1.How Do We Measure How Much Consumers Alter Their Purchases in Response to a Price Change?

CHAPTER 6

Elasticity: Demand and Supply

Summary

1.How do we measure how much consumers alter their purchases in response to a price change?

• The price elasticity of demand is a measure of the responsiveness of consumers to changes in price. It is defined as the percentage change in the quantity demanded of a good divided by the percentage change in the price of the good. §1.a
• The price elasticity of demand is always a negative number because price and quantity demanded are inversely related. §1.a
• A straightstrai-line demand curve is separated into three parts by the price elasticity of demand. Demand is price elastic at the top of the curve and then as you move down the curve It becomes unit elastic and then inelastic. §1.b.1

2Why are measurements of elasticity important?

• Comparing the price elasticity of demand for various products/services allows economists to see how consumers respond to price changes. In other words, it can tell us how big a difference price makes in a particular purchasing decision. §1.c

3.What determines whether consumers alter their purchases a little or a lot in response to a price change?

• Everything else held constant, the greater the number of close substitutes, the greater the price elasticity of demand. §2.a
• Everything else held constant, the greater the proportion of a household’s budget that a good constitutes, the greater the household’s elasticity of demand for that good. §2.a
• Everything else held constant, the longer the time period under consideration, the greater the price elasticity of demand. §2.c.

4.How do we measure whether changes in income, changes in the prices of related goods, or changes in advertising expenditures affect consumer purchases?

• Elasticities can be calculated for any variable that affects demand -- the determinants of demand -- such as income, prices of related goods, advertising, and others. §3
• The cross-price elasticity of demand is defined as the percentage change in the demand for one good divided by the percentage change in the price of a related good, everything else held constant. §3.a
• When the cross price elasticity is positive, the goods are substitutes. When it is negative, the goods are complements. §3.a
• The income elasticity of demand is defined as the percentage change in the demand for a good divided by the percentage change in income, everything else held constant. §3.b

5.How do we measure whether producers respond to a price change?

• The price elasticity of supply is defined as the percentage change in the quantity supplied of a good divided by the percentage change in the price of that good, everything else held constant. §4.a
• The short run is a period of time short enough that the quantities of at least some of the resources cannot be varied. The long run is a period of time just long enough that the quantities of all resources can be varied. §4.b
• In general, the more elastic the demand and the less elastic the supply, everything else held constant, the more the incidence of a tax or the incidence of a cost increase falls on businesses and the less on consumers. §4.c