# The Snails' Book Club discussion

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Principles Of Economics Mankiw > Chapter 5 (20-21 July 2016)

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Chapter 5 notes and discussion.

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Chapter 5 Elasticity And Its Application

The Elasticity Of Demand
Elasticity: a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants

Price elasticity of demand: a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price.

Demand for a good is said to be elastic if the quantity demanded responds substantially to changes in the price. Demand is said to be inelastic if the quantity responds only slightly to changes in the price.

Rule of thumb:
Availability of close substitutes: goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others.

Necessities versis luxuries: necessities tend to have inelastic demands, whereas luxuries have elastic demands.

Definition of market: narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly defined goods.

Time horizon: goods tend to have more elastic demand over longer time horizons.

Price elasticity of demand = percentage change in quantity demanded / percentage change in price

Midpoint method

Elasticity > 1 ===> elastic
Elasticity = 1 ===> unit elasticity
Elasticity < 1 ===> inelastic

Total revenue: the amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity good.

When demand is inelastic (price elasticity < 1), price and total revenue move in the same direction
When demand is elastic (price elasticity > 1), price and total revenue move in opposite directions
When demand is unit elastic (price elasticity =1), total revenue remains constand when the price changes

Income elasticity of demand: a measure of how much the quantity demanded of a good responds to a change in consumers’ income, computed as the percentage change in quantity demanded divided by the percentage change in income.

Cross-price elasticity of demand: a measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second good

The Elasticity of Supply
Price elasticity of supply: a measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price.

In most markets, a key determinant of the price elasticity of supply is the time period being considered. Supply is usually more elastic in the long run than in the short run.

Price elasticity of supply = percentage change in quantity supplied / percentage change in price

message 3: by (new) The Elasticity of Demand
A measure of responsiveness of quantity supplied and quantity supplied to a change in one of its determinants.

The Price Elasticity of Demand and its Determinants
The price elasticity of demand, a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price.

Determinants
1) Availability of Close Substitute
2) Necessities versus Luxuries
3) Definition of the Market
4) Time Horizon

Computing the Price Elasticity of Demand
Price Elasticity of Demand=percentage change in quantity demanded/percentage change in price
Following with common practice, all price elasticity of demand are reported positive numbers which imply a greater or smaller responsiveness of quantity demanded to changes in price.

The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities
Standard Method
A percentage change= a percentage change/initial level
Midpoint Method
A percentage change= a percentage change/midpoint or average of initial level and final level
The answer will be regardless of the direction of change.
Price Elasticity of Demand={(Q2-Q1)/[(Q2+Q1)/2]}/{(P2-P1)/[(P2+P1)/2]}

The Variety of Demand Curve
>1, elastic which means the quantity moves proportionately more than the price.
<1, inelastic which means the quantity moves proportionately less than the price.
=1, unit elasticity which means the quantity moves the same around proportionately as the price, and the demand is said to have unit elasticity.

Total Revenue and the Elasticity of Demand
Total revenue, the amount paid by the buyers and received by the sellers, computed as the price of good times the quantity sold.
1) When demand is inelastic (a price elasticity is less than 1), price and revenue move in the same direction.
2) When demand is elastic (a price elasticity is greater than 1), price and revenue move in opposite direction.
3) If demand is unit elastic(a price elasticity exactly equal to 1), total revenue remains constant when the price changes.

Elasticity and Total Revenue along a Linear Demand Curve
There may be elastic, inelastic and unit elastic in the linear demand curve.

Other Demand Elasticities

The Income Elasticity of Demand, measures how much the quantity demanded changes as consumer income changes.
Income Elasticity of Demand= percentage change in quantity demanded/percentage change in income
Normal goods have positive income elasticity of demand, income+, demand+
Inferior goods have negative income elasticity of demand, income+, demand-

The Cross-Price Elasticity of Demand
The cross-price elasticity of demand measures how much the quantity demanded changes in the price of another good.
Cross-price elasticity of demand=percentage change in quantity demanded of good 1/percentage change in price of good 2
Substitute positive
Complement negative

The Elasticity of Supply
The Price Elasticity of Supply and its Determinants
Price elasticity of supply, a measure of how much quantity supplied of a good responds to a change in price of that good,

message 4: by (new) 11A US\$3.33/P
11B The policy will have a larger effect on smoking 5 years from now.
11C They are sensitive to the price since they don’t have a comparable stable income like adults.

12 I will decrease the price of admission. The price elasticity of demand is greater than 1. It is an elasticity curve. A decrease in the price leads to an increase of quality demanded that is proportionately larger, so total revenue increases.

13A Both the equilibrium price and quantity will increase in each market.
13B Pharmaceutical drugs experience a larger change in price.
13C Computer experiences a larger change in quantity.
13D No big change to total consumer spending on pharmaceutical drugs. However computer’s total consumer spending turns bigger.

message 5: by (last edited Jul 22, 2016 09:23AM) (new) 11A The price should increase to \$3.33.
11B Five years from now.

12. I should increase the price of admission.In the short run,both the supply and the demand is relatively inelastic,Demand is inelastic because buying habits do not respond apprently to changes in the price.Thus,when the price increase,the revenue will increase.

13. A.Both the equilibrium price and quantity increase in each market.
B.Pharmaceutical drugs experiences a larger changer in price.
C.Computer experiences a larger changer in price.
D.

14.A.The crops destroyed by the floods affects the supply curve.Because flooding reduce the amount of crops that can be harvested,farmerswhose crops were destroyed are now supply less crops.In other word ,the supply curve shifts to the left.The demand curve remains the same because consumers'desire is not affected (normal goods),therefor they were much more worse off.

By contrast,the price of crops increase,and farmers whose crops were not destroyed benefited from the floods.

B.Whether total revenue rises or falls depends on the elasicity of demand.

15.When there's a drought around the world ,grains becomes more scarce and supply of the grains drops,result in an left shift of
supply curve ,and price increase.However,as a necessity,the demand for grain is inelastic,therefor the quantity won't change much.So farmers benefit from highter price.
If the drought only happens inKansas,consumer can turn to somewhere else to buy the grainswhere the price wasn't affected by the drought.So the total revenue that Kansas receive reduces.

message 6: by (last edited Jul 23, 2016 12:56AM) (new)

Review question 11:

A. Change in Qty / Change In price = elasticity of demand for cigarettes (0.4)
0.2 / percent change in price = 0.4
Percent change in price = 50%
Price of the cigarettes shall be increased to \$3 per pack.

B. If the government permanently increases the price of cigarettes, the policy will have larger effect in five years from now than in one year from now. This is because people can't immediately adjust their behaviour in short term. Smokers will have hard time to suddenly stop smoking. However, over longer period of time, with the higher price, people will have enough time to change their behaviour. For example, teenagers have limited amount of pocket money. With higher price, some teenagers will stop trying to start smoking. They may shift their attention to other activities. This will reduce total number of smokers. For smoking adults, they can take time to gradually cut down their consumption on cigarettes. Therefore, when the price of cigarette is permanent raised, the long term effect is more impactful since both number of smokers and average consumption of cigarette per smoker will be decreased.

C. Teenagers has higher price elasticity than do adults to change in price of cigarettes. There are two reasons. First, teenagers has limited spending power. They are more likely to respond to price hike. Second, teenagers are beginning smokers. It is relatively easier for them to cut down on cigarette consumption or quit smoking.

12. I will increase the price of admission. Museum goers are relatively stable group of people. Change in price will not signification affect their numbers. The demand for museum ticket is price inelastic. Therefore, by increasing ticket price, the museum will increase revenue.

13. A. when technological advances double the supply of both drug and computer, the supply curves of the two product shift to right.

Because demand for drug is inelastic, the new equilibrium price will drop a little, the new equilibrium quantity will be almost doubled.

Since demand for computer is elastic, the new equilibrium price for computer will decrease a lot, the new equilibrium quantity will be increased, but not as much as increase in drug.

B. Computer experiences a larger change in price.

C. Drug experiences a larger change in quantity.

D. Total consumer spending on computer will decrease, total computer spending on drug will increase.

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Chapter 5 Elasticity and Its Application

5.1
• price elasticity of demand :a measure of how much the quantity demanded of a good responds to a change in the price of that good

price elasticity of demand = percentage change in quantity demanded / percentage change in price

the midpoint method: price elasticity of demand =【 (Q2 - Q1)/ [(Q2 + Q1)/2]】÷
【(P2 - P1)/ [(P2 + P1)/2]】

some determinants that can influence the price elasticity of demand include availability of close substitutes, property of the goods (necessities or luxuries), definition of the market (narrow or broad), and time horizon.

5.2

total revenue = the price of the good * the quantity sold

income elasticity of demand = percentage change in quantity demanded /percentage change in income

cross-price elasticity of demand = percentage change in quantity demanded of good 1 / percentage change in the price of good 2

5.3

price elasticity of supply = percentage change in quantity supplied / percentage change in price