ELASTICITY OF DEMAND & SUPPLY PERFECT ELASTIC DEMAND CURVE

PRICE ELASTICITY OF DEMAND

 Measure of the sensitivity or responsiveness 14

of quantity demanded to a change in price. 12

 Price elasticity of demand is a measure of 10

the extent to which the quantity demanded 8 D

of a good changes when the price of the
6
good changes.
4
 To determine the price elasticity of demand, 2
we compare the percentage change in the
quantity demanded with the percentage 5 10 15 20 25 30
change in price. Quantity

From formula: The elasticity of a perfectly elastic demand curve is

infinity
% Change∈Qd
Ep=
% Change∈Price PERFECT INELASTIC DEMAND CURVE
 If Price Elasticity of Demand > 1, demand is
elastic D

 If Price Elasticity of Demand = 1, demand is

30
unit elastic
25
 If Price Elasticity of Demand < 1, demand is
20
inelastic
15

10

DEMAND ELASTICITY 5

 Elastic Demand – When % Change in 5 10 15 20 25

Quantity Demanded > % Change in Price Quantity

 Unit Elastic Demand – When % Change in The elasticity of a perfectly inelastic demand curve is 0
Quantity Demanded = % Change in Price
RELATIVITY ELASTICITY OF DEMAND CURVES
 Inelastic Demand – When % Change in
Quantity Demanded < % Change in Price

 Perfectly Elastic Demand – When Quantity

Demanded Changes by a very large
percentage in response to an almost zero
Change in Price

 Perfectly Inelastic Demand – When the

Quantity Demanded remains constant as D1

Price changes
D2

Quantity
CHARACTERISTICS AFFECTING PRICE ELASTICITY New price−Initial price
¿ x 100
OF DEMAND Initial price

Tend Toward Tend Toward $ 3−$ 5

¿ x 100=−40 %
Elastic Demand Inelastic Demand $5
Luxuries Necessities
 The same price change, $2, over the
Large expenditures Small expenditures
Durable goods Perishable goods same interval, $3 to $5, is a different
Substitute goods Complementary goods percentage change depending on whether the
Multiple uses Limited Uses price rises or falls.

 We need a measure of percentage

CALCULATION OF THE PRICE ELASTICITY OF change that does not depend on the direction
DEMAND of the price change.

Percentage Change in Price  We use the average of the initial

price and the new price to measure the
Suppose Starbucks raises the price of a latte from percentage change.
$3 to $5 a cup. What is the percentage change in
price?

New price−Initial price

¿ x 100
Initial price
$ 5−$ 3
¿ x 100=66.67 %
$3
Many students need a refresher and some practice
at doing what seems too simple to bother with,
calculating percentages and percentage changes.
Don’t be afraid to start with this pre-elasticity warm
up. Just toss out some numbers. Suppose that the
campus book store increases the price of an
economics text from $80 to $100. What is the
percentage increase in price? Now suppose the
campus book store cuts the price of an economics
text from $100 to $80. What is the percentage
decrease in price? You’re now all set to get the
students using the average of the original and new
price to calculate percentages that are independent
of the direction of change.
THE MIDPOINT METHOD
To calculate the percentage change in the price divide
the change in the price by the average price and then
multiply by 100.
The average price is at the midpoint between the
initial price and the new price, hence the name
midpoint method.
New price−Initial price
¿ X 100
( New price+ Initial price ) ÷2
$ 5−$ 3
¿ x 100=5 0 %
( $ 5+ $ 3 ) ÷ 2
% change in price = 50%
The percentage change in price calculated by the
midpoint method is the same for a price rise and a
price fall.

TOTAL REVENUE METHOD

Suppose Starbucks cuts the price of a latte from $5
to $3 a cup. What is the percentage change in
price?
 Total revenue is the amount spent
on a good and received by its sellers and equals
the price of the good multiplied by the quantity
of the good sold.
 Total revenue test is a method of
estimating the price elasticity of demand by
observing the change in total revenue that results
from a price change.
 If price changes and total revenue is
constant, unit elasticity of demand exists
 If price changes and total revenue moves
in the opposite direction, demand is elastic
 If price changes and total revenue moves
in the same direction, demand is inelastic
 Po is the initial price.
Figure shows total revenue and elastic demand.
 Refers to the relationship between changes
in price and the subsequent change in quantity
demanded.
 The arc elasticity formula is used if the
change in price is relatively large. It is more
accurate a measure of elasticity than simple
''price elasticity''.
 If the arc or price elasticity of demand is
greater than 1, demand is said to be elastic.
The demand curve has a ''flat'' appearance.
 If the arc or price elasticity of demand is less
than 1, demand is said to be inelastic. The
demand curve has a ''steep'' appearance.
Qo is the initial quantity demanded.
Q1 is the new quantity demanded.
P1 is the new price.

 At $3 a cup, the quantity demanded is 15 cups

an hour.
 Total revenue is $45 an hour.
 When the price rises to $5 a cup, the quantity
demanded decreases to 5 cups an hour.
 Total revenue decreases to $25 an hour.
 Demand is elastic.

Consider the market for music CDs. When the

price of CDs is $30 per unit, consumers buy 6 per
year. When the price falls to $20 per unit,
consumers buy 12 per year. Calculate Ped by Arc
Elasticity Method.

ARC ELASTICITY OF DEMAND POINT METHOD

  Point Elasticity is the elasticity of Demand at
a definite point.
Figure shows that the elasticity decreases along a
 This is the approach taken in the definition linear demand curve as the price falls.
of point-price elasticity, which uses
differential calculus to calculate the 1. At any price above the midpoint, demand
elasticity for an infinitesimal change in price is elastic.
and quantity at any given point on the 2. At the midpoint, demand is unit elastic.
demand curve. 3. At any price below the midpoint, demand
is inelastic.
 In other words, it is equal to the absolute
value of the first derivative of quantity with
respect to price (dQd/dP) multiplied by the
point's price (P) divided by its quantity (Qd).

P dQ
Ep= x
Q dP

Interpreting the Price Elasticity of Demand Number

The elasticity of demand for a Starbucks latte of 2 tells

us three things:

1. The demand for Starbucks lattes is

elastic—it has substitutes and the proportion of a
buyer’s income spent is small.

2. If Starbucks raised its price, revenue

per cup will rise but it will lose lots of potential
business.

3. Even a slightly lower price could bring

in a lot more revenue.

Elasticity along a Linear Demand Curve

Slope measures responsiveness. But slope and

elasticity are not the same thing!

Along a linear (straight-line) demand curve, the slope

is constant but the elasticity varies.

Along a linear demand curve, demand is:

 Unit elastic at the midpoint of

the curve.

 Elastic above the midpoint of

the curve.

 Inelastic below the midpoint

of the curve.
To show the importance of a units-free measure of  A fall in the price of a
elasticity, you can calculate the slope of a demand substitute of the good brings a decrease in
curve when the vertical axis is measured in dollars the quantity demanded of the good.
and again when it is measured in cents. Draw a
demand curve for tacos, such that when the price  The quantity demanded of
rises from $1.00 to $1.05, the quantity demanded the good and the price of its substitute
decreases from 50 to 45 tacos. The slope of the change in the same direction.
demand curve with the price measured in dollars is
The cross elasticity of demand for a complement
−0.01. Then, draw the identical demand curve, only
is negative.
this time measure the price in cents. When the
price rises from 100 cents to 105 cents, the quantity  A fall in the price of a
demanded decreases from 50 to 45 units. Now the complement of the good brings an
slope is −1.00. Point out that having the slope of the increase in the quantity demanded of the
identical demand curve change simply because the good.
units of the price change is surely not a good
feature. In addition, the slope changes when the  The quantity demanded of
quantity units change. For this reason, economists the good and the price of one of its
do not use the slope as their measure of sensitivity. complements change in opposite
They use elasticity because elasticity is calculated directions.
using units-free percentage changes. Elasticity does
not change if the units of the price or the quantity
are changed.

Other Types of Elasticity

 Cross elasticity of demand

 Income elasticity of demand
 Price elasticity of supply

CROSS ELASTICITY OF DEMAND

- is a measure of the extent to which the
demand for a good changes when the
price of a substitute or complement
changes, other things remaining the same

% change ∈quantity
demanded of a good
¿
% change ∈the price of one of
its substitutes∨complements

Suppose that when the price of a burger falls by INCOME ELASTICITY OF DEMAND
10 percent, the quantity of pizza demanded
decreases by 5 percent. - is a measure of the extent to which the
demand for a good changes when income
−5 % changes, other things remaining the same.
¿ =0.5
−10 %
% change∈quantity demanded
¿
The cross elasticity of demand for a substitute is % change∈income
positive.
The income elasticity of demand for a normal
good is positive.
 An increase in income
brings an increase in the quantity
demanded of the good.
 The quantity demanded of
the good and income change in the same
direction.
The income elasticity of demand for an inferior
good is negative.
 An increase in income
brings a decrease in the quantity
demanded of the good.
 The quantity demanded of
the good and income change in opposite
directions.
 The percentage change in the
quantity supplied exceeds the
percentage change in price.
 Unit elastic supply
 The percentage change in the
quantity supplied equals the
percentage change in price.
 Inelastic supply
 The percentage change in the
quantity supplied is less than the
percentage change in price.
 Perfectly inelastic supply
 The percentage change in the
quantity supplied is zero when the
price changes.

PRICE ELASTICITY OF SUPPLY

Computing the Price Elasticity of Supply
 is a measure of the extent to
which the quantity supplied of a good
changes when the price of the good
changes.
 To determine the price elasticity of
supply, we compare the percentage
change in the quantity supplied with the
percentage change in price.
% change∈quantity supplied
¿
% change∈ price
• If the price elasticity of supply is
greater than 1, supply is elastic.
• If the price elasticity of supply
equals 1, supply is unit elastic.
• If the price elasticity of supply is
less than 1, supply is inelastic.

 Elastic and Inelastic Supply

 Perfectly elastic supply Effect of a Tax on Cigarettes

 An almost zero percentage change

in price brings a very large
percentage change in the quantity
supplied.

 Elastic supply