CHAPTER 4

Elasticity
The Responsiveness of the
Quantity Demanded to Price
 When price rises, quantity demanded
decreases.
 The question is how much quantity
will decrease in response to a given
price increase.
 We want a measure that is units free
and can be compared across
different commodities.
 The Responsiveness of
Quantity Demanded to Price

The measure we will study that

meets the criteria we want is
the price elasticity of
demand.
 Price Elasticity of Demand
 Price elasticity of demand is a
measure of the responsiveness of
the quantity demanded of a good to a
change in its price (ceteris paribus).

 Elastic Demand - means demand is

sensitive to price

 Inelastic Demand - means demand is

insensitive to price
 Elasticity: A Units-Free
Measure

Percentage change
in quantity demanded
Price elasticity of
demand =
Percentage change in price
 Calculating Elasticity
 Negative sign is ignored for
convenience.

 The changes in price and quantity

are expressed as percentages of the
average price and average quantity
between the two prices and
quantities being compared.
– Avoids having two values for the price
elasticity of demand
 Calculating Elasticity
Percentage change in quantity demanded
Price elasticity of demand =
Percentage change in price

%Q

%P
 Calculating Elasticity
Percentage change in quantity demanded
Price elasticity of demand =
Percentage change in price

%Q Q / Qave
 
%P P / Pave
 Calculating Elasticity
Percentage change in quantity demanded
Price elasticity of demand =
Percentage change in price

%Q Q / Qave
 
%P P / Pave

(Q2 - Q1)/Qave
=
(P2 - P1)/Pave
 Calculating the Elasticity of
Demand - Example
 P1 = 410
 P2 = 390
 Q1 = 36
 Q2 = 44
 Calculating the
Elasticity of Demand
Price (dollars per chip)
Original
410 point (P1, Q1)

400

390
Da

36 40 44
Quantity (millions of chips per year)
 Calculating the
Elasticity of Demand
Price (dollars per chip)
Original
410 point (P1, Q1)

400

New
point (P2, Q2)
390
Da

36 40 44
Quantity (millions of chips per year)
 Calculating the
Elasticity of Demand
Price (dollars per chip)
Original
410 point (P1, Q1)

 P `=$20

400

New
point (P2, Q2)
390
Da
Q = 8
36 40 44
Quantity (millions of chips per year)
 Calculating the
Elasticity of Demand
Price (dollars per chip)
Original
410 point (P1, Q1)

 P= $20

400
Pave =
$400 New
point (P2, Q2)
390
Da
Q = 8
36 40 44
Quantity (millions of chips per year)
 Calculating the
Elasticity of Demand
Price (dollars per chip)
Original
410 point (P1, Q1)

 P= $20

400
Pave =
$400 New
point (P1, Q1)
Qave = 40
390
Da
Q = 8
36 40 44
Quantity (millions of chips per year)
 Calculating Elasticity
Percentage change in quantity demanded
Price elasticity of demand =
Percentage change in price

%Q Q / Qave
 
%P P / Pave

(Q2 - Q1)/Qave  8 / 40
=
(P2 - P1)/Pave 20 / 400
 Calculating Elasticity
Percentage change in quantity demanded
Price elasticity of demand =
Percentage change in price

%Q Q / Qave
 
%P P / Pave

(Q2 - Q1)/Qave  8 / 40 = 4
=
(P2 - P1)/Pave 20 / 400
 Elasticity Using Different Bases
 Use P1 and Q1 as base
– E = ((44 – 36)/36)/((390 – 410)/410)
– = (8/36)/(-20/410) = .222/.0488 = 4.55
 Use P2 and Q2 as base
– E = ((44 – 36)/44)/((390 – 410)/390)
– = (8/44)/(-20/390) = .182/.051 = 3.57
 Note that average of these two elasticities
is about 4, which is the elasticity obtained
using the average Ps and Qs
 P1 = 410, Q1 = 36; P2 = 390, Q2 = 44
 Inelastic and Elastic
Demand
 Five demand curves that cover the
entire range of possible elasticities
of demand:
– Perfectly inelastic (Elasticity=0)
– Inelastic (0<Elasticity<1)
– Unit elastic (Elasticity=1)
– Elastic (1<Elasticity<  )
– Perfectly elastic (Elasticity=  )
 Inelastic and Elastic
Price
D1
Demand
Elasticity = 0
12

Perfectly Inelastic
6

Quantity
 Inelastic and Elastic
Demand
 Perfectly inelastic demand
– Implies that quantity demanded remains
constant when price changes occur.
– Price elasticity of demand = 0
 Inelastic and Elastic
Price
D
Demand
2

0<Elasticity<1
12

Inelastic
6

Quantity
 Inelastic and Elastic
Demand
 Inelastic demand
– Implies the percentage change in quantity
demanded is less than the percentage change in
price.
– Price elasticity of demand > 0 and < 1
 Inelastic and Elastic
Price
D3 Demand
Elasticity = 1
12

Unit Elasticity
6

1 2 3 Quantity
 Inelastic and Elastic
Demand
 Unit elastic demand
– Implies that the percentage change in quantity
demanded equals the percentage change in
price.
– Price elasticity of demand = 1
Inelastic and Elastic
Price
Demand
1<Elasticity< ∞
12
D4
Elastic

Quantity
 Inelastic and Elastic
Demand
 Elastic demand
– Implies the percentage change in quantity
demanded is greater than the percentage
change in price.
– Price elasticity of demand > 1 and <
 Inelastic and Elastic
Price
Demand
Elasticity = 
12 D5

6 Perfectly Elastic

Quantity
 Inelastic and Elastic
Demand
 Perfectly elastic demand
– Implies that if price changes by any percentage
quantity demanded will fall to 0.
– Price elasticity of demand =
 Examples of Elasticity
Calculation
(1)
 Q1 = 10, P1 = 50, Q2 = 8, P2 = 60
 Elasticity = ((8-10)/9)/(60-50)/55)
 = (-2/9)/(10/55)=-1.22
 Therefore demand over this range is
elastic
 Examples of Elasticity
Calculation
(2)
 Q1 = 30, P1 = 20, Q2 = 28, P2 = 26
 Elasticity = ((28-30)/29)/(26-20)/23) =
 (-2/29)/(6/23)=-.264
 Therefore demand over this range is
inelastic
 Examples of Elasticity
Calculation
(3)
 Q1 = 55, P1 = 9, Q2 = 45, P2 = 11
 Elasticity = ((45-55)/50)/(11-9)/10)
 = (-10/50)/(2/10)=-1.00
 Therefore demand over this range is
unitary elastic
 The Factors that Influence
the Elasticity of Demand
 The closer the substitutes for a good,
the more elastic is demand.
 The higher the proportion of income
spent on a good, the more elastic is
demand.
 The greater the time elapsed since a
price change, the more elastic is
demand.
 Other Commonly Used
Elasticities
 Income Elasticity of Demand
 Cross Price Elasticity of Demand
 Price Elasticity of Supply