Elasticity and Its ApplicationChapter 5Copyright 2001 by Harcourt, Inc.All rights reserved. Requests for permission to make copies of any part of the work should be mailed to:Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida 32887-6777.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Elasticity . . .u is a measure of how much buyers and sellers respond to changes in market conditions u allows us to analyze supply and demand with greater precision.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Price Elasticity of DemanduPrice elasticity of demand is the percentage change in quantity demanded given a percent change in the price. uIt is a measure of how much the quantity demanded of a good responds to a change in the price of that good.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Determinants of Price Elasticity of DemanduNecessities versus LuxuriesuAvailability of Close SubstitutesuDefinition of the MarketuTime HorizonHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Determinants of Price Elasticity of DemandDemand tends to be more elastic :uif the good is a luxury.uthe longer the time period.uthe larger the number of close substitutes.uthe more narrowly defined the market.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Computing the Price Elasticity of DemandThe price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Computing the Price Elasticity of DemandExample: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones then your elasticity of demand would be calculated as:Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Computing the Price Elasticity of Demand Using the Midpoint FormulaThe midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Computing the Price Elasticity of DemandExample: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones the your elasticity of demand, using the midpoint formula, would be calculated as:Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Ranges of ElasticityInelastic DemanduQuantity demanded does not respond strongly to price changes. uPrice elasticity of demand is less than one. Elastic DemanduQuantity demanded responds strongly to changes in price. uPrice elasticity of demand is greater than one.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Computing the Price Elasticity of DemandDemand is price elastic$54DemandQuantity1000Price50Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Ranges of ElasticityuPerfectly Inelastic Quantity demanded does not respond to price changes.uPerfectly Elastic Quantity demanded changes infinitely with any change in price.uUnit Elastic Quantity demanded changes by the same percentage as the price.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.A Variety of Demand CurvesBecause the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Perfectly Inelastic Demand - Elasticity equals 0QuantityPrice4$5Demand100 2. .leaves the quantity demanded unchanged.1. An increase in price.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Inelastic Demand - Elasticity is less than 1QuantityPrice4$51. A 22% increase in price.Demand10090 2. .leads to a 11% decrease in quantity.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Unit Elastic Demand - Elasticity equals 1QuantityPrice4$51. A 22% increase in price.Demand10080 2. .leads to a 22% decrease in quantity.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Elastic Demand - Elasticity is greater than 1QuantityPrice4$51. A 22% increase in price.Demand10050 2. .leads to a 67% decrease in quantity.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Perfectly Elastic Demand - Elasticity equals infinityQuantityPriceDemand$41. At any price above $4, quantity demanded is zero.2. At exactly $4, consumers will buy any quantity.3. At a price below $4, quantity demanded is infinite.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Elasticity and Total RevenueuTotal revenue is the amount paid by buyers and received by sellers of a good.uComputed as the price of the good times