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Task:

1.Elasticity is a means of measuring the responsiveness of quantity demanded to a change in the price of a product.
a.If the response to, say, a 10% increase in the price of a product is a 20% decrease in the quantity demanded, we would consider this a “large” response and use the term elastic to describe it.
b.Suppose instead that in response to a 10% price increase the quantity demanded decreases by only 5%. We would consider this a “small” response to a price increase and use the term inelastic to describe it.
c.What determines whether a response is likely to be elastic or inelastic?
i.Availability of substitutes
ii.Importance in a consumer’s budget
iii.Luxury vs. necessity
iv.Time
d.Technically called the “own price elasticity of demand”, it is calculated as:

% change in quantity demanded
       % change in price

e.When calculated as the elasticity of demand at a particular point on a demand curve, it is precisely calculated as (the absolute value of):

ed   =    1/slope  *  P/Q

f.For a straight line demand curve, the slope is the same at any point. BUT: as you move to lower price / higher quantity combinations, you will find that the ratio of  P/Q is getting smaller. Thus, the measured elasticity along a straight line demand curve gets smaller and smaller (more and more inelastic or less and less elastic) as price falls and quantity increases.
g.Special cases for elasticity: horizontal (perfectly elastic) and vertical (perfectly inelastic) demand curves
2.Elasticity and total revenue
a.Total revenue (or total expenditure) = Price * Quantity
b.As one moves down along a particular demand curve, price falls and quantity increases; initially the percentage quantity changed exceeds  the percentage price change so total expenditure initially increases and then decreases when the percentage change in quantity becomes smaller than the percentage change in price.
c.Since both the elasticity calculation and the total revenue calculation change as we move along a demand curve, might want to know if they are related. They certainly are.
d.When demand is elastic: an increase in price will decrease total revenue; a decrease in price will increase total revenue
e.When demand is inelastic: an increase in price will increase total revenue; a decrease in price will decrease total revenue

ECO101 Principles of Economics

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