elastcity of demand

Prepared by: Milan Padariya

Elasticity is a measure of the responsiveness of one variable to another.

The greater the elasticity, the greater the responsiveness.

Q. What’s the difference between an economist and a befuddled old man with Alzheimer’s?

A. The economist is the one with a calculator.

Elasticity is a measure of the responsiveness of one variable to another.

The greater the elasticity, the greater the responsiveness.

The price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price.

According to the law of demand, whenever the price rises, the quantity demanded falls. Thus the price elasticity of demand is always negative.

Because it is always negative, economists usually state the value without the sign.

Price elasticity of demand and supply gives the exact quantity response to a change in price.

Demand is elastic if the percentage change in quantity is greater than the percentage change in price.

E > 1

Demand is inelastic if the percentage change in quantity is less than the percentage change in price.

E < 1

Elastic Demand means that quantity changes by a greater percentage than the percentage change in price.

Inelastic Demand means that quantity doesn't change much with a change in price.

When price elasticity is between zero and -1 we say demand is inelastic.

When price elasticity is between -1 and - infinity, we say demand is elastic.

When price elasticity is -1, we say demand is unit elastic.

Percentages allow us to have a measure of responsiveness that is independent of units.

This makes comparisons of responsiveness of different goods easier.

To determine elasticity divide the percentage change in quantity by the percentage change in price.

The end-point problem – the percentage change differs depending on whether you view the change as a rise or a decline in price.

Economists use the average of the end points to calculate the percentage change.

Pric

e

Quantity of software (in hundred thousands)

$26242220181614

0

D

B

A

10 12 14

C (midpoint)

Elasticity of demand between A and B = 1.27

D

P

Q

What is the price elasticity of demand between A and B?

$20

10

$26

14

MidpointB

A

ED = %ΔQ%ΔP

Q2–Q1

½(Q2+Q1)P2–P1

½(P2+P1)

=

C

12

$23

=

10–14½(10+14)

26–20½(26+20)

-.33.26 = 1.27 =

7-18

Price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in

• This tells us exactly how quantity supplied responds to a change in price

ES =

• Elasticity is independent of units

% change in Quantity Supplied% change in Price

7-19

Supply is elastic if the percentage change in quantity is greater than the percentage change in price

Elastic supply is when ES > 1

• Supply is inelastic if the percentage change in quantity is less than the percentage change in price

Inelastic supply is when ES < 1

7-20

P

Q

What is the price elasticity of supply between A and

B?

$4.50

476

$5.00

485

B

A

ES = %ΔQ%ΔP

Q2–Q1

½(Q2+Q1)P2–P1

½(P2+P1)

=

=

485–476½(485+476)

5–4.50½(5+4.50)

Midpoint

C

480.5

$4.750.01870.105 = 0.18 =

S

7-21

Elasticity of supply between A and B = 0.18

Wag

e pe

r ho

ur

Quantity of workers

$6.005.505.004.504.003.503.00

0

CB

A

470

(midpoint)

480 490

)PP(PP

)QQ(QQ

P%

Q% E

2121

12

2121

12

27.126.

33.

236

124

)2026(2026

)1014(1410

E

21

21

D

P%

Q% E

Pri

ce

Quantity of software (in hundred thousands)

$26

24

22

20

18

16

14

0

Demand

B

A

10 12 14

Cmidpoint

Elasticity of demand between A and B:

2.105.

021.

75.450.

48010

)50.45(50.45

)475485(475485

E

21

21

S

P%

Q% E

Wag

e p

er h

ou

r

Quantity of workers

$6.005.505.004.504.003.503.00

0

CB

A

470 480 490

Elasticity of supply between A and B:

Let us now turn to a method of calculating the elasticity at a specific point, rather than over a range or an arc.

To calculate elasticity at a point, determine a range around that point and calculate the arc elasticity.

Pric

e

Quantity

$10 9 8 7 6 5 4 3 2 1

C

BA

24 402820

66.5.

33.

42

248

)35(35

)2028(2028

E

21

21

Aat

Pri

ce

Quantity

$10 9 8 7 6 5 4 3 2 1

C

BA

24 402820

To calculate elasticity at a point determine a range around that point and calculate the arc elasticity.

Two important points to consider:◦ Elasticity is related (but is not the same as) slope.◦ Elasticity changes along straight-line demand and

supply curves.

6 12 18 30 36 42 48

Pric

e

Quantity

87654321

$109

A

24 6054

D

BC

SupplyEA = 2.33

EB = 0.11

Demand

EC = 0.75

ED = 0.86

Two important points to consider:◦ Elasticity is related (but is not the same as) slope.◦ Elasticity changes along straight-line demand and

supply curves.

The steeper the curve at a given point, the less elastic is supply or demand.

There are two limiting examples of this.

When the curves are flat, we call the curves perfectly elastic.

• The quantity changes enormously in response to a proportional change in price (E = ).

When the curves are vertical, we call the curves perfectly inelastic.

• The quantity does not change at all in response to an enormous proportional change in price (E = 0).

Perfectly inelastic demand curve

Pric

e

0Quantity

Perfectly elastic demand curve

Pric

e

0Quantity

Perfectly Elastic Demand Curve◦ The demand curve is horizontal, any change in price can

and will cause consumers to change their consumption.

Perfectly Inelastic Demand Curve◦ The demand curve is vertical, the quantity demanded is

totally unresponsive to the price. Changes in price have no effect on consumer demand.

In between the two extreme shapes of demand curves are the demand curves for most products.

Elasticity is not the same as slope. Elasticity changes along straight line supply

and demand curves–slope does not.

Pri

ce

$10987654321

0 1 2 3 4 5 6 7 8 9 10 Quantity

Elasticity declines along demand curve as we move

toward the quantity axis

Ed = 1

Ed = 0

Ed < 1

Ed > 1

Ed = ∞

The Price Elasticity of Demand Along a Straight-line Demand Curve

As a general rule, the more substitutes a good has, the more elastic is its supply and demand.

The less a good is a necessity, the more elastic its demand curve.

• Necessities tend to have fewer substitutes than do luxuries.

Demand for goods that represent a large proportion of one's budget are more elastic than demand for goods that represent a small proportion of one's budget.

Goods that cost very little relative to your total expenditures are not worth spending a lot of time figuring out if there is a good substitute.

• It is worth spending a lot of time looking for substitutes for goods that take a large portion of one’s income.

The larger the time interval considered, or the longer the run, the more elastic is the good’s demand curve.◦ There are more substitutes in the long run than in

the short run.◦ The long run provides more options for change.

The degree to which the price elasticity of demand is inelastic or elastic depends on:◦ How many substitutes there are ◦ How well a substitute can replace the good or

service under consideration◦ The importance of the product in the consumer’s

total budget◦ The time period under consideration