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Lecture Economics: Chapter 4 - Dean Karlan, Jonathan Morduch

Chapter 4 - Elasticity, in this chapter you will learn: Concept of elasticity; calculate price elasticity of demand and supply using the mid‐point method; explain how the determinants of price elasticity of demand and supply affect the degree of elasticity; calculate cross‐price and income elasticities of demand, and interpret the sign of the elasticities. | Chapter 4 Elasticity © 2014 by McGraw‐Hill Education 1 What will you learn in this chapter? • Concept of elasticity. • Calculate price elasticity of demand and supply using the mid‐point method. • Explain how the determinants of price elasticity of demand and supply affect the degree of elasticity. • Calculate cross‐price and income elasticities of demand, and interpret the sign of the elasticities. © 2014 by McGraw‐Hill Education 2 What is elasticity? • Elasticity is a measure of the responsiveness to a change in a market condition. • The concept applies to supply and demand. • It measures the response to a change in: – the price of the good. – the price of a related good. – income. © 2014 by McGraw‐Hill Education 3 1 Price elasticity of demand • The price elasticity of demand measures the magnitude of change in the quantity demanded from a change in its price. In other words, it estimates price sensitivity. Price ($) 3.00 2.50 A 2.00 1. When price Decreases by 25%. B 1.50 D 1.00 2. quantity demanded increases by 50%. 0.50 0 5 10 15 20 Quantity of coffee (millions of cups) © 2014 by McGraw‐Hill Education 4 Calculating price elasticity • The midpoint method calculates the elasticity at the midpoint of any two points. The formula is: %∆ %∆ where point 1 is , / / / / and point 2 is , . • The midpoint elasticity is the difference of any two numbers divided by their average. © 2014 by McGraw‐Hill Education 5 Active Learning: Calculating the price elasticity of demand Find the price elasticity of demand using the midpoint formula for the points along a demand curve: ($10,350) and ($20, 150). © 2014 by McGraw‐Hill Education 6 2 Determinants of price elasticity of demand • Consumers are more sensitive to price changes for some goods and services than for others. • Many factors determine consumers’ responsiveness to price changes. – Availability of substitutes. – Degree of necessity. – Cost relative to income. –