AP ECON 1000 Chapter 5_ Elasticity 11

York University Date: October 18, 2022 . AP ECON 1000 D Name: Siya Patel . Chapter 5: Elasticity Price Elasticity of Demand Elasticity measures how responsive quantity demanded is to a change in price. ● Why do businesses put items on sale? ○ They hope to make up the price in volume. ○ They may get less per unit, but if there's a sufficient increase in the volume of sales, then that will more than compensate for the slightly lower price. ● Elasticity (or price elasticity of demand ) measures by how much quantity demanded responds to a change in price. ● Price elasticity of demand = % change in quantity / % change in price ● Inelastic demand: small response in quantity demanded when price rises ○ Example: Demand for insulin by a diabetic ○ Elasticity < 1 ○ Low willingness to shop elsewhere ● Elastic demand : large response in quantity demanded when price rises ○ Example: Demand for blue earbuds ○ Elasticity > 1 ○ High willingness to shop elsewhere Extreme Elasticities of Demand Perfectly Inelastic Demand Perfectly Elastic Demand ● Perfectly inelastic demand: price elasticity of demand equals zero; quantity demanded does not respond to change in price ○ Vertical demand curve ● Perfectly elastic demand: price elasticity of demand equals infinity; quantity demanded has infinite response to change in price ○ Horizontal demand curve ● The price elasticity of demand is influenced by ○ Available substitutes – more substitutes mean more elastic demand ○ Time to adjust – longer time to adjust means more elastic demand ○ Proportion of income spent – greater proportion of income spent on a product or service means more elastic demand Elasticity and Total Revenue

Elasticity determines business pricing strategies to earn maximum total revenue – cut prices when demand is elastic and raise prices when demand is inelastic. ● Total revenue (all money a business receives from sales) = price per unit ( P ) multiplied by quantity sold ( Q ) ○ For businesses facing elastic demand (> 1), price cuts increase total revenue ○ For businesses facing inelastic demand (< 1), price rises increase total revenue ● As you move down a straight line demand curve, elasticity changes and is not the same as slope ○ Elasticity goes from elastic, to unit elastic, to inelastic ○ Total revenue increases, reaches a maximum when elasticity equals 1, then decreases Price Elasticity of Supply Elasticity of supply measures the responsiveness of quantity supplied to a change in price, and depends on the difficulty, expense, and time involved in increasing production. ● Elasticity of supply: measures by how much quantity supplied responds to a change in price ● Elasticity of supply = % change in quantity supplied / % change in price ● Inelastic supply: small response in quantity supplied when price rises ○ Difficult and expensive to increase production ○ Example: supply of mined gold ○ Elasticity of supply < 1 ● Elastic supply: large response in quantity supplied when price rises ○ Easy and inexpensive to increase production ○ Example: snow-shovelling services ○ Elasticity of supply > 1 Extreme Elasticities of Supply Perfectly Inelastic Supply Perfectly Elastic Supply ● Perfectly inelastic supply: price elasticity of supply = 0; quantity supplied does not respond to change in price ● Perfectly elastic supply: price elasticity of supply = infinity; quantity supplied has infinite response to change in price ● Elasticity of supply influenced by ○ Availability of additional inputs — more available inputs means more elastic supply ○ Time production takes — less time means more elastic supply ● Elasticity of supply allows more accurate predictions of future outputs and prices, helping businesses avoid disappointing customers

More Elasticities of Demand Elasticity measures explain the responsiveness of quantity demanded to changes in prices of related products and income, and the division of a tax between buyers and sellers. ● Cross elasticity of demand: measures responsiveness of the demand for a product or service to a change in price of a substitute or complement ● Cross elasticity of demand = % change in quantity demanded / % change in price of a substitute or complement ● Cross elasticity of demand is a positive number for substitutes . ○ The larger the number, the Larger the change ( increase ) in demand ○ Larger the rightward shift of the demand curve ○ Closer products or services are to perfect substitutes ● Cross elasticity of demand is a negative number for complements . ○ The larger the number, the Larger the change ( decrease ) in demand ○ Larger the leftward shift of the demand curve ○ Closer products or services are to perfect complements ● Income elasticity of demand: measures responsiveness of the demand for a product or service to a change in income ● Income elasticity of demand = % change in quantity demanded / % change in income ● Positive for normal goods; increase in income increases demand for normal goods ● Negative for inferior goods; increase in income decreases demand for inferior goods ● Income inelastic demand: ○ Income elasticity less than 1, but greater than 0 ○ % change in quantity is less than % change in price ○ Normal goods that are necessities ● Income elastic demand: ○ Income elasticity greater than 1 ○ % change in quantity is greater than % change in price ○ Normal goods that are luxuries Tax Incidence & Government Tax Choices Who pays a tax depends on elasticities of demand and supply – the more inelastic demand, the more buyers pay, and the more inelastic supply, the more sellers pay. ● Tax incidence: the division of a tax between buyers and sellers; depends on elasticities of demand and supply ● Who pays the GST/HST – businesses or consumers ? A Sales Tax on Businesses Tax Revenue ● The more inelastic demand and supply are, greater the tax revenue for government