Microeconomics - Elasticity and its Applications

1. The Elasticity of Demand

 

(1) Terms

• Elastic demand : Quantity demanded responds substantially to changes in price
• Inelastic demand : Quantity demanded responds only slightly to changes in pric

 

 

(2) The Elasticity of Demand

• Determinants
  • Availability of close substitutes (ex. 코카콜라 / 펩시콜라)
  • Necessities vs luxuries ( Necessities : inelastic demand, Luxuries : elastic demand)
  • Definition of the market ( Narrowly defined markets -> more elastic demand)
  • Time horizon (longer time -> elastic)
• the price elasticity of demand

• Midpoint method

p2 + p1, q2 + q1 is always same

and, if larger elasticity, midpoint method is more precise.

 

ex ) Price of ice cream increases from CHF 2 to CHF 2.20 and the amount the consumer buys drops from 10 to 8 cones

• Price elasticity of demand = ((8 - 10) / 10) / ((2.2 - 2) / 2 ) = -2
• Midpoint method = ((8-10) / ((8+10)/2)) / (2.2 - 2) / ((2.2 + 2) / 2) = -2.32

 

Elasitc (= quantity demanded respond strongly)	price elasticity of demand > 1
Inelastic (=quantity demanded does not respond strongly)	price elasticity of demand < 1
unit elasticity	price elasticity of demand = 1
perfectly inelastic (= quantity demanded never change)	price elasticity of demand = 0
perfectly elastic	price elasticity of demand = infinity Demand curve is horizontal

 

• The price elasticity of demand determines whether the demand curve is steep or flat.

 

2. Demand Elasticity and Revenue