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Elasticity = Responsiveness • Allow us to analyze S & D with greater precision. • Are measures of how much buyers and sellers respond to changes in market conditions. • BY HOW MUCH? Copyright © 2004 South-Western/Thomson Learning Price Elasticity of Demand/Supply • For any market shock… • Examine if the supply or demand curve shifts. • Determine the direction of the shift of the curve. • Use the supply-and-demand diagram to see how the market equilibrium changes. Copyright © 2004 South-Western/Thomson Learning An Example of Price Elasticity of Demand • Can good news for farming be bad news for farmers? • What happens to wheat farmers and the market for wheat when scientists discover a new more productive wheat hybrid? Copyright © 2004 South-Western/Thomson Learning Figure 8 An Increase in Supply in the Market for Wheat Price of Wheat 2. . . . leads to a large fall in price . . . 1. When demand is inelastic, an increase in supply . . . S1 S2 $3 2 Demand 0 Quantity of Wheat 3. . . . and a proportionately smaller increase in quantity sold. As a result, revenue falls from $300 to $220. 100 110 Copyright©2003 Southwestern/Thomson Learning Figure 8 An Increase in Supply in the Market for Wheat $220 Copyright©2003 Southwestern/Thomson Learning Summary • Price elasticity of demand measures how much the Qd responds to changes in the P. • Change in S, P adjusts, Q responds, Law of D • Price elasticity of demand is calculated as the % change in Qd divided by the % change in P. • Demand is typically more elastic in the long run than in the short run. Copyright © 2004 South-Western/Thomson Learning Summary • If a demand curve is elastic, total revenue falls when the price rises. • If a demand curve is inelastic, total revenue rises as the price rises. • Don’t memorize this, test it, use logic Copyright © 2004 South-Western/Thomson Learning Elasticity of a Linear Demand Curve •Draw this D curve •Calculate Total Revenue •Calculate Elasticity Copyright © 2004 South-Western/Thomson Learning Summary • The price elasticity of supply measures how much the Qs responds to changes in the P. • Change in D, P adjusts, Qs responds, Law of S • The price elasticity of supply is calculated as the % change in Qs divided by the % change in P. • Supply is typically more elastic in the long run than in the short run. Copyright © 2004 South-Western/Thomson Learning Summary • Income elasticity measures how much the Qd responds to changes in consumers’ income. • normal good (+), inferior good (-) • luxury good (>1), necessity good (<1) • Cross-price elasticity measures how much the Qd of one good responds to changes in the price of another good. • complement goods (-), substitute goods (+) Copyright © 2004 South-Western/Thomson Learning