Assignment 6: Elasticity And Its Applications (10 Points)

Assignment 6: Elasticity and Its Applications (10 Points) Terms and Definitions

Define the following terms: Elastic Demand, Elasticity, Income Elasticity, Inelastic Demand, Inferior Good, Luxury Good, Normal Good, Unit Elastic Demand.

Paper For Above instruction

Elasticity is a crucial concept in economics that measures the responsiveness of the quantity demanded or supplied to changes in price or income. Understanding elasticity helps businesses and policymakers anticipate how changes in market conditions will affect overall economic activity, revenue, and consumer welfare. The primary types of elasticity include price elasticity of demand, income elasticity of demand, and cross-price elasticity, each providing insights into different market dynamics.

Elastic Demand

Elastic demand occurs when a small percentage change in price results in a larger percentage change in the quantity demanded. For example, if a 5% decrease in price causes a 10% increase in quantity demanded, demand is considered elastic. This typically happens for products with many substitutes or non-essential goods, where consumers can easily switch or delay purchases. In such cases, businesses need to be cautious when raising prices, as it could significantly reduce revenue.

Elasticity

Elasticity, broadly speaking, refers to how quantity demanded or supplied responds to changes in price or other factors. Price elasticity of demand specifically measures the percentage change in quantity demanded resulting from a one-percent change in price. It is calculated as:

Price Elasticity of Demand = (% Change in Quantity Demanded) / (% Change in Price)

Values greater than 1 indicate elastic demand, equal to 1 is unit elastic, and less than 1 signifies inelastic demand.

Income Elasticity

Income elasticity of demand measures the responsiveness of quantity demanded to a change in consumer income. If demand for a good increases as income rises, it is considered a normal good. Conversely, if demand decreases as income increases, it qualifies as an inferior good. Luxury goods have high positive income elasticities, while necessities tend to have low or positive but less than one elasticities.

Inelastic Demand

Inelastic demand is characterized by a situation where a change in price causes only a small change in quantity demanded. Products such as life-saving medicines or basic utilities often exhibit inelastic demand because consumers need them regardless of price changes. For example, a 10% increase in price might only reduce demand by 1%, illustrating price inelasticity.

Inferior Good

Inferior goods are those whose demand decreases as consumer incomes increase. An example might be generic or budget brands of groceries, where consumers shift to higher-quality products as their income rises. The demand curve for inferior goods slopes downward, reflecting this inverse relationship with income.

Luxury Good

Luxury goods are special categories of goods with high income elasticity, typically above one, indicating that demand for these items increases disproportionately as income rises. Examples include high-end cars, designer clothes, and luxury watches. They are typically non-essential and demand is sensitive to income changes.

Normal Good

Normal goods are goods for which demand increases as consumer income increases, with an income elasticity typically between zero and one. Most everyday products like clothing, food, and electronics fall into this category. When incomes rise, consumers tend to buy more of these goods.

Unit Elastic Demand

Unit elastic demand describes a situation where the percentage change in quantity demanded exactly equals the percentage change in price. This means that total revenue remains constant when the price changes. For example, a 10% decrease in price results in a 10% increase in quantity demanded, keeping total revenue unchanged.

Discussion Questions

1. If the percentage change in demand is greater than the percentage change in price, then demand is said to be elastic.
2. If the percentage change in quantity demanded is equal to the percentage change in price, the demand is said to be unit elastic.
3. If the percentage change in quantity demanded is less than the percentage change in price, then demand is said to be inelastic.
4. When total revenue increases as price decreases, demand elasticity is considered elastic.
5. When total revenue decreases as price increases, demand elasticity is considered inelastic.
6. Total revenue is maximized where demand elasticity is unit elastic.
7. A horizontal demand curve is considered perfectly elastic because the percentage change in quantity demanded is theoretically infinite at a given price, and the price sensitivity is extreme.
8. A vertical demand curve is considered perfectly inelastic because the percentage change in quantity demanded is zero regardless of price changes.

Explanation of Substitutes, Price, and Elasticity

The more substitutes a good has, the higher its demand elasticity because consumers can easily switch to alternatives if the price rises. For instance, if there are many brands of bottled water, an increase in one brand’s price will lead consumers to switch to others, making demand highly elastic. Conversely, if a product has few substitutes, demand tends to be more inelastic, as consumers have limited alternatives.

More expensive goods tend to be more elastic because high-cost items involve larger expenditure considerations. Consumers may delay or forego such purchases if prices increase, especially when many substitutes are available. Luxury items like cars or jewelry are more sensitive to price changes because they are discretionary and non-essential, amplifying their price elasticity.

Short Answer Questions

Question 1

A 10% change in the price of gasoline decreases demand by 0.5%. Elasticity = 0.5% / 10% = 0.05. Since the absolute value is less than 1, demand is inelastic, indicating that consumers are relatively unresponsive to price changes for gasoline.

Question 2

Price rises from $8.00 to $10.00 (a 25% increase), and quantity sold drops from 1000 to 600 units (a 40% decrease). Elasticity = 40% / 25% = 1.6. Since elasticity is greater than 1, demand for movie tickets is elastic, indicating high sensitivity to price changes.

Question 3

Price increases from $4.00 to $5.00 (a 25% increase), and quantity demanded decreases by 5%. Elasticity = 5% / 25% = 0.2. Since the value is less than 1, demand for cigarettes is inelastic, reflecting the addictive nature of cigarettes and low responsiveness to price changes.

Question 4

Elasticity calculations depend on specific points B to C, C to D, and D to E, which are not provided fully here. Typically, to calculate elasticity between points, the percentage change in quantity and price between those points are used, reflecting the steepness or flatness of the demand curve in those segments.

Question 5

Ordering points from most inelastic to most elastic usually involves analyzing the slope of the demand curve. Steeper segments are more inelastic, flatter segments are more elastic. Without specific data, the exact order cannot be provided here.

Question 6

Total revenue at each point is calculated as Price x Quantity. For example, at point A, multiply the price at A by the quantity demanded at A to get TR, and similarly for other points. Specific numbers are needed for exact calculations.

Question 7

If incomes increase by 10%, and demand for BMWs increases by 25%, the income elasticity = 25% / 10% = 2.5. Since the value exceeds 1, it indicates that BMWs are a luxury good, with demand highly responsive to income changes.

References

• Mankiw, N. G. (2020). Principles of Economics (9th ed.). Cengage Learning.
• Krugman, P. R., & Wells, R. (2018). Economics (5th ed.). Worth Publishers.
• Pindyck, R. S., & Rubinfeld, D. L. (2018). Microeconomics (9th ed.). Pearson.
• Case, K. E., Fair, R. C., & Oster, S. M. (2017). Principles of Economics (12th ed.). Pearson.
• Baumol, W. J., & Blinder, A. S. (2015). Economics: Principles and Policy (13th ed.). Cengage Learning.
• Perloff, J. M. (2019). Microeconomics (8th ed.). Pearson.
• Strauss, D., & Hill, D. (2016). Microeconomics (8th ed.). Cengage Learning.
• Frank, R. H., & Bernanke, B. S. (2019). Principles of Economics (7th ed.). McGraw-Hill Education.
• Samuelson, P. A., & Nordhaus, W. D. (2010). Economics (19th ed.). McGraw-Hill Education.
• Varian, H. R. (2014). Intermediate Microeconomics: A Modern Approach (9th ed.). W. W. Norton & Company.