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The Income Effect, Substitution Effect, and Elasticity

Module. 10. Micro: Econ:. 46. The Income Effect, Substitution Effect, and Elasticity. KRUGMAN'S MICROECONOMICS for AP*. Margaret Ray and David Anderson. What you will learn in this Module :. How the income and substitution effects explain the law of demand

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The Income Effect, Substitution Effect, and Elasticity

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  1. Module 10 Micro: Econ: 46 The Income Effect, Substitution Effect, and Elasticity • KRUGMAN'S • MICROECONOMICS for AP* Margaret Ray and David Anderson

  2. What you will learnin thisModule: • How the income and substitution effects explain the law of demand • The definition of elasticity, a measure of responsiveness to changes in prices or incomes • The importance of the price elasticity of demand, which measures the responsiveness of the quantity demanded to changes in price • How to calculate the price elasticity of demand

  3. The Law of Demand • The substitution effect • The income effect I

  4. Defining Elasticity • Definition of elasticity • Law of demand • Example

  5. Calculating Elasticity • Calculating elasticity • Elasticity is the % change in the dependent variable divided by the % change in the independent variable • In symbols, elasticity is %∆dep/%∆ind • Price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in the price. • In symbols: Ed = %ΔQd/ΔP note: we drop the negative sign for Ed only.

  6. The Midpoint Formula • The problem with calculating percentage changes • The solution: Use the Midpoint formula! • %ΔQd= 100*(New Quantity – Old Quantity)/Average Quantity • %ΔP = 100*(New Price – Old Price)/Average Price • Ed = %ΔQd/ΔP • Example

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