# Chapter Five - Elasticity and its Applications

1. Define Price Elasticity of Demand
- how much the quantity demanded responds to a change in price - demand for a good is said to be elastic if the quantity demanded responds substantially to changes in the price - is said to be inelastic if the quantity demanded responds only slightly to changes in the price
1. What are the factors that affect price elasticity of demand?
- Necessity vs. Luxury
ex. vacation flight (luxury) vs. business flight (necessity)
- Availability and # of close substitutes
ex. cereal (lots of competition)
ex. cigarettes and alcohol
ex. luis vuitton, coke...
- Proportion of income spent on the good
ex. paper clips (small portion) and cars (large portion)

1. Describe the midpoint method of determining elasticity of demand.
The midpoint method for calculating elasticity measures the percentage change by dividing the change by the midpoint of the initial and final levels of two points on the demand curve ex. Point A=\$4, Point B=\$6, midpoint is 5, in order to calculate % change = (6-4)/5 x 100 = 40 so we can say that when going from Point A to point B, there is a 40% rise, and quantity falls by 40%, and vice versa The formula= ((Q2-Q1)/[(Q2+Q1)/2])/(P2-P1)/[(P2+P1)/2]
1. What is the variety of shapes the demand curve come in? What does each shape indicate related to elasticity?

1. Explain the Total Revenue test for determining elasticity.
Total revenue is defined by price times quantity, and is affected by price elasticity of demand. If demand is inelastic, then an increase in price will cause an increase in total revenue, indicating that quantity demanded has no changed that much. When there is an increase in price and a decrease in total revenue, then demand is elastic
1. Why are there ranges of elasticity along the demand curve?

1. What is income elasticity of demand and how is it used to determine normal and inferior goods?
- A measure of how much the quantity demanded of a good responds to a change in customers' income, computed as the percentage change in quantity demanded divided by the percentage change in income
- normal goods = positive income elasticities
- inferior goods = negative income elasticities

1. What is cross-price elasticity of demand and how is it used in economics?
• measures the responsiveness of one good to the changes in price of a related good
• negative # - goods are complements
• positive # - goods are substitutes
• example: if the price of beef goes up, what will happen to the demand for ketchup?
• Answer: Demand for ketchup will decrease
• Why? The goods are complements

1. Define price elasticity of supply and the factors that affect PES.
• measures how much the quantity supplied reacts to changes in price
• supply is elastic if quantity suppliedresponds significantly to change in price
• supply is inelastic if QS responds slightly to change in price
• depends on flexibility of sellers to change the amount of a good they produce, ex. Manufactured goods such as watches and cras are more elastic because more of them can be produced quickly, while real estate is more inelastic
• Time period is key determinant
• Supply is usually more elastic in long run than short run bc eventually more of the product can be produced
From Part II: Elasticity and its Applications
1. Describe the farming scenario on pg. 109 and how it relates to elasticity.

1. Explain the OPEC example and how it relates to elasticity.

1. Describe the Drug interdiction example on pg. 112 and its relationship to the concept of elasticity.
• Drug interdiction on behalf of the government could increase drug-related crimes. If government agents are out to get drug dealers it becomes harder to sell drugs. As a result the price of drugs goes up and drugs then become an inelastic product. People are willing to pay higher for the drugs and in many cases will pay high prices because of addictions.