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![Page 1: Elasticity and Demand. The law of demand tells us that there is an inverse relationship between price and quantity demanded. But it does not tell us how.](https://reader031.fdocuments.us/reader031/viewer/2022032702/56649cee5503460f949bcc08/html5/thumbnails/1.jpg)
Elasticity and Demand
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Elasticity and Demand
• The law of demand tells us that there is an inverse relationship between price and quantity demanded.
• But it does not tell us how responsive consumers are to price changes.
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Elasticity and Demand
• To find out exactly how responsive consumers are to a price change, we need the price elasticity of demand for that good or service.
• Price elasticity of demand:– A measure of how responsive people are to
price changes.
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Elastic vs. Inelastic
• Elastic demand – occurs when slight changes in price produce very large changes in quantity demanded.
• Inelastic demand- occurs when large price change produce only small changes in quantity demanded.
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Computing Price Elasticity
• Price elasticity of demand = EP.
• Ep = percentage change in quantity demanded of a product divided by the percentage change in the price of that product.
EP = % ^ QD.
% ^ P .• If EP > 1.00 then we have elastic demand.
• If EP < 1.00 then we have inelastic demand.
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Elasticity and Total RevenueElastic demand
• If demand is elastic, a decrease in price will result in an increase in revenue.
• The price cut will lead to a very large increase in quantity demanded. (Sales)
• This increase in sales swamps the lower price per unit.
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Elastic demand
• If demand is elastic what will happen to revenue when prices are increased?
• The price hike will lead to a very large decrease in quantity demanded. (Sales)
• This decrease in sales swamps the higher price per unit.
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Inelastic Demand
• If demand is in inelastic, a decrease in price will result in a decrease in revenue.
• The price cut will lead to a very small
• Increase in quantity demanded. (Sales)
• But the lower price per unit swamps the slight increase in sales.
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Inelastic Demand
• If demand is inelastic what will happen to revenue when prices are increased?
• The price hike will lead to a very small decrease in quantity demanded. (Sales)
• But the higher price per unit swamps the slight decrease in sales.
![Page 10: Elasticity and Demand. The law of demand tells us that there is an inverse relationship between price and quantity demanded. But it does not tell us how.](https://reader031.fdocuments.us/reader031/viewer/2022032702/56649cee5503460f949bcc08/html5/thumbnails/10.jpg)
Determinants of Elasticity of Demand
A. Substitutes• The greater the number of substitutes
available, the easier it is to switch between products.
• Therefore, the greater the number of substitutes available, the higher the elasticity of demand for a good.
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Determinants of Elasticity of Demand
B. Closeness of the Substitutes• The closer the substitutes are to the
original product, the easier it is to switch between products.
• Therefore, the closer the substitutes are to the original, the higher the elasticity of demand for a product.
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Determinants of Elasticity of Demand
C. Luxuries vs. Necessities• Necessities have low elasticity's of
demand.
• Luxuries have a high elasticity of demand.
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Determinants of Elasticity of Demand
D. Time• The longer the time period, the more
time people have to search for substitutes.
• The longer the time, the more elastic the demand will be.
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Elasticity Problems• Discuss and explain why the demand for the good
is elastic or inelastic.1 oranges2 cigarettes 3 Winston cigarettes4 gasoline5 butter6 diamond engagement rings7 automobiles 8 tickets to a live, professional football game9 your econ textbook, from 1 week before the semester
starts to 1 week after the end of the semester
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Accounting vs. Economic Profits
• Accountants and economists count costs and profits differently!
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Accounting vs. Economic Profits
1. Accountants
• Total profits = total revenues –total costs
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Accounting Profits
• A dentist has a practice that generates revenues of $500,000.
• All expenses total $400,000.
• Accounting profits equal $100,000.
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Economists’ Profits
2. Economists
• Economic profits = total revenues –
total costs –total implicit
costs
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Economists’ Profits
• The total revenues of the same dentist are $500,000.
• Total explicit, direct costs are $400,000.
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Opportunity or Implicit Costs
• What are implicit costs?
• The opportunity costs.
• Opportunity cost is the value of the best alternative given up.
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Opportunity Cost of Capital
• Suppose the dentist had used $400,000 of his or her own money to start this business. What if they had taken this money and invested it for an annual rate of return of 10%? What did they give up when they invested this money in their business?
• Opportunity cost of capital = $40,000.
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Opportunity Cost of Labor
• Suppose the dentist could have earned $50,000 working for a company. What did they give up in order to set up their own business?
• Opportunity cost of labor = $50,000
• Total opportunity costs =
• $40,000 + $50,000
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Total Opportunity Costs
• The total opportunity costs are:
• $40,000 + $50,000 = $90,000
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Total Economic Profits
Economic Profits = Total Revenues
– Total Costs– Total Opportunity Costs
• $500,000 - $400,000 - $90,000 = $10,000.
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Total Economic Profits
Economic Profits =
$500,00- $400,000- -$90,000
- = $10,000
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Short Run vs. the Long Run
Short Run• Short Run = the time period in which
all inputs of production are fixed.
• Often defined as:= All inputs of production
except labor, are fixed.
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Short Run vs. Long Run
Long Run• Long Run = the time period in which
all inputs of production can be varied.
• In other words, firms can make all the necessary adjustments to changing market conditions.