Chapter 5 covered the idea of elasticity and how elasticity works. Elasticity is defined as how much buyers and sellers respond to changes in the market. Specifically, demand for (or supply of) a good is elastic if the quantity demanded changes substantially with a change in price, and inelastic if it isn't. The price elasticity of demand is the percent change in the quantity demanded divided by the percent change in price. Elasticity of supply is defined analogously. The midpoint method provides a more accurate definition of the elasticity of any good. If elasticity is greater than 1, the good is elastic, if it is less than 1, it is inelastic, and if it is 1, the good is unit elastic. The extreme case of an elasticity of 0 is known as perfect inelasticity. The other extreme, of an undefined elasticity, is known as perfect elasticity. Price elasticity of demand is influenced by the availability of substitutes, the necessity of the good, the definition of the market, and the time horizon under consideration. Price elasticity of demand allows for the calculation of total revenue, or price times quantity. If demand is inelastic, price and total revenue are directly related. If demand is inelastic, they are inversely related, and if demand is unit elastic, total revenue is constant. In addition to price elasticity of demand, there is also income elasticity of demand and cross-price elasticity of demand.
There are many applications of price elasticity of supply and demand. It can show that even though farmers' total revenue decreases from adopting more efficient wheat production methods, they must adopt it because of the forces of a competitive market. The changes in elasticity with respect to time horizon explain why OPEC failed to keep prices high for long periods of time.
I have no questions about this material. Difficulty: 1/3.
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