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Computing the Price Elasticity of Demand Price elasticity of demand =
Percentage change in quantity demanded Percentage change in price
• Example: 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: (10 8) 100 20% 10 2 (2.20 2.00) 100 10% 2.00
The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities • The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change. (Q2 Q1) / [(Q2 Q1) / 2] Price elasticity of demand = (P2 P1) / [(P2 P1) / 2]
The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities • Example: 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, using the midpoint formula, would be calculated as:
Elasticity and Total Revenue along a Linear Demand Curve • With an inelastic demand curve, an increase in price leads to a decrease in quantity that is proportionately smaller. Thus, total revenue increases.
Elasticity and Total Revenue along a Linear Demand Curve • With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases.
Income Elasticity of Demand • Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income. • It is computed as the percentage change in the quantity demanded divided by the percentage change in income.
THE ELASTICITY OF SUPPLY • Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good. • Price elasticity of supply is the percentage change in quantity supplied resulting from a percent change in price.
Computing the Price Elasticity of Supply • The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price. Percentage change in quantity supplied Price elasticity of supply = Percentage change in price
APPLICATION of ELASTICITY • Can good news for farming be bad news for farmers? • What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties?
THE APPLICATION OF SUPPLY, DEMAND, AND ELASTICITY • Examine whether the supply or demand curve shifts. • Determine the direction of the shift of the curve. • Use the supply-and-demand diagram to see how the market equilibrium changes.
Summary • In most markets, supply is more elastic in the long run than in the short run. • The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in price. • The tools of supply and demand can be applied in many different types of markets.