Elasticity

Chapter 5

Elasticity and Its Application

WHAT’S NEW IN THE THIRD EDITION:

The three general rules about demand elasticity and total revenue are phrased more simply.

LEARNING OBJECTIVES:

By the end of this chapter, students should understand:

➢ the meaning of the elasticity of demand.

➢ what determines the elasticity of demand.

➢ the meaning of the elasticity of supply.

➢ what determines the elasticity of supply.

➢ the concept of elasticity in three very different markets (the market for wheat, the market for oil, and the market for illegal drugs).

CONTEXT AND PURPOSE:

Chapter 5 is the second chapter of a three-chapter sequence that deals with supply and demand and how markets work. Chapter 4 introduced supply and demand. Chapter 5 shows how much buyers and sellers respond to changes in market conditions. Chapter 6 will address the impact of government polices on competitive markets.

The purpose of Chapter 5 is to add precision to the supply-and-demand model. We introduce the concept of elasticity, which measures the responsiveness of buyers and sellers to changes in economic variables such as prices and income. The concept of elasticity allows us to make quantitative observations about the impact of changes in supply and demand on equilibrium prices and quantities.

KEY POINTS:

1. The price elasticity of demand measures how much the quantity demanded responds to changes in the price. Demand tends to be more elastic if close substitutes are available, if the good is a luxury rather than a necessity, if the market is narrowly defined, or if buyers have substantial time to react to a price change.

2. The price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. If the elasticity is less than one, so that quantity demanded moves proportionately less than the price, demand is said to be inelastic. If the elasticity is...