TAILIEUCHUNG - Ten Principles of Economics - Part 10

Ten Principles of Economics - Part 10. Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. | CHAPTER 5 ELASTICITY AND ITS APPLICATION 95 little concern over his health sailboats might be a necessity with inelastic demand and doctor visits a luxury with elastic demand. Availability of Close Substitutes Goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others. For example butter and margarine are easily substitutable. A small increase in the price of butter assuming the price of margarine is held fixed causes the quantity of butter sold to fall by a large amount. By contrast because eggs are a food without a close substitute the demand for eggs is probably less elastic than the demand for butter. Definition of the Market The elasticity of demand in any market depends on how we draw the boundaries of the market. Narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly defined goods. For example food a broad category has a fairly inelastic demand because there are no good substitutes for food. Ice cream a more narrow category has a more elastic demand because it is easy to substitute other desserts for ice cream. Vanilla ice cream a very narrow category has a very elastic demand because other flavors of ice cream are almost perfect substitutes for vanilla. Time Horizon Goods tend to have more elastic demand over longer time horizons. When the price of gasoline rises the quantity of gasoline demanded falls only slightly in the first few months. Over time however people buy more fuelefficient cars switch to public transportation and move closer to where they work. Within several years the quantity of gasoline demanded falls substantially. COMPUTING THE PRICE ELASTICITY OF DEMAND Now that we have discussed the price elasticity of demand in general terms let s be more precise about how it is measured. Economists compute the price elasticity of demand as the percentage change in the quantity demanded .

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