Elasticity Essay

3183 words - 13 pages

1
© 2007 Thomson South-Western © 2007 Thomson South-Western
In this chapter, look for the answers to these questions: • What is elasticity? What kinds of issues can
elasticity help us understand? • What is the price elasticity of demand?
How is it related to the demand curve? How is it related to revenue & expenditure?
• What is the price elasticity of supply? How is it related to the supply curve?
• What are the income and cross-price elasticities of demand?
© 2007 Thomson South-Western
You design websites for local businesses. You charge $200 per website, and currently sell 12 websites per month. Your costs are rising (including the opp. cost of your time), so you're thinking of raising the price to $250. The law of demand says that you won't sell as many websites if you raise your price. How many fewer websites? How much will your revenue fall, or might it increase?
A scenario…
© 2007 Thomson South-Western
Elasticity . . .
• … allows us to analyze supply and demand with greater precision.
• … is a measure of how much buyers and sellers respond to changes in market conditions
• Elasticity is a numerical measure of the responsiveness of Qd or Qs to one of its determinants.
© 2007 Thomson South-Western
THE ELASTICITY OF DEMAND • The price elasticity of demand is a measure of
how much the quantity demanded of a good responds to a change in the price of that good.
• When we talk about elasticity, that responsiveness is always measured in percentage terms.
• Specifically, the price elasticity of demand is the percentage change in quantity demanded due to a percentage change in the price.
© 2007 Thomson South-Western
The Price Elasticity of Demand and Its Determinants • Availability of Close Substitutes • Necessities versus Luxuries • Definition of the Market • Time Horizon • Demand tends to be more elastic:
• the larger the number of close substitutes. • if the good is a luxury. • the more narrowly defined the market. • the longer the time period.

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© 2007 Thomson South-Western
What determines price elasticity? To learn the determinants of price elasticity, we look at a series of examples. Each compares two common goods. In each example:
• Suppose the prices of both goods rise by 20%. • The good for which Qd falls the most (in percent) has
the highest price elasticity of demand. Which good is it? Why?
• What lesson does the example teach us about the determinants of the price elasticity of demand?
© 2007 Thomson South-Western
EXAMPLE 1: Rice Krispies vs. Sunscreen • The prices of both of these goods rise by 20%.
For which good does Qd drop the most? Why? • Rice Krispies has lots of close substitutes
(e.g., Cap'n Crunch, Count Chocula), so buyers can easily switch if the price rises.
• Sunscreen has no close substitutes, so consumers would probably not buy much...

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