CHAPTER 5 Elasticity

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CHAPTER 5Elasticity

What you will learn in this chapter:Definition of elasticity¾price elasticity of demand¾income elasticity of demand and¾price elasticity of supplyFactors that influence the size of elasticitiesHow elasticity affects the incidence of a tax, andwho bears its burden?2

Defining and Measuring ElasticityThe price elasticity of demand is the ratio ofthe percent change in the quantity demanded tothe percent change in the price as we move alongthe demand curve.3

The World Demand for Oil4

Using the Midpoint Method to CalculateElasticities5

Some Estimated Price Elasticities ofDemandGoodPrice elasticityInelastic demandEggsBeefStationeryGasoline0.10.40.50.5Price elasticity ofdemand 1Elastic demandHousingRestaurant mealsAirline travelForeign travel1.22.32.44.1Price elasticity ofdemand 16

Interpreting the Price Elasticity of Demand:How Elastic Is Elastic?Two Extreme Cases of Price Elasticity of Demand¾ perfectly inelastic¾ perfectly elastic7

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Interpreting the Price Elasticity of Demand:How Elastic Is Elastic?Demand is:¾ elastic if the price elasticity of demand is greaterthan 1,¾inelastic if the price elasticity of demand is lessthan 1, and¾unit-elastic if the price elasticity of demand isexactly 1.10

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Elasticity and Total Revenue A price effect: After a price increase, each unitsold sells at a higher price, which tends to raiserevenue. A sales effect: After a price increase, fewer unitsare sold, which tends to lower revenue.15

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Elasticity and Total Revenue¾ If demand for a good is elastic, an increase in pricereduces total revenue. (Sales effect Price effect).¾ If demand for a good is inelastic, a higher priceincreases total revenue. (Price effect Sales effect).¾ If demand for a good is unit-elastic, an increase inprice does not change total revenue. (Sales effect Price effect).17

The Price Elasticity of Demand Changes Along theDemand Curve18

What Factors Determine the PriceElasticity of Demand?¾ Whether Close Substitutes Are Available¾ Whether the Good Is a Necessity or aLuxury¾ Time19

Other Demand ElasticitiesCross-Price Elasticity¾Substitutes¾ComplementsIncome elasticity of demand¾Normal Goods¾Inferior Goods20

Price Elasticity of SupplyThe price elasticity of supply is a measure ofthe responsiveness of the quantity of a goodsupplied to the price of that good.21

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Factors that Determine the PriceElasticity of Supply¾The Availability of Inputs¾Time24

Elasticity determines tax incidence:An Excise Tax Paid Mainly by Consumers25

Elasticity determines tax incidence:An Excise Tax Paid Mainly by Producers26

The End of Chapter 5Coming attraction:Chapter 6:Consumer and Producer Surplus27

2 What you will learn in this chapter: Definition of elasticity ¾price elasticity of demand ¾income elasticity of demand and ¾price elasticity of supply Factors that influence the size of elasti

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