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Price elasticity of demand

§The price elasticity of a good measures


the responsiveness of the quantity
demanded of the good to changes in the
price of that good.
§It is the percentage change in the
quantity demanded (ΔD x /D x )divided by
percentage change in the price (ΔP x /P x )of
the commodity.
Determining Price Elasticity

Percentage Change in Quantity


Ep= ___________________________________
Percentage Change in Price

Change in Quantity
Quantity
Ep= ____________________________________
Change in Price
Price
Factors influencing the price
elasticity of demand
Availability of substitutes: greater the number
of substitutes, greater the elasticity.
Degree of necessity or luxury: Luxury products
tend to have grater elasticity than necessities.
Proportion of income required by the item:
Products requiring a large amount of
consumers income tend to have greater
elasticity.
Time period considered: Elasticity tends to be
greater over the long run because consumers
have more time to adjust their behaviour to
price changes.
Examples:
The demand for automobiles would, in the
short term, be somewhat elastic, as the
purchase of a new vehicle can often be
delayed. The demand for a specific model
automobile would likely be highly elastic,
because there are so many substiutes.
The demand for automobiles in rural areas
would probably be inelastic, since there are few
alternative modes of transportation.
Examples:
Schooling itself is considered an essential
service by most parents, and better schools are
so desirable to many parents that they
undertake considerable sacrifices to send their
children to alternative schools. This would tend
to produce a highly inelastic demand. However,
there is also a widely available substitute for
alternative schools, namely the traditional
public schools. For most goods and services,
the availability of substitutes produces a highly
elastic demand
. Estimated Price Elasticities of
Demand for Various Goods and
Services
Approx unitary elastic
Elastic

Source: Economics: Private and Public


Choice, James D. Gwartney and
Richard L. Stroup, eighth edition 1997
Price elasticity & total
revenue
Why do we care whether a good is elastic or
inelastic?
The elasticity can tell us something about what
happens to total revenue as price changes
Important Observations:
When demand is elastic, a decrease
in price will result is an increase in
the revenue (sales).
When demand is inelastic, a
decrease in price will result is a
decrease in the revenue (sales).
When demand is unit-elastic, an
increase (or a decrease) in price will
not change the revenue (sales).
Relationship between total revenue
& price elasticity of demand
When the demand curve is inelastic, a price
increase raises total revenue, while a price
decrease reduces total revenue.
When the demand curve is elastic, a price
increase reduces total revenue, while a price
decrease raises total revenue.
When the demand curve is unit elastic, a price
change does not affect total revenue.