5-1 The Elasticity of Demand

• Elasticity: a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants.

The Price Elasticity of Demand and Its Determinants

• Law of Demand: a drop in the price of a good leads to a rise in the quantities demand.

• Price elasticity of demand: a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price.

• Demand is often inelastic if the demand in quantity changes slightly in the price.

• Demand is often elastic if the demand in quantity substantially changes in the price.

• Goods with close substitutes are often more elastic in demand.

• While necessities tend to include inelastic demands, luxury goods have quite elastic demands.

• Labeling a good as a luxury often depends on the buyer's preferences, not the good's properties.

• The market's elasticity of demand relies on how the boundaries are drawn in said market.

• Time horizons have less of elastic demand than goods.

  • Ex: When gasoline prices rise, the quantity of gasoline drops in the first few months.

Computing the Price Elasticity of Demand

• Price elasticity of demand = percentage change in quantity demanded / percentage change in price.

  • Ex. Price elasticity of demand = 20% / 10% = 2.

• The percentage change in price is positive, while the percentage change in the demanded quantity is negative.

The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities

• Price elasticity of demand = (Q2-Q1) / [(Q2+Q1)/2] / (P2-P1) / [(P2+P1)/2]

• The midpoint method helps to better calculate elasticities.

• The numerator is the percentage change in quantity when using the midpoint method.

• The denominator is the percentage change in price when using the midpoint method.

The Variety of Demand Curves

• A unit elasticity is when the elasticity is exactly one and the percentage change in quantity is equal to the percentage change in price.

Total Revenue and the Price Elasticity of Demand

• Total revenue is often used when studying the changes in supply or demand in markets.

• Total revenue: the amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold.

• The total revenue increases when the demand is inelastic, and vice versa.

• Inelastic demand means the price and total revenue are moving in the same direction, and when the price increases, the total revenue will also increase.

• Elastic demand means the price and total revenue are moving in opposite directions, and when the price increases, the total revenue will decrease.

• A unit elastic demand means that the price elasticity is equal to one, and therefore the total revenue will remain constant when the price changes.

Elasticity and Total Revenue along a Linear Demand Curve

• Slope = rise/run.

• Rise: ratio of the change in price; Run: change in quantity.

• Slope: ratio of changes in the two variables; Elasticity: ratio of percentage changes in the two variables.

Other Demand Elasticities

• Income elasticity of demand = percentage change in quantity demanded / percentage change in income.

• Cross-price elasticity of demand = percentage change in quantity demanded of good one/percentage change in the price of good two.

• Income elasticity of demand: a measure of how much the quantity demanded of a good response to a change in consumers' income, computed as the percentage change in quantity demanded divided by the percentage change in income.

• The cross-price elasticity of demand: a measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second good.

• Engel's Law: as a family's income increases, the percentage of its income spent on food decreases.

5-2 The Elasticity of Supply

The Price Elasticity of Supply and Its Determinants

• Price elasticity of supply: a measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price.

Computing the Price Elasticity of Supply

• Price elasticity of supply = percentage change in quantity supplied / percentage change in price.

• Price elasticity of supply = 20% / 10% = 2.

The Variety of Supply Curves

• The price elasticity of supply tells us whether the supply curve is steep or flat.

5-3 Three Applications of Supply, Demand, and Elasticity.

Can Good News for Farming Be Bad News for Farmers?

• A decrease in price results in the fall of the total revenue.

• In 1950, 10 million people worked on farms in the U.S. and made up 17% of the workforce.

Why Did OPEC Fail to Keep the Price of Oil High?

• OPEC successfully kept and maintained a high price of oil but only for a short period of time.

Does Drug Interdiction Increase or Decrease Drug-Related Crime?

• Drug interdiction is aimed to decrease drug use, thus reducing drug-related crime.

• Drug interdiction directly affects drug sellers rather than buyers.

• The demand for drugs is inelastic over short periods of time because higher prices don't have as harsh of an effect on drug use by established addicts.

5-4 Conclusion

• Educating yourself about supply and demand will allow you to analyze important events and policies in history and in the economy that'll help you become a better economist.