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The Elasticity of Demand

- Chapter 7

The Concept of Elasticity

- Elasticity is a measure of the responsiveness of

one variable to another. - The greater the elasticity, the greater the

responsiveness.

Laugher Curve

- Q. Whats the difference between an economist

and a befuddled old man with Alzheimers? - A. The economist is the one with a calculator.

The Concept of Elasticity

- Elasticity is a measure of the responsiveness of

one variable to another. - The greater the elasticity, the greater the

responsiveness.

Price Elasticity

- The price elasticity of demand is the percentage

change in quantity demanded divided by the

percentage change in price.

Sign of Price Elasticity

- 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.

What Information Price Elasticity Provides

- Price elasticity of demand and supply gives the

exact quantity response to a change in price.

Classifying Demand and Supply as Elastic or

Inelastic

- Demand is elastic if the percentage change in

quantity is greater than the percentage change in

price. - E gt 1

Classifying Demand and Supply as Elastic or

Inelastic

- Demand is inelastic if the percentage change in

quantity is less than the percentage change in

price.

E lt 1

Elastic Demand

- Elastic Demand means that quantity changes by a

greater percentage than the percentage change in

price.

Inelastic Demand

- Inelastic Demand means that quantity doesn't

change much with a change in price.

Defining elasticities

- 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.

Elasticity Is Independent of Units

- Percentages allow us to have a measure of

responsiveness that is independent of units. - This makes comparisons of responsiveness of

different goods easier.

Calculating Elasticities

- To determine elasticity divide the percentage

change in quantity by the percentage change in

price.

The End-Point Problem

- The end-point problem the percentage change

differs depending on whether you view the change

as a rise or a decline in price.

The End-Point Problem

- Economists use the average of the end points to

calculate the percentage change.

Graphs of Elasticities

Elasticity of demand between A and B 1.27

Calculating Elasticities Price elasticity of

Demand

What is the price elasticity of demand between A

and B?

P

B

Midpoint

26

C

23

A

20

D

Q

10

14

12

7-18

Price Elasticity Supply

- Price elasticity of supply is the percentage

change in quantity supplied divided by the

percentage change in

change in Quantity Supplied change in Price

ES

- This tells us exactly how quantity supplied

responds to a change in price

- Elasticity is independent of units

7-19

Price Elasticity Supply

- Supply is elastic if the percentage change in

quantity is greater than the percentage change in

price

Elastic supply is when ES gt 1

- Supply is inelastic if the percentage change in

quantity is less than the percentage change in

price

Inelastic supply is when ES lt 1

7-20

Calculating Elasticities Price elasticity of

Supply

What is the price elasticity of supply between A

and B?

P

S

?Q ?P

ES

B

5.00

A

4.50

Q

476

485

7-21

Graphs of Elasticities

Elasticity of supply between A and B 0.18

Calculating Elasticity

Calculating Elasticity of Demand Between Two

Points

Elasticity of demand between A and B

26

B

24

22

midpoint

C

Price

20

A

18

16

Demand

14

0

10

12

14

Quantity of software (in hundred thousands)

Calculating Elasticity of Supply Between Two

Points

6.00

5.50

Elasticity of supply between A and B

5.00

B

C

4.50

Wage per hour

A

4.00

3.50

3.00

0

470

480

490

Quantity of workers

Calculating Elasticity at a Point

- Let us now turn to a method of calculating the

elasticity at a specific point, rather than over

a range or an arc.

Calculating Elasticity at a Point

- To calculate elasticity at a point, determine a

range around that point and calculate the arc

elasticity.

Calculating Elasticity at a Point

Calculating Elasticity at a Point

To calculate elasticity at a point determine a

range around that point and calculate the arc

elasticity.

Elasticity and Demand Curves

- Two important points to consider
- Elasticity is related (but is not the same as)

slope. - Elasticity changes along straight-line demand and

supply curves.

Calculating Elasticity at a Point

10

Demand

9

Supply

EA 2.33

8

7

6

Price

5

ED 0.86

4

3

EB 0.11

EC 0.75

2

1

6

12

18

30

36

42

48

Quantity

24

60

54

Elasticity and Demand Curves

- Two important points to consider
- Elasticity is related (but is not the same as)

slope. - Elasticity changes along straight-line demand and

supply curves.

Elasticity Is Not the Same as Slope

- The steeper the curve at a given point, the less

elastic is supply or demand. - There are two limiting examples of this.

Elasticity Is Not the Same as Slope

- When the curves are flat, we call the curves

perfectly elastic.

- The quantity changes enormously in response to a

proportional change in price (E ).

Elasticity Is Not the Same as Slope

- 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

Perfectly Elastic Demand Curve

Demand Curve Shapes and Elasticity

- 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.

Demand Curve Shapes and Elasticity

Elasticity Changes Along Straight-Line Curves

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

demand curvesslope does not.

Elasticity Along a Demand Curve

Ed 8

Elasticity declines along demand curve as we move

toward the quantity axis

10

9

8

7

6

Ed 1

Price

5

4

3

2

1

0

1

2

3

4

5

6

7

8

9

10

Quantity

The Price Elasticity of Demand Along a

Straight-line Demand Curve

Substitution and Elasticity

- As a general rule, the more substitutes a good

has, the more elastic is its supply and demand.

Substitution and Demand

- The less a good is a necessity, the more elastic

its demand curve.

- Necessities tend to have fewer substitutes than

do luxuries.

Substitution and Demand

- 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.

Substitution and Demand

- 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 ones income.

Substitution and Demand

- The larger the time interval considered, or the

longer the run, the more elastic is the goods

demand curve. - There are more substitutes in the long run than

in the short run. - The long run provides more options for change.

Determinants of the Price Elasticity of Demand

- 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 consumers

total budget - The time period under consideration

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