04

Elasticity

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
 Price Elasticity of Demand

• Measures buyers’ responsiveness to

price changes
• Elastic demand
• Sensitive to price changes
• Large change in quantity
• Inelastic demand
• Insensitive to price changes
• Small change in quantity
LO1 4-2
 Price Elasticity of Demand Formula

• Formula for price elasticity of demand

Percentage Change in Quantity

Demanded of Product X
Ed =
Percentage Change in Price
of Product X

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 Price Elasticity of Demand Formula

• Use the midpoint formula

• Ensures consistent results

Change in quantity Change in price

Sum of quantities / 2 Sum of prices / 2
Ed = ÷

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 Price Elasticity of Demand Formula

• Use percentages
• Unit free measure
• Compare responsiveness across
products
• Eliminate the minus sign
• Easier to compare elasticities

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 Interpretation of Elasticity of Demand

• Ed > 1 demand is elastic

• Ed = 1 demand is unit elastic
• Ed < 1 demand is inelastic
• Extreme cases
• Perfectly inelastic
• Perfectly elastic

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Interpretations of Elasticity
Elastic Demand
.04
Ed = .02
=2
Inelastic Demand
.01
Ed = .02
= .5
Unit Elasticity
.02
Ed = .02
=1
6-7
 Extreme Cases

P D1
Perfectly
inelastic
demand
(Ed = 0)

Perfectly inelastic demand

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 Extreme Cases

D2
Perfectly
elastic
demand
(Ed = ∞)

Perfectly elastic demand

LO1 4-9
 Total Revenue Test

• Total Revenue = Price x Quantity

• Inelastic demand
• P and TR move in the same
direction
• Elastic demand
• P and TR move in opposite
directions

LO2 4-10
 Elasticity on a Linear
Demand Curve

(1)
Total Quantity of (3) (4) (5)
Tickets Demanded (2) Elasticity Total Revenue Total-Revenue
Per Week, Thousands Price Per Ticket Coefficient (Ed) (1) X (2) Test

1 $8 $8,000
2 7
] 5.00
14,000
] Elastic

3 6
] 2.60
18,000
] Elastic

4 5
] 1.57
20,000
] Elastic
] 1.00 ] Unit Elastic
5 4 20,000
] 0.64 ] Inelastic
6 3 18,000
7 2
] 0.38
14,000
] Inelastic

8 1
] 0.20
8,000
] Inelastic

6-11
Summary of Price Elasticity of Demand
Price Elasticity of Demand: A Summary
Absolute
Value of Impact on Total Revenue of a:
Elasticity
Coefficient Demand Is Description Price Increase Price Decrease
Greater than 1 Elastic or Qd changes by a Total revenue Total revenue
(Ed > 1) relatively larger decreases increases
elastic percentage than
does price
Equal to 1 Unit or unitary Qd changes by Total revenue Total revenue
(Ed = 1) elastic the same is unchanged is unchanged
percentage as
does price
Less than 1 Inelastic or Qd changes by a Total revenue Total revenue
(Ed < 1) relatively smaller increases decreases
inelastic percentage than
does price

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 Factor effecting of Elasticity of
Demand
• Substitutability
• More substitutes, demand is more elastic
• Proportion of Income
• Higher proportion of income, demand is more
elastic
• Luxuries vs. Necessities
• Luxury goods, demand is more elastic
• Time
• More time available, demand is more elastic
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 Application of Elasticity of Demand
• Large crop yields
• Excise Taxes
• Decriminalization of illegal drugs

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 Price Elasticity of Supply

• Measures sellers’ responsiveness to

price changes
• Elastic supply, producers are
responsive to price changes
• Inelastic supply, producers are not
responsive to price changes

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 Price Elasticity of Supply

• Formula to compute elasticity

• Es > 1 supply is elastic
• Es < 1 supply is inelastic

Percentage Change in Quantity

Supplied of Product X
Es =
Percentage Change in Price
of Product X

LO3 4-16
 Cross Elasticity of Demand

• Measures responsiveness of sales to

change in the price of another good
• Substitutes – positive sign
• Complements – negative sign
• Independent goods - zero
Percentage change in quantity demanded of product
X
Ex,y =
Percentage change in price of product Y
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 Income Elasticity of Demand

• Measures responsiveness of buyers

to changes in income
• Normal goods – positive sign
• Inferior goods – negative sign

Percentage change
in quantity demanded
Ei =
Percentage change in income
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