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. What’s the difference between an economist and a befuddled old man with Alzheimer’s? 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.

. economists usually state the value without the sign. Thus the price elasticity of demand is always negative. • Because it is always negative.Sign of Price Elasticity • According to the law of demand. the quantity demanded falls. whenever the price rises.

.What Information Price Elasticity Provides • Price elasticity of demand and supply gives the exact quantity response to a change in price.

E>1 .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.

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.

.infinity.Defining elasticities • When price elasticity is between zero and -1 we say demand is inelastic. • When price elasticity is between -1 and . • When price elasticity is -1. we say demand is elastic. we say demand is unit elastic.

• This makes comparisons of responsiveness of different goods easier. .Elasticity Is Independent of Units • Percentages allow us to have a measure of responsiveness that is independent of units.

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. .

Graphs of Elasticities $26 24 22 20 18 16 14 0 B C (midpoint) A D Elasticity of demand between A and B = 1.27 Price 10 12 14 Quantity of software (in hundred thousands) .

26 = 1.27 ½(26+20) D Q 7-18 10 12 14 .Calculating Elasticities: Price elasticity of Demand P What is the price elasticity of demand between A and B? B C A $26 $23 $20 Midpoint Q2–Q1 ½(Q2+Q1) %ΔQ ED = %ΔP = P2–P1 ½(P2+P1) 10–14 ½(10+14) -.33 = 26–20 = .

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 when price1 • 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 .

00 $4.5 485 .Calculating Elasticities: Price elasticity ofelasticity of Supply What is the price P supply between A and B? S $5.105 = ½(5+4.75 $4.0187 0.50 = 0.50 B Midpoint C A Q2–Q1 %ΔQ ½(Q2+Q1) ES = %ΔP = P2–P1 ½(P2+P1) 485–476 ½(485+476) 0.50) Q 7-21 476 480.18 = 5–4.

00 3.00 5.50 3.00 4.00 0 Wage per hour A Elasticity of supply between A and B = 0.18 B C (midpoint) 470 480 490 Quantity of workers .Graphs of Elasticities $6.50 5.50 4.

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 Price B midpoint 22 20 18 16 14 0 %∆ Q Elasticity of E= demand %∆P between A and − 14 10 −4 1 B: (14 + 10) C ED = A − .27 26 − 20 6 .33 = 12 = = 1.26 1 23 2 (26 + 20) 2 Demand 10 12 14 Quantity of software (in hundred thousands) .

50 3.00 0 Wage per hour A C B Elasticity of supply between= %∆Q E %∆ P A and B: 485 − 475 10 1 480 = .00 5.50) 470 480 490 Quantity of workers .50 4.00 3.105 1 4.00 4.Calculating Elasticity of Supply Between Two Points $6.50 5.021 = .50 .75 2 (5 + 4.2 2 ( 485 + 475 ) ES = = 5 − 4.50 .

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 Price C A B 20 24 28 40 Quantity .

5 1 4 2 (5 + 3) Price 20 24 28 Quantity 40 .66 = = 5−3 2 .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.33 = . C A E at A B 28 − 20 8 1 2 (28 + 20) 24 = .

– Elasticity changes along straight-line demand and supply curves. .Elasticity and Demand Curves • Two important points to consider: – Elasticity is related (but is not the same as) slope.

33 D C E = 0.75 C 6 Supply Price ED = 0.Calculating Elasticity at a Point $10 9 8 7 6 5 4 3 2 1 Demand A EA = 2.86 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.

• The quantity changes enormously in response to a proportional change in price (E = ∞). we call the curves perfectly elastic.Elasticity Is Not the Same as Slope • When the curves are flat. .

we call the curves perfectly inelastic. • The quantity does not change at all in response to an enormous proportional change in price (E = 0).Elasticity Is Not the Same as Slope • When the curves are vertical. .

Perfectly Inelastic Demand Curve Perfectly inelastic demand curve Price 0 Quantity .

Perfectly Elastic Demand Curve Price Perfectly elastic demand curve 0 Quantity .

the quantity demanded is totally unresponsive to the price. any change in price can and will cause consumers to change their consumption. • Perfectly Inelastic Demand Curve – The demand curve is vertical. . • In between the two extreme shapes of demand curves are the demand curves for most products.Demand Curve Shapes and Elasticity • Perfectly Elastic Demand Curve – The demand curve is horizontal. Changes in price have no effect on consumer demand.

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 curves–slope 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 Ed = 1 Ed < 1 Ed = 0 3 4 5 6 7 8 9 10 Quantity Price .

The Price Elasticity of Demand Along a Straight-line Demand Curve .

the more substitutes a good has. . the more elastic is its supply and demand.Substitution and Elasticity • As a general rule.

• Necessities tend to have fewer substitutes than do luxuries.Substitution and Demand • The less a good is a necessity. . the more elastic its demand curve.

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. .

• It is worth spending a lot of time looking for substitutes for goods that take a large portion of one’s income. .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.

Substitution and Demand • The larger the time interval considered. . or the longer the run. – There are more substitutes in the long run than in the short run. – The long run provides more options for change. the more elastic is the good’s demand curve.

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 consumer’s total budget – The time period under consideration .

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