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ELASTICITIES Chapter 4

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Elasticities The study of Elasticities examines the responsiveness of consumers or producers to a change in a variable in the marketplace. Studying this has implications for businesses – so they can be aware of the effects of changes – and implications for governments – so they can decide which good to place taxes on, for example.

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Elasticity of Demand Elasticity of Demand is a measure of how much the demand for a product changes when there is a change in one of the factors that determines demand. There are 3 elasticities of demand to consider: Price elasticity of demand (PED) Cross elasticity of demand (XED) Income elasticity of demand (YED)

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Price Elasticity of Demand (PED) – Elastic or Inelastic? If a small increase in price leads to a proportionally large decrease in quantity demanded, consumers are said to be very price sensitive and demand therefore is price elastic. If a large increase in price has little effect on the quantity of a good demanded, consumers are not very price sensitive, and demand is said to be price inelastic.

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Price Elasticity of Demand (PED): PED coefficient PED= Percentage change in quantity demanded Percentage change in price PED = %ΔQ d %ΔP PED=(Q d2 -Q d1 )÷ Q d1 (P 2 -P 1 ) ÷ P 1

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PED coefficient The PED coefficient is negative because of the inverse relationship between price and quantity. Since the law of demand applies to nearly all goods and services, we typically ignore the the negative and express PED as an absolute value.

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Exercises page 75 1-3 1. PED 40/50 =.8 2. First, calculate the change in price. Plug this into PED formula. Simplify(1.5x25)=37.5. % change in quantity resulting from a 25% increase in price is 37.5%. Therefore, new quantity is 200- (.375x200). An increase in price from $8 to $10 leads to a decrease in the quantity demanded from 200 to 125 units. 3. PED usually expressed as an absolute value and the PED coefficient is therefore positive. (law of demand – inverse relationship)

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Cross Elasticity of Demand

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