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Lecture 2, Thursday, September 28

TA Sections begin this Friday (tomorrow) Syllabus may be found on CourseWork Problem Set 1 due next Friday in Sections

LAST CLASS Supply/demand shocks have different effect

on market equilibrium P, Q depending on elasticity of demand/supply

TODAY Elasticities

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Demand Elasticity Measures the responsiveness of quantity demanded to a change in the price of that good.

,DXX P

E =

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Linear Demand Curve D

XX a bP= −

,DXX P

E =

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Demand Curve with Constant Own-Price Elasticity D b

XX aP−=

,DXX P

E =

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An Alternative way to compute elasticity

,DXX P

E =

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Elasticity - Definitions We say that the demand for X is . . . - relatively (own price-) elastic if: -relatively inelastic if: -unitary elastic if: What if E > 0?

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Table 2.1

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Table 2.2 and 2.3

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Demand typically more elastic in long run

Table 2.8

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Price Elasticity and Total Spending Total Spending on good D

XX P X= • [ ]

X

spendingP

∂=

∂

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Price Elasticity & Total Spending (cont…) Intuition:

AS P↑:

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Price Elasticity and Total Spending (cont…)

Linear Demand:

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Demand Curve –vs- Demand Function Demand Curve: displays the relationship between quantity demanded and price, holding all other factors constant. Demand Function: shows the quantity demanded as a function of its own price, the price of other goods, income, etc. e.g. DX =

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We can define other elasticities: 1) Income elasticity of demand for good X:

,DEX I = 2) Cross-price elasticity of demand for good X:

,DYEX P =

3) Price elasticity of supply:

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,DXEX P =

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Example: a demand function for which all elasticities are constant

“Log Linear” Demand: D B C D

X YX aP P I= or. . . .: Take ln

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Elasticities – Interesting Things to Know 1) For a given elasticity and observed price/quantity combination, we can estimate a functional form for a demand curve.

e.g. , 0.8DXEX P =

5

2500X

D

P

X

=

=

if we assume a linear demand: DXX a bP= −

2) Consider the demand function:

D

X Y

IXP P

=+

Confirm that:

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Examples of Income Elasticity Table 2.4

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Examples of Cross-Price Elasticities Tables 2.5 and 2.6

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