ECON 1000 Lecture Notes - Lecture 3: Margarine, Demand Curve, Normal Good
12 Dec 2016
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Econ Chapter 5:
Elasticity and its Application
The Elasticity of Demand:
- The Price Elasticity of Demand (P.E.D) measures how much the quantity
of demand responds to a change in price.
- PED looks at how willing customers are to buy less of a good as the prices
rise.
ā ELASTIC: when Qd responds a lot to price changes
ā INELASTIC: when Qd responds only a little bit to price changes
Determinants of Elasticity
1) Availability of Close Substitutes
- Tends to be more elastic if there are easy substitutes to switch to that
have not changed prices
Ex.) If the price of butter rises and margarine does not, people will be more likely to
switch to margarine
Ex.) If the price of eggs rises, there is no close substitute so they more Inelastic
because people will continue to buy them despite the change of price
2) Necessities v. Luxuries
- Necessities = inelastic
- Luxuries = elastic
- This depends on the customers preferences though
Ex.) If the price of the dentist rises, it will be more inelastic because people tend to
see the dentist as a necessity
Ex.) If the price of sailboats rises, it will be more elastic because people do not need
the sailboat and view it as a luxury
- However if a Olympic sailor needs a sailboat, they will still buy one
despite a rise in prices and may skip the dentist trip
3) Definition of the Market
- The E.d. of any market depends on how the boundaries are drawn.
- Narrowly defined markets:
o More elastic
o Easier to find close substitutes
Ex.) Ice-cream is a narrow market, it is easy to find a substitute for it.
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- Broadly defined markets:
o More inelastic
o Not as simple to find substitutes
Ex.) Food is a broad market and there is no suitable substitute for food.
4) Time Period
- Goods have more E.d. over longer periods of time
- If prices rise for a short period of time the goods remain inelastic
- If prices rise for a prolonged period of time they will become elastic
o People will not be able to deal with the higher prices and will have
to find substitutes.
Ex.) If gas prices rise for a week people will continue buying the gas, it will remain
inelastic. Once the gas prices are raised for a very long period, it will become elastic
because people will find alternate ways to get around.
Calculating the PED
Mid-Point Method
- The best way to calculate percentage changes and elasticity
- It calculates at the midpoint between two points rather than calculating
using the two points
- PED is always negative
- AāB or BāA, PED should always be the same.
To calculate percentage change in either price or quantity:
- Divide the change in P or Q by the mid point amount respectively
Ex.) = Change in P/Midpoint #
= 1/6.5
= 0.1538
= 15%
(Q2-Q1)/(Q2+Q1)
______________________
2
PED = __________________________
(P2-P1)/(P2+P1)
_______________________
2
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Document Summary
The price elasticity of demand (p. e. d) measures how much the quantity of demand responds to a change in price. Ped looks at how willing customers are to buy less of a good as the prices rise. Elastic: when qd responds a lot to price changes. Inelastic: when qd responds only a little bit to price changes. Determinants of elasticity: availability of close substitutes. Tends to be more elastic if there are easy substitutes to switch to that have not changed prices. If the price of butter rises and margarine does not, people will be more likely to switch to margarine. If the price of eggs rises, there is no close substitute so they more inelastic because people will continue to buy them despite the change of price: necessities v. luxuries. This depends on the customers preferences though. If the price of the dentist rises, it will be more inelastic because people tend to see the dentist as a necessity.
