unlike the competitive model where all buyers and sellers exchange at exactly the same price). • C. Customers are grouped according to elasticities: Business travelers have more inelastic demand for air travel, and can be charged a higher price than the more price elastic tourist. Next: Chapter 21 Consumer Behavior and Utility Maximization
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