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5
CHAPTER CHECKLIST
1 Define the price elasticity of demand, and explain the factors that influence it and how to calculate it.
2 Define the price elasticity of supply, explain the factors that influence it and how to calculate it. 3 Define the cross elasticity of demand and the income elasticity of demand, and and explain the factors that influence them.
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x 100
x 100
$3 $5
Percent change in price = $5
x 100 = 40 percent
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Percent change in price = 50 percent. The percentage change in price calculated by the midpoint method is the same for a price rise and a price fall.
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5.1 THE PRICE ELASTICITY OF DEMAND Demand is inelastic if the percentage change in the
quantity demanded is less than the percentage change in price.
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The greater the proportion of income spent on a good, the more elastic is the demand for the good.
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If the price elasticity of demand is greater than 1, demand is elastic. If the price elasticity of demand equals 1, demand is unit elastic. If the price elasticity of demand is less than 1, demand is inelastic.
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We can use this formula to calculate the price elasticity of demand for a Starbucks latte: Price elasticity of demand =
100%
50%
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1. The demand for Starbucks lattes is elasticit has substitutes and the proportion of a buyers income spent is small.
2. If Starbucks raised its price, revenue per cup will rise but it will lose potential business. 3. Even a slightly lower price could bring in more revenue.
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So even a substantial price rise brings only a modest decrease in the quantity demanded.
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High taxes on cigarettes and alcohol limit the number of young people who become habitual users of these products. High taxes have only a modest effect on the quantities consumed by established users.
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The cost of storage is the main influence on the elasticity of supply of a storable good.
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Suppose that when the price of a burger falls by 10 percent, the quantity of pizza demanded decreases by 5 percent.
Cross elasticity of demand
5 percent 10 percent
0.5
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What Do You Do When the Price of Gasoline Rises? If you are like most people, you complain when the price of gasoline rises, but you dont cut back very much on your gas purchases. University of London economists Phil Goodwin, Joyce Dargay, and Mark Hanly studied the effects of a hike in the price of gasoline on the quantity of gasoline demanded and on the volume of road traffic. They estimated that a 10 percent rise in the price of gasoline decreases the quantity of gasoline used by 2.5 percent within one year and by 6 percent after five years.
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What Do You Do When the Price of Gasoline Rises? The short-run (up to one year) price elasticity of demand is 2.5 percent divided by 10 percent, which equals 0.25. The long-run (after five years) price elasticity of demand is 6 percent divided by 10 percent, which equals 0.6.
Because these price elasticities are less than one, the demand for gasoline is inelastic.
When the price of gasoline rises, the quantity of gasoline demanded decreases but the amount spent on gasoline increases.
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What Do You Do When the Price of Gasoline Rises? A 10-percent rise in the price of gasoline decreases the volume of traffic by only 1 percent within one year and by 3 percent after five years. How can the volume of traffic fall by less than the quantity of gasoline used? The answer is by switching to smaller, more fuel-efficient vehicles.
The demand for gasoline is inelasticbecause gasoline has poor substitutes, but it does have a substitutea smaller vehicle.
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