CHAPTER 7

Deciding How Much -- Elasticity

I. Introduction

A. Examples of Elasticity

1. Elasticity affects total revenue (TR)
   example: MCC library fees or Harper Tuition increase
   
2. If the P increases what happens to quantity sold of:
   (Remember: HOW MUCH?)
   • gasoline?
   • Big Mac?
   • salt?
   • new car?

B. Definition of Elasticity -- HOW MUCH
C. Types of elasticity

1. price elasticity of demand
(quantity demanded and price)

2. price elasticity of supply
(quantity supplied and price)

3. cross elasticity of demand
(price of one product and the quantity of another)

4. income elasticity of demand
(income and quantity of a product)

II. Price Elasticity of Demand

A. Definition

1. price elasticity of demand vs. the law of demand
2. coefficient of the price elasticity of demand (Ed)
3. examples (Table 7-2)

B. The Elasticity Formula

1. Ed =

% D Qd

/

% D P

2. calculating the % D Qd

a. calculating %
b. problems with calculating % D Qd

3. midpoints formula

C. Interpreting the Coefficient of Price Elasticity of Demand

1. price elastic demand
2. price inelastic demand
3. unit elastic demand

D. Price Elasticity Changes Along a Single Demand curve (Figure 7-2)

1. elasticity and price range
2. elasticity is not slope

E. Special Cases (Figure 7-1)

1. perfectly price elastic demand
2. perfectly price inelastic demand

III. The Total Revenue Test

A. Calculating Total Revenue (TR)
B. Rules (Table 7-2)

1. when demand is price elastic:

a. and P­ , then TR¯ (because quantity D a lot)
b. and P¯ , then TR­ (because quantity D a lot)

2. when demand is price inelastic:

a. and P ­ , then TR­ (because quantity D a little)
b. and P ¯, then TR¯ (because quantity D a little)

3. when demand is unit elastic: TR does not change if P changes

C. Graphic Portrayal

IV. Determinants of the Price Elasticity of Demand
REVIEW: http://www.hencc.uky.edu/thurmanm/Elastic.html

A. Number of Substitutes (Substitutability)
B. Product Price as a Proportion of Income
C. Luxuries versus Necessities
D. Time

V. Some Practical Applications

A. Bumper Crops
B. Automation
C. Airline Deregulation
D. Excise Taxes
E. Cocaine and Street Crime
F. Minimum Wage (how much unemployment?)

VI. Price Elasticity of Supply

A. Definition
B. Coefficient of Elasticity (Es)
C. Example
D. Determinants of Price Elasticity of Supply

1. ease of storage (market period)
2. available excess capacity (short run)
3. characteristics of the production process (long run)
4. time

a. market period
b. short run
c. long run

VIII. Excise Tax and Efficiency Loss (pp. 372-377)

A. Definitions

1. tax incidence
2. excise tax

B. Division of burden

1. excise taxes and supply
2. determine the amount of tax
3. tax incidence
4. incidence and the price elasticity of demand "With a specific supply curve, the more inelastic the demand for a product, the larger the portion of the tax shifted to consumers."

5. incidence and the price elasticity of supply

"With a specific demand curve, the more inelastic the supply, the larger the portion of the tax borne by producers."

C. Efficiency Loss of a Tax

1. tax revenue
2. efficiency loss

a. allocative efficiency: MSB=MSC
b. efficiency loss:

1) definition

"the sacrifice of net benefit accruing to society because consumption and production of the taxed product are reduced below their allocatively efficient levels"

2) graphically:smaller quantity

e. role of elasticities
f. qualifications

IX. Cross and Income Elasticity of Demand

A. Cross Elasticity of Demand

1. definition
2. coefficient of cross elasticity of demand (Eab)
3. the sign IS important
4. example

B. Income Elasticity of Demand

1. definition
2. coefficient of income elasticity of demand (Edy)
3. the sign IS important
4. example