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Elasticity, Microeconomic Policy, and Consumer Theory Rapid Review for AP Economics

By — McGraw-Hill Professional
Updated on Mar 4, 2011

More in-depth study guides for these concepts can be found at:

Elasticity: measures the sensitivity, or responsiveness, of a choice to a change in an external factor.

Price elasticity of demand (Ed ): measures the sensitivity of consumer quantity demanded for good X when the price of good X changes.

Price elasticity formula: Ed = (%ΔQd)/(%ΔP). Ignore the negative sign.

Price elastic demand: Ed > 1 or the (%ΔQd) > (%ΔP). Consumers are price sensitive.

Price inelastic demand: Ed < 1 or the (%ΔQd) < (%ΔP). Consumers are not price sensitive.

Unit elastic demand: Ed = 1 meaning the (%ΔQd) = (%ΔP).

Perfectly inelastic: Ed = 0. In this special case, the demand curve is vertical and there is absolutely no response to a price change.

Perfectly elastic: Ed = ∞. In this special case, the demand curve is horizontal meaning consumers have an instantaneous and infinite response to a price change.

Slope and elasticity: in general, the more vertical a good's demand curve, the more inelastic the demand for that good. The more horizontal a good's demand curve, the more elastic the demand for that good. Despite this generalization, be careful as elasticities and slopes are not equivalent measures.

Determinants of elasticity: if a good has more readily available substitutes (luxuries vs. necessities), it is likely that consumers are more price elastic for that good. If a high proportion of a consumer's income is devoted to a particular good, consumers are generally more price elastic for that good. When consumers have more time to adjust to a price change, their response is usually more elastic.

Total Revenue: TR = P * Qd.

Total Revenue Test: total revenue rises with a price increase if demand is price inelastic and falls with a price increase if demand is price elastic.

Elasticity and demand curves: at the midpoint of a linear demand curve, Ed = 1. Above the midpoint demand is elastic and below the midpoint demand is inelastic.

Income elasticity: a measure of how sensitive consumption of good X is to a change in the consumer's income.

Income elasticity formula: EI = (%Δ Qd good X)/(% Δ Income).

Luxury: a good for which the income elasticity is greater than one.

Necessity: a good for which the income elasticity is above zero, but less than one.

Values of Income Elasticity: if EI > 1, the good is normal and a luxury. If 1 > EI > 0, the good is normal and income inelastic (necessity). If EI < 0, the good is inferior.

Cross-Price Elasticity of Demand: a measure of how sensitive consumption of good X is to a change in the price of good Y.

Cross-Price elasticity formula: Ex,y = (%Δ Qd good X)/(% Δ Price Y).

Values of Cross-Price Elasticity of Demand: If Ex,y > 0, goods X and Y are substitutes. If Ex,y < 0, goods X and Y are complementary.

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