Elasticity: A Measure of Responsiveness
This chapter explored the numbers behind the laws of demand and supply. The law of demand tells us that an increase in price decreases the quantity demanded, ceteris paribus. If we know the price elasticity of demand for a particular product, we can determine just how much less of it will be purchased at the higher price. Similarly, if we know the price elasticity of supply for a product, we can determine just how much more of it will be supplied at a higher price. Here are the main points of the chapter: • The price elasticity of demand—defined as the percentage change in quantity demanded divided by the percentage change in price—measures the responsiveness of consumers to changes in price. • Demand is relatively elastic if there are good substitutes. • If demand is elastic, the relationship between price and total revenue is negative. If demand is inelastic, the relationship between price and total revenue is positive. • The price elasticity of supply—defined as the percentage change in quantity supplied divided by the percentage change in price—measures the responsiveness of producers to changes in price. • If we know the elasticities of demand and supply, we can predict the percentage change in price resulting from a change in demand or supply.
Applying the Concepts
After reading this chapter, you should be able to answer these four key questions: 1. How does the price elasticity of demand vary over time? 2. How does an increase in price affect total expenditures? 3. Where do I find estimates of elasticities of demand? 4. How does a change in demand affect the equilibrium price in the short run and long run?
4.1 The Price Elasticity of Demand
The price elasticity of demand measures the responsiveness of the quantity demanded to changes in price. It is equal to the absolute value of the...