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An important aspect of a product's demand curve is how much the quantity demanded
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changes when the price changes. The economic measure of this response is the price
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elasticity of demand.
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Price elasticity of demand is calculated by dividing the proportionate change in
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quantity demanded by the proportionate change in price. Proportionate (or
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percentage) changes are used so that the elasticity is a unit-less value and does not
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depend of on
Usethe types of measures used (e.g. kilograms, pounds, etc).
Q2 - Q1
( Q1 + Q2 ) / 2
P2 - P1
( P1 + P2 ) / 2
where
Q1 = Initial quantity
Q2 = Final quantity
P1 = Initial price
P2 = Final price
The average values for quantity and price are used so that the elasticity will be the
same whether calculated going from lower price to higher price or from higher price to
lower price. For example, going from $8 to $10 is a 25% increase in price, but going
from $10 to $8 is only a 20% decrease in price. This asymmetry is eliminated by using
the average price as the basis for the percentage change in both cases.
For slightly easier calculations, the formula for arc elasticity can be rewritten as:
( Q2 - Q1 ) ( P2 + P1 )
( Q2 + Q1 ) ( P2 - P1 )
Elasticity > 1
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3/5/2020 Price Elasticity of Demand
In this case, the change in quantity demanded is proportionately larger than the
change in price. This means that an increase in price would result in a decrease in
revenue, and a decrease in price would result in an increase in revenue. In the
extreme case of near infinite elasticity, the demand curve would be nearly horizontal,
meaning than the quantity demanded is extremely sensitive to changes in price. The
case of infinite elasticity is described as being perfectly elastic and is illustrated below:
From this demand curve it is easy to visualize how an extremely small change in price
would result in an infinitely large shift in quantity demanded.
Elasticity < 1
In this case, the change in quantity demanded is proportionately smaller than the
change in price. An increase in price would result in an increase in revenue, and a
decrease in price would result in a decrease in revenue. In the extreme case of
elasticity near 0, the demand curve would be nearly vertical, and the quantity
demanded would be almost independent of price. The case of zero elasticity is
described as being perfectly inelastic.
From this demand curve, it is easy to visualize how even a very large change in price
would have no impact on quantity demanded.
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3/5/2020 Price Elasticity of Demand
Elasticity = 1
The price elasticity of demand can be applied to a variety of problems in which one
wants to know the expected change in quantity demanded or revenue given a
contemplated change in price.
Because the elasticity is greater than one over the price range of interest, we know
that an increase in price actually would decrease the revenue collected by the
automobile registration authority, so the price hike would be unwise.
The price elasticity of demand for a particular demand curve is influenced by the
following factors:
Time period considered: elasticity tends to be greater over the long run because
consumers have more time to adjust their behavoir to price changes.
Price points: decreasing the price from $2.00 to $1.99 may result in greater
increase in quantity demanded than decreasing it from $1.99 to $1.98.
Point Elasticity
dQ
dP
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3/5/2020 Price Elasticity of Demand
dQ P
dP Q
The point elasticity can be approximated by calculating the arc elasticity for a very
short arc, for example, a 0.01% change in price.
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