Chapter 4

Demand
Elasticity
l
Managerial Economics: Economic
Tools for Today’s Decision Makers, 4/e
B P
By Paull Keat
K t andd Phili
Philip Young
Y
 Demand Elasticity
• The Economic Concept of Elasticity
• The Price Elasticity of Demand
• The Cross-Elasticity of Demand
• Income Elasticity
• Other Elasticity Measures
• Elasticity of Supply

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Economic Concept of Elasticity

Elasticity: The sensitivity of one

variable to another or, more precisely,
the percentage change in one variable
relative to a percentage change in
another.
h
p
percent change
g in A
El ti it =
C ffi i t off Elasticity
Coefficien
percent change in B

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Price Elasticity of Demand
Price elasticity of demand: The
percentage change in quantity
demanded caused by a 1 percent
change in price.
%Δ Quantity
p=
Ep
%Δ Price

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Price Elasticity of Demand
Arc elasticity: Elasticity which is
measured over a discrete interval of a
demand (or a supply) curve.
curve

Q2 − Q1 P2 − P1
Ep = ÷
(Q1 + Q2 ) / 2 ( P1 + P2 ) / 2

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Price Elasticity of Demand
Point elasticity: Elasticity measured at
a given point of a demand (or a supply)
curve.
curve

dQ P1
εP = x
dP Q1

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Price Elasticity of Demand
The point elasticity of a linear demand
function can be expressed as:

ΔQ P1
εP = x
ΔP Q1

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Price Elasticity of Demand

Elasticity
differs along
a linear
demand
curve.

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Price Elasticity of Demand
Catego es of
Categories o Elasticity
ast c ty
1. Relative elasticity of demand
EP > 1
2. Relative inelasticity of demand
EP < 1
3. Unitaryy elasticity
y of demand
EP = 1

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Price Elasticity of Demand
Limiting cases
1. Perfect elasticity
EP = ∞
2.. Perfect
e ec inelasticity
e as c y
EP = 0

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Price Elasticity of Demand
Determinants of Elasticityy
• Ease of substitution
• Proportion of total expenditures
• Durability of product
• Possibility of postponing purchase
• Possibility of repair
• Used product market
• Length of time period

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Price Elasticity of Demand

A long
long-run
run demand
curve will be more
elastic than a short-run
curve.

As the time period

lengthens consumers
find way to adjust to
the price change

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Price Elasticity of Demand
Derived demand: The demand for products
or factors that are not directly consumed,
but go into
to the
t e production
p oduct o oof a final
a pproduct.
oduct.

The demand
Th d d for
f suchh a product
d t or factor
f t
exists because there is demand for the final
product.
d t

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Price Elasticity of Demand
The derived demand curve will be more
inelastic:
1. the more essential is the component
p in
question.
2. the more inelastic is the demand curve for
the final product.
3. the smaller is the fraction of total cost going
g g
to this component.
4. the more inelastic is the supply
pp y curve of
cooperating factors.
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
 The Price Elasticity of Demand
There
e e iss a relationship
e at o s p between
betwee tthee pprice
ce eelasticity
ast c ty
of demand and revenue received.

• If price decreases and, in percentage terms,

quantity rises more than price dropped, then total
revenue will increase.
increase

• If price decreases and

and, in percentage terms,
terms
quantity rises less than price dropped, then total
revenue will decrease.

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Price Elasticity of Demand

As price decreases
• revenue rises when
demand is elastic
• falls when it is
inelastic
• reaches it peak
when elasticity of
demand equals 1.

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Price Elasticity of Demand
Marginal Revenue: The change in
total revenue resulting from changing
quantity by one unit.
unit

Δ Total Revenue
MR =
Δ Quantity

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Price Elasticity of Demand

For a straight-line
straight line
demand curve the
marginal revenue
curve is twice as
steep as the
demand.

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Price Elasticity of Demand
At the point where
marginal revenue
ccrosses
osses tthee X-axis,
a s,
the demand curve is
unitaryy elastic
u e s c andd
total revenue
reaches a
maximum.

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Cross
Cross-Elasticity
Elasticity of Demand
Cross elasticity of demand: The
Cross-elasticity
percentage change in quantity
consumed of one product as a result of
a 1 percent change in the price of a
related
l d product.
d
%Δ QQuantityy off goodA
g
Ex =
%Δ Price of good B

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Cross
Cross-Elasticity
Elasticity of Demand
Arc Elasticity

Q2 A − Q1 A P2 B − P1B
Ex = ÷
(Q1 A + Q2 A ) / 2 ( P1B + P2 B ) / 2

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Cross
Cross-Elasticity
Elasticity of Demand
Point Elasticity

dQA PB
εx = x
dPB QA

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 The Cross
Cross-Elasticity
Elasticity of Demand

The sign of cross-elasticity for

substitutes
b i is
i positive.
ii

The sign of cross-elasticity for

complements is negative.
negative

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 Income Elasticity
Income Elasticity of Demand: The
percentage change in quantity
demanded caused by a 1 percent
change in income.

%ΔQuantity
EY =
%ΔIncome

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 Income Elasticity
Arc Elasticity

Q2 − Q1 Y2 − Y1
EY = ÷
(Q1 + Q2 ) / 2 (Y1 + Y2 ) / 2

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 Income Elasticity
Point Elasticity

dQ Y
εY = x
dY Q

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 Income Elasticity
Catego es of
Categories o income
co e elasticity
e ast c ty
• Superior goods
EY > 1
• Normal goods
0 > EY > 1
• Inferior goods
g
EY < 1

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 Income Elasticity

Categories of
Income Elasticity

• Superior goods
• Normal goods
• Inferior goods

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 Other Elasticity Measures
Elasticity is encountered every time a
change in some variable affects
quantities.
quantities

• Advertising expenditure
• Interest rates
• Population size

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 Elasticity of Supply
Price Elasticity of Supply: The
percentage change in quantity supplied
as a result of a 1 percent change in
price
%Δ Quantity supplied
ES =
%Δ Price

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 Elasticity of Supply
Arc elasticity

Q2 − Q1 P2 − P1
Es = ÷
(Q1 + Q2 ) / 2 ( P1 + P2 ) / 2

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 Elasticity of Supply
Point elasticity

dQ P1
εS = ×
dP Q1

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 Elasticity of Supply

If the supply curve slopes upward and

to the right, the coefficient of supply
elasticityy is a ppositive number.

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

 Elasticity of Supply
When the supply curve is more elastic
elastic, the
effect of a change in demand will be greater
on quantity than on the price of the product.
product

Withh a supply
Wi l curve off low
l elasticity,
l i i a
change in demand will have a greater effect
on price
i than
h on quantity.
i

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young