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AG BM 102

Introduction

• Key question about demand is how

responsive is consumption to a price

change?

• The demand curve provides a quantitative

answer

• But that answer is dependent on units of

measurement

• Elasticity does not depend on units of

measure!

Own Price Elasticity of Demand

- the percentage change in

quantity demanded in response

to a one percent change in the

price

An Example - Beef

Price/lb. Quantity Price/lb. Quantity

lb./cap. lb./cap.

$5.00 50 $3.75 75

$4.75 55 $3.50 80

$4.50 60 $3.25 85

$4.25 65 $3.00 90

$4.00 70 $2.75 95

Beef Demand

5

4

$/lb.

2

40 50 60 70 80 90 100

lbs./capita

Calculating the Equation for the

Demand Curve

• Take any two points, such as $4.00 and

70 lb, and $3.00 and 90 lb.

• The equation for a straight line demand

curve is Q = a + b P

Q = a + bP

b = ( Q 1 − Q 2) / ( P 1 − P 2)

a = Q 1− bP 1

Q ! = 7 0 l b s . , P 1 = $ 4 .0 0 ,

Q 2 = 9 0 lb s. and P 2 = $ 3 .0 0

b = (7 0 − 9 0) / (4 − 3) = −2 0

a = 7 0 − ( − 2 0 )(4 ) = 150

Q = 150 − 20P

To check put in Prices

• If P=3, Q = 150 - 20(3) = 90

Formula for Demand Elasticity

ε = [( Q 2 − Q 1) / ( Q 1) ] / [( P 2 − P 1) / ( P 1) ]

Elasticity at P=$4.00 and Q=70 lbs.

ε = [ ( 9 0 − 7 0 ) / ( 7 0 ) ] / [ ( 3 − 4 ) / ( 4 ) ] = − 1 .1 4

Interpreting elasticity

• Inelastic 0 > ε > −1

• elastic − 1 > ε > −∞

• unitary elastic ε = −1

Inelastic demand means

quantity change is

proportionately less than price

change, or that demand is not

especially price responsive –

like drinking milk

Elastic demand means quantity

change is proportionately more

than price change, or that

demand is particularly price

responsive – like lobster

Another view of the formula

ε = [( Q 2 − Q 1) / ( P 2 − P 1) ] * [( P 1) / ( Q 1) ] = b ( P 1 / Q 1)

Note

• The units cancel out, so elasticity is not

dependent on units used in the data

• For straight-line demand curves, the value

of elasticity changes as you move along

the curve

• The closer you are to the vertical access

the more elastic demand

• The closer to the horizontal access the

more inelastic

Some demand issues

• Is the demand for all food elastic or

inelastic?

• Is the demand for all meat elastic or

inelastic?

• Is the demand for chicken elastic or

inelastic?

• Is the demand for prime rib elastic or

inelastic?

Concluding comments

• Elasticity allows discussion of demand

without units

• It makes description of demand curves

more descriptive

• Makes analysis of changes easier

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