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.

Percentage change in quantity demanded ED = 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>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<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.

(Q2 - Q1)

Elasticity = (P

Q2 Q1 P1 + P2

- P1)

Graphs of Elasticities
B $26 24 22 20 18 16 14 0 C (midpoint) A D Elasticity of demand between A and B = 1.27

10 12 14 Quantity of software (in hundred thousands)

Calculating Elasticities: Price elasticity of Demand

P

What is the price elasticity of demand between A and B?

$26 $23 $20

B
C

Midpoint

Q2Q1 (Q2+Q1) %Q ED = %P = P2P1 (P2+P1) 1014 (10+14) -.33 = 2620 = .26 = 1.27 (26+20) D
Q
7-18

10 12 14

Price Elasticity: Supply

Price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in
ES =
% change in Quantity Supplied % change in Price

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 Elastic change in ES > percentagesupply is whenprice1
Supply is inelastic if the percentage change in quantity is less than the percentage change in price Inelastic supply is when ES < 1

7-20

Calculating Elasticities: Price elasticity ofelasticity of Supply What is the price

P

supply between A and B?

S

$5.00
Midpoint $4.75 $4.50

B
C A

Q2Q1 %Q (Q2+Q1) ES = %P = P2P1 (P2+P1) 485476 (485+476) 0.0187 0.18 = 54.50 = 0.105 = (5+4.50)
Q
7-21

476

480.5

485

Graphs of Elasticities
$6.00 5.50 5.00 4.50 4.00 3.50 3.00
0

A Elasticity of supply between A and B = 0.18

B C (midpoint)

470 480 490 Quantity of workers

Calculating Elasticity

Q 2 Q1 1 %Q 2 (Q 1 Q 2 ) E P2 P1 % P 1 2 (P1 P2 )

Calculating Elasticity of Demand Between Two Points

$26
24 22 20 18 16 14 0

Elasticity of demand between A and B:

B midpoint C A

%Q E %P

10 14 4 1 .33 2 (14 10 ) ED 12 1.27 26 20 6 .26 1 23 2 (26 20 )

Demand

10 12 14 Quantity of software (in hundred thousands)

Calculating Elasticity of Supply Between Two Points

$6.00 5.50 5.00 4.50 4.00 3.50 3.00
0 B Elasticity of supply between A and B: E %Q

%P

485 475 10 1 .021 2 ( 485 475 ) ES 480 .2 5 4.50 .50 .105 1 4.75 2 (5 4.50 )

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

$10 9 8 7 6 5 4 3 2 1

(28 - 20)

at A

=
C

28 20 0.66 (5 - 3) 5 + 3
A
B

20 24 28

40

Quantity

Calculating Elasticity at a Point

$10 9 8 7 6 5 4 3 2 1
To calculate elasticity at a point determine a range around that point and calculate the arc elasticity.

C A

E at A
B

28 20 8 1 2 (28 20 ) 24 .33 .66 53 2 .5 1 4 2 (5 3)

20 24 28 Quantity

40

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 9 8 7 6 5 4 3 2 1

Demand
A EA = 2.33

Supply

D
C E = 0.75 C 6

ED = 0.86 EB = 0.11 B

12 18 24 30 36 42 48 54 60 Quantity

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 inelastic demand curve

0 Quantity

Perfectly Elastic Demand Curve

Perfectly elastic demand curve

0 Quantity

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 = $10 9 8 7 6 5 4 3 2 1 0 1 2 Ed > 1 Elasticity declines along demand curve as we move toward the quantity axis

Price

Ed = 1
Ed < 1 Ed = 0 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