AP Microeconomics Notes

Chapter 5: Applications of Demand and Supply- Elasticity

  1.  Basic Concepts
    1. P x Q = TR
      1. ​P- price
      2. Q- quantity demanded
      3. TR- total revenue
      4. Unit Elastic Change
        1. ​proportional change
        2. ex: P increases by 20 percent, Q decreases by 20 percent, so TR stays the same
      5. ​Elastic Change
        1. ​greater than proportional change
        2. ex: P increases by 20 percent, Q decreases by 25 percent, so TR decreases
      6. ​Inelastic Change
        1. ​less than proportional change
        2. ex: P increases by 20 percent, Q decreases by 10 percent, so TR increases
    2. ​​Price Elasticity of Demand
      1. ​Price Elasticity of Demand = (% Change in Q) / (% Change in P)
        1. ​= 1 – unit elastic
        2. ​< 1 – inelastic
        3. > 1 – elastic
    3. ​​Numerical Coefficient of Elasticity (E)
      1. ​Ed = (Change in Q / Change in P) x [ .5(P1 + P2) / .5(Q1 + Q2) ]
    4. ​Price Elasticity of Supply
      1. ​As P increases, Q supplied also increases
      2. Total revenue check useless in the supply case
      3. Es = (Change in Q / Change in P) x [ .5(P1 + P2) / .5(Q1 + Q2) ]
  2. ​​Limits and Degrees of Elasticity
    1. ​Long vs. Short Run
      1. ​The long run demand function for any given product will be relatively more elastic than the demand function in the short run
      2. Long run
        1. ​supply has fully adjusted to demand
        2. ​buyers are more resistant to prices increases for a given product
      3. ​​​Short run
        1. ​buyers have more limited choices because of the relative scarcity of products
    2. ​​Graphically
      1. ​Perfectly elastic demand curve
        1. ​horizontal function (slope of zero)
      2. ​​​Perfectly inelastic demand curve
        1. ​vertical function (slope undefined)
    3. ​​Degrees of Elasticity
      1. ​Depend on the competitive nature of the market
      2. ​​Depend on the nature of the product
        1. ​luxury goods will be more sensitive to price increases than goods that are necessities
  3. ​​​Cross-Elasticity of Demand
    1. ​Ultimate Question
      1. What effect on quantities demanded of one product will a price change in another product have?
      2. Ultimate answer gives us clues to:
        1. market share
        2. the degree of competition that may extend from one market to another
        3. the related leverage a dominant product in one market may have on products in another
      3. Mathematically
        1. ​CPED = (% Change in Quantity Demanded of Product Y) / (% Change of Price of Product X)
        2. CPED – Cross Price Elasticity of Demand
    2. Determinants of Price Elasticity of Demand
      1. The period of adjustment
        1. “long run vs. short run”
        2. long run is more elastic
      2. The ratio of the cost of a particular product to the total budget of the consumer
        1. ​mathematically = ($ Cost of Product A) / ($ Total Budget)
        2. the higher the value, the more elastic the product is
      3. Competitive structure of the market and consumer choices
        1. as both increase, elasticity increases
    3. ​​Income Elasticity of Demand
      1. Mathematically
        1. ​Income Elasticity of Demand = (% Change in Q Demanded) / (% Change in Consumer I)
        2. I – income
      2. For normal goods
        1. this ratio will have a positive sign
        2. as I increases, Q demanded will increase
      3. Meaning of values
        1. = 1 – unit elastic
        2. < 1 – inelastic
        3. > 1 – elastic
    4. ​​Price Elasticity of Supply
      1. Mathematically
        1. ​Price Elasticity of Supply = (% Change Quantities Supplied) / (% Change Price)
        2. as prices increase, suppliers are willing to produce and sell more
    5. Incidence of Tax on Suppliers and Consumers
      1. Case 1: Elastic demand function
        1. the supplier takes on the higher burden
      2. Case 2: Inelastic demand function
        1. the consumer takes on more of the incidence of the tax by paying a higher price
        2. supplier has a relatively small reduction in quantities supplied

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How to cite this note (MLA)

Aboukhadijeh, Feross. "Chapter 5: Applications of Demand and Supply- Elasticity" StudyNotes.org. Study Notes, LLC., 12 Oct. 2013. Web. 20 Aug. 2019. <https://www.apstudynotes.org/microeconomics/outlines/chapter-5-applications-of-demand-and/>.
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