Application Of Elasticity And Its Application

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Econ 1000C: Intro to Economics 9/19/13

Lecture #5

Elasticity and its applications


Basic idea:
Elasticity measures how much one variable.

Elasticity is a numerical measure of the responsiveness of Qd or Qs to one of its determinants.

Price of elasticity of demand

Price of elasticity of demand measures how much Qd responds to change in P
Price of elasticity of demand = % change in Qd / % Change in P

Calculating Percentage Changes

Standard method of computing the % change
End value – Start value
P rises 25% Q falls 33%, elasticity = 33/25= 1.33
P falls 20%, rises 50%, 50/20 = 2.50
So, we instead use the midpoint method, End value – Start value/midpoint * 100%

Determinants of Price of Elasticity (PE): Summary

The PE of demand depends on:
The extent to which close substitutes are available
Whether the good is a necessity or a luxury
How broadly or narrowly the good is defined
The time horizon – elasticity is higher in the long run than the short run

Variety of Demand Curves

PE of demand is closely related to the slope of the demand curve
Rule of thumb:
The flatter the curve, the bigger the elasticity. The steeper the curve, the smaller the elasticity

1. “Inelastic Demand”
2. “Unit Elastic Demand”
3. “Elastic Demand”
4. “Perfectly elastic demand”
5. Elasticity of a Linear Demand Curve, The slope of a linear demand curve is constant, but the elasticity is not.

Price of Elasticity and Total Revenue
Continuing our scenario, if you raise your price from $200 to $250, would your revenue rise or fall?
Revenue = P*Q
A price increase has two effects on revenue
Higher P means more revenue on each unit you sell
But you sell fewer units (Lower Q)
If demand is elastic, then PE of demand > 1
% Change in q > % change in P
When D is elastic a price increase causes revenue to fall

PE of Supply
PE of supply measures how much Qs responds to change in P
PE of supply = % change in Qs / % change in P

Variety of Supply Curves
The slope of the supply curve is closely related to PE of supply
Rule of Thumb:
The flatter