Elasticity of Demand

Elasticity – the concept

• The responsiveness of one variable to changes
in another
• When price rises, what happens
to demand?
• Demand falls
• BUT!
• How much does demand fall?
 Elasticity – the concept
• If price rises by 10% - what happens to
demand?
• We know demand will fall
• By more than 10%?
• By less than 10%?
• Elasticity measures the extent to which
demand will change
 The Concept of Elasticity
• Elasticity is a measure of the responsiveness
of one variable to another.
• The greater the elasticity, the greater the
responsiveness.
• Elasticity . . .
… allows us to analyze supply and demand
with greater precision.
…is a measure of how much buyers and sellers
respond to changes in market conditions
 Elasticity
• 4 basic types used:
• Price elasticity of demand
• Price elasticity of supply
• Income elasticity of demand
• Cross elasticity
PRICE ELASTICITY OF DEMAND
• Price elasticity of demand is a measure of how
much the quantity demanded of a good
responds to a change in the price of that good.
• Price elasticity of demand is the percentage
change in quantity demanded given a percent
change in the 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.
 The Price Elasticity of Demand and Its
Determinants
• Availability of Close Substitutes
• Necessities versus Luxuries
• Definition of the Market
• Time Horizon
 The Price Elasticity of Demand and Its
Determinants
• Demand tends to be more elastic :
• the larger the number of close substitutes.
• if the good is a luxury.
• the number of uses of a commodity
• Complementary goods
• Time and elasticity
 Classifying Demand as elastic
• Demand is elastic if the percentage change in
quantity is greater than the percentage
change in price.

E>1
 Classifying Demand as Inelastic
• Demand is inelastic if the percentage change
in quantity is less than the percentage change
in price.

E<1
 Classifying Demand as Unit elastic
• Demand is unitary elastic if the percentage
change in quantity is equal to the percentage
change in price.

E=1
 Classifying Demand as Perfectly Inelastic

• Demand is Perfectly inelastic if the percentage

change in price will result in the quantity
demanded unchanged.

E=0
 Classifying Demand as Perfectly elastic

• Demand is Perfectly elastic if the percentage

change in price above a particular level will
result in buyers shifting completely away from
the product and a small reduction in price
would cause buyers to increase the quantity
demanded from zero to all they wanted.

E=∞
The Total Revenue Test for Elasticity

Increase in Total Decrease in

Revenue Total Revenue

Increase in Price INELASTIC ELASTIC

DEMAND DEMAND

Decrease in ELASTIC INELASTIC

Price DEMAND DEMAND