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Elasticity of Demand

 Demand Elasticity: A measure that shows how a change in


quantity demanded responds to a change in price.

• Demand is elastic when a given change in price causes a


relatively larger change in quantity demanded.

• Demand is inelastic when a given change in price causes a


relatively smaller change in the quantity demanded.

Demand Elasticity
Variation of Elastic Unit Elastic Inelastic
Price > 1 = 1 <1
Increase of Decrease of Expense Increase of
price Expense doesn’t change Expense
Decrease of Increase of Expense Decrease of
price Expense doesn’t change Expense

Formula to Determine Price Elasticity of Demand

Initial Price = P1
Final Price = P2
Initial Quantity = Q1
Final Quantity= Q2

(Q2 - Q1)
PEoD = (Q1 + Q2) / 2
(P2 – P1)
(P1 + P2) / 2

If, PEoD > 1 = Elastic

If, PEoD = 1 = Unit Elastic

If , PEoD < 1 = Inelastic

When we analyze price elasticities we're concerned with their


absolute value, so we ignore the negative value.
Examples:

Here you can prove the demand is elastic because:

• Price decreased, and total expenditure or expense increased.

(Q2 - Q1) (4-2) 2


PEoD = (Q1 + Q2) / 2 = (2+4) /2 = 3 = .666 = -1.6
(P2 – P1) (2-3) -1 -.4
(P1 + P2) / 2 (3+2)/2 2.5

= | -1.6 | = 1.6

1.6 > 1, means it is elastic demand.


Here you can prove the demand is inelastic because:

• Price decreased, and total expenditure or expense decreased.

(Q2 - Q1) (2.5-2) .5


PEoD = (Q1 + Q2) / 2 = (2+2.5) /2 = 2.25 = .2222 = -.55
(P2 – P1) (2-3) -1 -.4
(P1 + P2) / 2 (3+2)/2 2.5

= | -.55 | = .55

.55 < 1, means it is inelastic demand.


Here you can prove the demand is unit elastic because:

• Price decreased, and total expenditure or expense didn’t change

(Q2 - Q1) (3-2) 1


PEoD = (Q1 + Q2) / 2 = (2+3) /2 = 2.5 = 4 = -1
(P2 – P1) (2-3) -1 -4
(P1 + P2) / 2 (3+2)/2 2.5

= | -1 | = 1

1 = 1 = Unit Elastic demand


Answers to Homework
Airlines in the United States generally do not offer reduced
round-trip airfares during holidays such as Easter,
Thanksgiving, and Christmas. What can you conclude about
the elasticity of demand for airplane travel at these times?

The elasticity of demand for airplane travel at these times is


Inelastic. If you are willing to travel by plane in these dates, you will
buy the ticket no matter which is the price.
Inelastic demand says that an increase in price means an increase
in expense, and a decrease in price means a decrease in expense.

A hamburger stand raised the price of its hamburgers from


$2.00 to $2.50. As a result, its sales of hamburgers fell from 200
per day to 180 per day. Was the demand for its hamburgers
elastic or inelastic? Why?

Expenditure 1: $2.00 x 200= $400

Expenditure 2: $2.5 x 180= $450

These means that the demand of this product is inelastic because


the increase in price caused an increase in total expenditure.

Proof:
Q1= 200
Q2= 180
P1= 2
P2= 2.5

(Q2 - Q1)
PEoD = (Q1 + Q2) / 2
(P2 – P1)
(P1 + P2) / 2

(180 - 200) -20


PEoD = (200 + 180) / 2 = 190 = -.1053 = -.474
(2.5 – 2) .5 .2222
(2 + 2.5) / 2 2.25

= | -.474 | = .474

.474 < 1, means it is inelastic demand.


Formula to Determine Price Elasticity of Supply

Q1 = Initial Quantity Supplied


Q2 = The New Quantity Supplied
P1 = Initial Price
P2 = New Price

(Q2-Q1)
PEoS= (Q2+Q1)/2
(P2 – P1)
(P2 + P1)/2

If, PEoS > 1 = Elastic

If, PEoS = 1 = Unit Elastic

If , PEoS < 1 = Inelastic

When we analyze price elasticities we're concerned with their


absolute value, so we ignore the negative value.

Change in quantity supplied


Type of elasticity
due to a change in price

Elastic > 1 More than proportional

Unit elastic = 1 Proportional

Inelastic < 1 Less than proportional


Examples:

(Q2-Q1) (6-2) 4
PEoS= (Q2+Q1)/2 = (6+2) /2 = 4 = 1 = 1.5
(P2 – P1) (2-1) 1 .666
(P2 + P1)/2 (2+1) /2 1.5
1.5 > 1 , it is elastic supply

(Q2-Q1) (3-2) 1
PEoS= (Q2+Q1)/2 = (3+2) /2 = 2.5 = .4 = .6
(P2 – P1) (2-1) 1 .666
(P2 + P1)/2 (2+1) /2 1.5
.6 < 1 , it is inelastic supply
(Q2-Q1) (4-2) 2
PEoS= (Q2+Q1)/2 = (4+2) /2 = 3= .666 = 1
(P2 – P1) (2-1) 1 .666
(P2 + P1)/2 (2+1) /2 1.5

1=1 , it is unit elastic supply