Elasticity of demand

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The Concept of Elasticity
• Elasticity is a measure of the
responsiveness of one variable to another.
• The greater the elasticity, the greater the
responsiveness.

Laughter Curve
Q. What’s the difference between an
economist and a befuddled old man with
Alzheimer’s?
A. The economist is the one with a
calculator.

Price Elasticity
• The price elasticity of demand is the
percentage change in quantity demanded
divided by the percentage change in price.

Percentage change in quantity demanded
ED =
Percentage change in price

Sign of Price Elasticity
• According to the law of demand, whenever
the price rises, the quantity demanded
falls. Thus the price elasticity of
demand is always negative.

• Because it is always negative, economists
usually state the value without the sign.

What Information Price
Elasticity Provides
• Price elasticity of demand and supply
gives the exact quantity response to a
change in price.

Classifying Demand and Supply
as Elastic or Inelastic
• Demand is elastic if the percentage
change in quantity is greater than the
percentage change in price.

E>1

Classifying Demand and Supply
as Elastic or Inelastic
• Demand is inelastic if the percentage
change in quantity is less than the

E<1

Elastic Demand
• Elastic Demand means that quantity
changes by a greater percentage than the

Inelastic Demand
• Inelastic Demand means that quantity
doesn't change much with a change in
price.

Defining elasticities
• When price elasticity is between zero and
-1 we say demand is inelastic.
• When price elasticity is between -1 and
- infinity, we say demand is elastic.
• When price elasticity is -1, we say demand
is unit elastic.

Elasticity Is Independent of
Units
• Percentages allow us to have a measure
of responsiveness that is independent of
units.
• This makes comparisons of
responsiveness of different goods easier.

Calculating Elasticities
• To determine elasticity divide the
percentage change in quantity by the

The End-Point Problem
• The end-point problem – the percentage
change differs depending on whether you
view the change as a rise or a decline in
price.

The End-Point Problem
• Economists use the average of the end
points to calculate the percentage change.

(Q2 - Q1)
½ Q2 Q1
Elasticity = (P 2 - P1)
½ P1 + P2

Graphs of Elasticities
B
$26
24 C (midpoint)
22 A
20
18
D
16
14 Elasticity of demand
between A and B = 1.27
0 10 12 14
Quantity of software (in hundred thousands)

Calculating Elasticities: Price
elasticity of Demand

P What is the price elasticity of
demand between A and B?
Q2–Q1
%ΔQ ½(Q2+Q1)
B
ED = %ΔP = P2–P1
$26 Midpoint
C ½(P2+P1)
$23
$20 A 10–14
½(10+14) -.33
= 26–20 = .26 = 1.27
D ½(26+20)
Q
10 12 14
7-19

Price Elasticity: Supply
• Price elasticity of supply is the
percentage change in quantity supplied
divided by the percentage change in
ES = % change in Quantity Supplied
% change in Price
• This tells us exactly how quantity supplied responds to
a change in price
• Elasticity is independent of units

7-20

Price Elasticity: Supply
• Supply is elastic if the percentage
change in quantity is greater than the
percentagesupply is whenprice1
Elastic change in ES >

• Supply is inelastic if the percentage change in quantity
is less than the percentage change in price

Inelastic supply is when ES < 1

7-21

Graphs of Elasticities

$6.00
5.50
5.00 B
4.50 C (midpoint)
A
4.00
3.50 Elasticity of supply
3.00 between A and B = 0.18

0
470 480 490
Quantity of workers

Calculating Elasticity

Q2 Q1
1
% Q 2 (Q 1 Q2 )
E
% P P2 P1
1
2 (P1 P2 )

Calculating Elasticity of Demand
Between Two Points
Elasticity of demand % Q
E
$26 between A and B: % P
B
24 10 14 4
1
22 midpoint C 2 (14 10) 12 .33
ED 1.27
20 26 20 6 .26
A 1
2 (26 20) 23
18
16 Demand
14

0
10 12 14
Quantity of software (in hundred thousands)

Calculating Elasticity of Supply
Between Two Points
$6.00
5.50 Elasticity of supply
5.00 B between A and B: E % Q
4.50 C % P
A
4.00 485 475 10
3.50 1
2 ( 485 475) 480 .021
ES .2
3.00 5 4.50 .50 .105
1
2 (5 4.50) 4.75

0
470 480 490
Quantity of workers

Calculating Elasticity at a Point
• Let us now turn to a method of calculating
the elasticity at a specific point, rather than
over a range or an arc.

• To calculate elasticity at a point, determine
a range around that point and calculate
the arc elasticity.


$10 (28 - 20)
9 ½ 28 20
8 E at A =
(5 - 3)
0.66
7
6 ½ 5+3
C
5
A
4
B
3
2
1
20 24 28 40 Quantity


To calculate elasticity at a point determine
$10 a range around that point and calculate
9 the arc elasticity.
8
7 28 20 8
6 1
C 2 (28 20) 24 .33
5 E at A .66
A 5 3 2 .5
4
B 1
2 (5 3) 4
3
2
1
20 24 28 40
Quantity

Elasticity and Demand Curves
• Two important points to consider:
– Elasticity is related (but is not the same as)
slope.
– Elasticity changes along straight-line demand
and supply curves.


$10 Demand
9 Supply
8 EA = 2.33
A
7
6
D
5 ED = 0.86
4
3 C E = 0.75 EB = 0.11
2 C
B
1
6 12 18 24 30 36 42 48 54 60 Quantity

Elasticity Is Not the Same as
Slope
• The steeper the curve at a given point, the
less elastic is supply or demand.
• There are two limiting examples of this.

Slope
• When the curves are flat, we call the
curves perfectly elastic.

• The quantity changes enormously in
response to a proportional change in price
(E = ).

Slope
• When the curves are vertical, we call the
curves perfectly inelastic.

• The quantity does not change at all in
response to an enormous proportional
change in price (E = 0).

Perfectly Inelastic Demand
Curve

Perfectly inelastic
demand curve

0
Quantity

Perfectly Elastic Demand Curve

Perfectly elastic
demand curve

0
Quantity

Demand Curve
Shapes and Elasticity
• Perfectly Elastic Demand Curve
– The demand curve is horizontal, any change in price can and
will cause consumers to change their consumption.

• Perfectly Inelastic Demand Curve
– The demand curve is vertical, the quantity demanded is totally
unresponsive to the price. Changes in price have no effect on
consumer demand.

• In between the two extreme shapes of demand curves
are the demand curves for most products.

Demand Curve
Shapes and Elasticity

Elasticity Changes Along
Straight-Line Curves
• Elasticity is not the same as slope.
• Elasticity changes along straight line
supply and demand curves–slope does
not.

Elasticity Along a Demand Curve
Ed = ∞
Elasticity declines along
$10 demand curve as we move
9 toward the quantity axis
8 Ed > 1
7
6
Price

Ed = 1
5
4
3 Ed < 1
2
1 Ed = 0
0 1 2 3 4 5 6 7 8 9 10 Quantity

The Price Elasticity of Demand Along a
Straight-line Demand Curve

Substitution and Elasticity
• As a general rule, the more substitutes a
good has, the more elastic is its supply
and demand.

Substitution and Demand
• The less a good is a necessity, the more
elastic its demand curve.

• Necessities tend to have fewer substitutes
than do luxuries.

• Demand for goods that represent a large
proportion of one's budget are more elastic
than demand for goods that represent a
small proportion of one's budget.

• Goods that cost very little relative to your
total expenditures are not worth spending
a lot of time figuring out if there is a good
substitute.

• It is worth spending a lot of time looking for
substitutes for goods that take a large
portion of one’s income.

• The larger the time interval considered, or
the longer the run, the more elastic is the
good’s demand curve.
– There are more substitutes in the long run
than in the short run.
– The long run provides more options for
change.

Determinants of the
Price Elasticity of Demand
• The degree to which the price elasticity of
demand is inelastic or elastic depends on:
– How many substitutes there are
– How well a substitute can replace the good or
service under consideration
– The importance of the product in the
consumer’s total budget
– The time period under consideration

Elasticity of demand

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Elasticity of demand