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Elasticity of Demand AP Microeconomics Rixie Unit 2, Day 1 The Law of Demand tells us that we will buy less of a product if the price increases, but how much less? Price Elasticity of Demand • A way to measure the responsiveness or sensitivity of consumers to a price change Ed = (% in quantity demanded of good X) / (% in price of good X) • Note: when calculating elasticity of demand (Ed), you should use the absolute value of your final answer. • The greater this ratio, the more responsive consumers are to a change in price of good X. • Price elastic – the consumer is generally responsive to a change in price • Price inelastic – the consumer is generally unresponsive to a change in price Range of Price Elasticity Practice If the price of corn rises 5 percent and the quantity demanded for corn falls 1 percent, then A. Ed = 5 and demand is price elastic B. Ed= 1/5 and demand is price elastic C. Ed= 5 and demand is price inelastic D. Ed= 1/5 and demand is price inelastic E. Ed = 5 and corn is unit elastic The answer is D! Practice problems for your notes: 1. The price of a laptop computer increases by 10%, and we observe a 20% decrease in quantity demanded. 2. The price of a pack of gum increases by 10%, and we observe a 5% decrease in quantity demanded. 3. The price of oranges increases by 5%, and the quantity demanded decreases by 5%. Midpoint Formula (used when moving point to point along a curve) • Allows us to calculate the same thing (elasticity of demand) as the previous formula, but is more precise when given numerical data to work with rather than percentages. Midpoint Formula Practice Problem • At the initial price of $10, the quantity demanded of Good X is 100. When the price rises to $20, the quantity demanded falls to 90. What is the elasticity? (note – you should still use the absolute value of your final answer) Ed = (90-100) (90+100)/2 (20-10) ÷ (20+10)/2 • The slope of a demand curve and elasticity of demand are NOT equivalent measures. However, the steepness of a demand curve can indicate whether a product is perfectly inelastic, relatively inelastic, relatively elastic, or perfectly elastic. (see next slide) Graphical Representation of Elasticity of Demand Total Revenue • Total Revenue (TR) is equal to price times quantity: TR = P x Q How does TR relate to elasticity? The Total Revenue Test • If you know that the demand for good X is elastic, TR and P (price) will change in opposite directions. (Ex: price increases, so total revenue decreases) • If you know that the demand for good X is inelastic, TR and P will change in the same direction. • If you know that the demand for good X is unit elastic, TR will not change with the change in price. Classwork – p. 370 #2, 4, & 5 (to be continued next class)