You are on page 1of 19

Elasticity of Demand

AG BM 102
Introduction
• Key question about demand is how
responsive is consumption to a price
change?
• The demand curve provides a quantitative
answer
• But that answer is dependent on units of
measurement
• Elasticity does not depend on units of
measure!
Own Price Elasticity of Demand
- the percentage change in
quantity demanded in response
to a one percent change in the
price
An Example - Beef
Price/lb. Quantity Price/lb. Quantity
lb./cap. lb./cap.
$5.00 50 $3.75 75

$4.75 55 $3.50 80

$4.50 60 $3.25 85

$4.25 65 $3.00 90

$4.00 70 $2.75 95
Beef Demand
5

4
$/lb.

2
40 50 60 70 80 90 100
lbs./capita
Calculating the Equation for the
Demand Curve
• Take any two points, such as $4.00 and
70 lb, and $3.00 and 90 lb.
• The equation for a straight line demand
curve is Q = a + b P
Q = a + bP

b = ( Q 1 − Q 2) / ( P 1 − P 2)

a = Q 1− bP 1
Q ! = 7 0 l b s . , P 1 = $ 4 .0 0 ,

Q 2 = 9 0 lb s. and P 2 = $ 3 .0 0

b = (7 0 − 9 0) / (4 − 3) = −2 0

a = 7 0 − ( − 2 0 )(4 ) = 150

Q = 150 − 20P
To check put in Prices
• If P=3, Q = 150 - 20(3) = 90

• If P=4, Q = 150 - 20(4) = 70


Formula for Demand Elasticity

ε = [( Q 2 − Q 1) / ( Q 1) ] / [( P 2 − P 1) / ( P 1) ]
Elasticity at P=$4.00 and Q=70 lbs.

ε = [ ( 9 0 − 7 0 ) / ( 7 0 ) ] / [ ( 3 − 4 ) / ( 4 ) ] = − 1 .1 4
Interpreting elasticity
• Inelastic 0 > ε > −1
• elastic − 1 > ε > −∞
• unitary elastic ε = −1
Inelastic demand means
quantity change is
proportionately less than price
change, or that demand is not
especially price responsive –
like drinking milk
Elastic demand means quantity
change is proportionately more
than price change, or that
demand is particularly price
responsive – like lobster
Another view of the formula

ε = [( Q 2 − Q 1) / ( P 2 − P 1) ] * [( P 1) / ( Q 1) ] = b ( P 1 / Q 1)
Note
• The units cancel out, so elasticity is not
dependent on units used in the data
• For straight-line demand curves, the value
of elasticity changes as you move along
the curve
• The closer you are to the vertical access
the more elastic demand
• The closer to the horizontal access the
more inelastic
Some demand issues
• Is the demand for all food elastic or
inelastic?
• Is the demand for all meat elastic or
inelastic?
• Is the demand for chicken elastic or
inelastic?
• Is the demand for prime rib elastic or
inelastic?
Concluding comments
• Elasticity allows discussion of demand
without units
• It makes description of demand curves
more descriptive
• Makes analysis of changes easier