Econ: Lecture 2

Elasticity of demand

Reference: Textbook, Reading 14

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1. Elasticity of demand
Own-price elasticity is a measure of the
responsiveness of the quantity demanded to a
change in price. It is calculated as the ratio of the
percentage change in quantity demanded to a
percentage change in price.
Formula:

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1. Elasticity of demand
Example: A demand function for gasoline is as follows:
QDgas = 138,500 – 12,500Pgas
Calculate the price elasticity at a gasoline price of $3
per gallon.

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1. Elasticity of demand
Elasticity changes along a
linear demand curve.
In the upper part of the
demand curve, elasticity is
greater (in absolute value)
than 1. In the lower part of the
curve, the percentage change
in quantity demanded is
smaller than the percentage
change in price.

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2. Types of elasticity
• Own-price elasticity of demand
• Income elasticity of demand
• Cross price elasticity of demand

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2. Types of elasticity
• Income elasticity of demand
• Normal goods
• Inferior goods
• Cross price elasticity of demand
• Substitutes
• Complements

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2. Types of elasticity
Example:
An individual has the following demand function for gasoline:
QDgas = 15 – 3Pgas + 0.02I + 0.11PBus – 0.008PCar
where income and car price are measured in thousands, and
the price of bus travel is measured in average dollars per 100
miles traveled.
Assuming the average automobile price is $22,000, income is
$40,000, the price of bus travel is $25, and the price of
gasoline is $3.
Calculate and interpret the income elasticity of gasoline
demand;
Calculate and interpret the cross price elasticity of gasoline
demand with respect to the price of bus travel.

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3. Homework
A demand function for air conditioners is given by:
QDair conditioner = 10,000 – 2 Pair conditioner + 0.0004 income + 30 Pelectric fan – 4 Pelectricity

At current average prices, an air conditioner costs

5,000 yen, a fan costs 200 yen, and electricity costs
1,000 yen. Average income is 4,000,000 yen.
Calculate and interpret the income elasticity of
demand for air conditioners.

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