# 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.

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

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.
.

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

. • 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.

27
Price
10 12 14 Quantity of software (in hundred thousands)
.Graphs of Elasticities
$26 24 22 20 18 16 14 0 B C (midpoint) A D Elasticity of demand between A and B = 1.

33 = 26–20 = .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) -.27 ½(26+20) D
Q
7-18
10 12 14
.26 = 1.

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
.

5
485
.50)
Q
7-21
476
480.00 $4.75 $4.105 = ½(5+4.Calculating Elasticities: Price elasticity ofelasticity of Supply What is the price
P
supply between A and B?
S
$5.18 = 5–4.0187 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 = 0.

00 4.00 3.00 0
Wage per hour
A Elasticity of supply between A and B = 0.50 4.50 5.00 5.18
B C (midpoint)
470 480 490 Quantity of workers
.Graphs of Elasticities
$6.50 3.

Calculating Elasticity
Q 2 − Q1 1 %∆Q 2 (Q 1 + Q 2 ) E= = P2 − P1 %∆ P 1 2 (P1 + P2 )
.

27 26 − 20 6 .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
− .33 = 12 = = 1.26 1 23 2 (26 + 20)
2
Demand
10 12 14 Quantity of software (in hundred thousands)
.

50 3.50 .00 4.2 2 ( 485 + 475 ) ES = = 5 − 4.50)
470 480 490 Quantity of workers
.00 5.00 3.105 1 4.021 = .50 .00 0
Wage per hour
A
C
B
Elasticity of supply between= %∆Q E %∆ P A and B:
485 − 475 10 1 480 = .50 4.50 5.75 2 (5 + 4.Calculating Elasticity of Supply Between Two Points
$6.

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.
.

. determine a range around that point and calculate the arc elasticity.Calculating Elasticity at a Point
• To calculate elasticity at a point.

Calculating Elasticity at a Point
$10 9 8 7 6 5 4 3 2 1
Price
C A B
20 24 28
40 Quantity
.

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

. – 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.Calculating Elasticity at a Point
$10 9 8 7 6 5 4 3 2 1 Demand A EA = 2.75 C 6 Supply
Price
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. • The quantity changes enormously in response to a proportional change in price (E = ∞). we call the curves perfectly elastic.

we call the curves perfectly inelastic.
.Elasticity Is Not the Same as Slope
• When the curves are vertical. • 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
Price
0
Quantity
.

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

.
• Perfectly Inelastic Demand Curve
– The demand curve is vertical. any change in price can and will cause consumers to change their consumption. the quantity demanded is totally unresponsive to the price.Demand Curve Shapes and Elasticity
• Perfectly Elastic Demand Curve
– The demand curve is horizontal. 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 supply and demand curves–slope does not.Elasticity Changes Along Straight-Line Curves
• Elasticity is not the same as slope.
.

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

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

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.
.

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.Substitution and Demand
• The larger the time interval considered. 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
.