Calculating Elasticity

Dr. Katherine Sauer

Principles of Microeconomics
Price Elasticity of Demand measures how much quantity
demanded changes in response to a price change.

Formula:
Because price and quantity demanded are inversely
related, the value inside the bars will always be negative.

Use the absolute value to ensure a positive number.

changeP
changeQ
d
d
%
%
= c
To compute the price elasticity well need to know:
- the original quantity demanded and the new
quantity demanded

- the original price and the new price

- the midpoint formula for a percent change
The midpoint formula for percent change in variable Z:

100
2
x
Z Z
Z Z
ngeinZ percentcha
original new
original new
|
|
.
|

\
|
+

=
The denominator is the average of the two Z values.

In other words, it is the midpoint between the two Z
values.
Suppose we have the following information from a local
restaurant:

When the price of a burger and fries is $7, on average 350
meals are sold per week.

Suppose now the burger and fries are on special for $6
and the restaurant sells 500 meals this week.

Lets calculate the price elasticity of demand for this
restaurants burgers and fries meal.
Calculate the numerator:
100
2
350 500
350 500
% x changeQ
d
|
.
|

\
|
+

=
= 150 / 425 x 100
= 35.3%
Quantity demanded increased by 35.3%.
Calculate the denominator:
100
2
7 6
7 6
% x changeP
|
.
|

\
|
+

=
= -1 / 6.5 x 100
= - 15.4%
Price decreased by 15.4%.
When the price fell by 15%, the quantity demanded
increased by 35%.

This yields a price elasticity of demand of:
% 4 . 15
% 3 . 35

=
d
c
= 2.3
*There are no units on an elasticity value. The %
cancel out.
There are 3 other types of elasticities well be studying.
Price Elasticity of Supply
- how quantity supplied
responds to a price change

changeP
changeQ
s
s
%
%
= c
The absolute value bars are not needed.

Since price and quantity supplied are positively related,
the value will always be positive.
Income Elasticity
- how quantity demanded
responds to an income change
changeI
changeQ
d
I
%
%
= c
Income elasticity might be positive and it might be
negative.
- this will give us information about the good

- normal goods have positive elasticity
- inferior goods have negative elasticity
Cross-Price Elasticity
- how the quantity demanded
of one good responds to a price
change in another good
y
dx
xy
changeP
changeQ
%
%
= c
Cross-Price elasticity might be positive and it might be
negative.
- this will give us information about the good

- substitute goods have positive elasticity
- complementary goods have negative
elasticity
Comparing the formulas:
y
dx
xy
changeP
changeQ
%
%
= c
changeI
changeQ
d
I
%
%
= c
changeP
changeQ
s
s
%
%
= c
changeP
changeQ
d
d
%
%
= c
Technical Side Note: Why the midpoint formula?

You may be used to calculating a percent change in a
variable using this formula:
100 x
Z
Z Z
ngeinZ percentcha
original
original new

=
This formula is often used in macroeconomics when
calculating how a variable has changed in the past month
or past year.
- months and years are sequential so there is never
confusion about new and initial
For the variables on a demand curve (price and quantity
demanded), time is not an element.

The midpoint formula saves us from any confusion.

Ex: Suppose we have the following demand schedule.
P Qd
20 1000
18 1245
15 1678
13 2000

Lets explore the prices of $18 and $15 using the basic
%change formula, NOT the midpoint formula.
% change from $15 to $18 % change from $18 to $15
100
15
15 18
% x changeP

= 100
18
18 15
% x changeP

=
= 3/15 x 100
= 20%
= -3/18 x 100
= -16.7%
The negative sign will disappear in the absolute value,
but the magnitudes are still different!

Lets see what happens when we use the midpoint
formula for each.
% change from $15 to $18 % change from $18 to $15
100
2
15 18
15 18
% x changeP
|
.
|

\
|
+

=
100
2
18 15
18 15
% x changeP
|
.
|

\
|
+

=
= 3/16.5 x 100
= 18.2%
= -3/16.5 x 100
= -18.2%
The negative sign will disappear in the absolute value.

The magnitude is now the same.