Elasticity of Demand

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Elasticity
 Elasticity is a measure of how much buyers and sellers respond to
changes in market conditions.
 Elasticity allows us to analyze supply and demand with greater
precision.
 If something is elastic it is responsive, flexible, or readily changed.
A rubber band is elastic and with little force it easily stretches. A
chain on the other hand is rigid and changes very little when
pulled.
 In the context of price elasticity of demand, the price change is
comparable to the force applied to a rubber band or chain and the
change in quantity demanded is comparable to the stretch.
 When consumers are relatively responsive to a price change, we
say that demand is elastic.
 When the change in quantity demanded by consumers is relatively
small in response to a price change, we say that demand is
inelastic.
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Price Elasticity of Demand
 According to the law of demand, when price goes up, consumers
demand fewer quantities of a product. If the price of a product
falls, quantity demanded will rise.
 But when the price of a product changes, by how much more (or
less) will consumers buy?
 To help answer this question, we will use a measurement called
the Price Elasticity of Demand.
 Price elasticity of demand is the percentage change in
quantity demanded given a percent change in the
price.
 It is a measure of how much the quantity demanded
of a good responds to a change in the price of that
good.

Computing the Price Elasticity of
Demand
 The price elasticity of demand is computed as the percentage
change in the quantity demanded divided by the percentage
change in price.
 Example: If the price of an ice cream cone increases from
$2.00 to $2.20 and the amount you buy falls from 10 to 8
cones then your elasticity of demand would be calculated as:
PriceinChangePercentage
DemandedQuantityinChangePercentage
=DemandofElasticityPrice
2
10
20
100
00.2
)00.220.2(
100
10
)810(
percent
percent

Ranges of Elasticity
Inelastic Demand
 Quantity demanded does not respond strongly to price changes.
 Price elasticity of demand is less than one.
Elastic Demand
 Quantity demanded responds strongly to changes in price.
 Price elasticity of demand is greater than one.
Perfectly Inelastic
 Quantity demanded does not respond to price changes.
Perfectly Elastic
 Quantity demanded changes infinitely with any change in price.
Unit Elastic
 Quantity demanded changes by the same percentage as the
price.

A Variety of Demand Curves
Perfectly Inelastic Demand - Elasticity equals 0
Inelastic Demand- Elasticity is less than 1
Price
Quantity100
$10
$5
1. An increase in price...
2. ...leaves the quantity
demanded unchanged.
Price
Quantity
90
$5
$4
1. A 22 % increase in price...
2. ...leaves 11% decrease in
Quantity.
100 © iTutor. 2000-2013. All Rights Reserved

Unit Elastic Demand - Elasticity equals 1
Elastic Demand - - Elasticity is greater than 1
A Variety of Demand Curves
Price
Quantity78
$5
$4
Quantity.
100
Price
Quantity33
$5
$4
Quantity.
100 © iTutor. 2000-2013. All Rights Reserved

Quantity
Price
Demand$4
1. At any price
above $4, quantity
demanded is zero.
2. At exactly $4,
consumers will
buy any quantity.
3. At a price below $4,
quantity demanded is infinite.
Perfectly Elastic Demand - Elasticity equals infinity

Total Revenue
Total Revenue
 A firm’s profit is determined by
taking the total revenue minus the
total cost.
 Total revenue is equal to the price
each unit sells for times the quantity
or number of units sold.
Quantity
Prices
$5
10
Price x Quantity = Total Revenue
If demand is elastic:
• A given percentage rise in price brings a larger
percentage decrease in the quantity demanded.
• And total revenue decreases.
If demand is inelastic:
• A given percentage rise in price brings a smaller
percentage decrease in the quantity demanded.
• And total revenue increases.
 Relationship Between Price
Elasticity of Demand and Revenue

Determinants of the Elasticity of Demand
 Available close substitutes
 The greater the number of close substitutes that are available
for a good, the more elastic it becomes.
 If there are many bread stores in the city and one bread store
raises its price, the quantity demanded decreases since there
are many other stores producing a similar product.
 Percent of Income
 The percent of income spent on the good influences the
elasticity of demand.
 The greater percent of income spent on the good the more
elastic it becomes, all else held constant.
 Luxury or necessity?
 Those items that are a necessities in life are more inelastic
than items that are a luxury.
 Food in general, salt, and life saving medical care are
examples of necessities and have lower price elasticity than
luxury items such as: jewelry, yachts, or vacation travel.

 Time period
 The longer the time period, the more elastic a good becomes
as more substitutes become available.
 If the price of gas doubled, car owners would still need to buy
gas.
 But in time, they may choose to trade their larger vehicle in
for one that is more fuel efficient or uses an alternative
fuel, or even choose to move to a different apartment so that
they are closer to work or able to use an alternative methods
of public transportation such as a subway, train or bus line.
 Market definition
 The last determinant of own price elasticity is the market
definition. The broader the definition the fewer number of
close available substitutes exist.
 f a single gas station in town raises its price, there are several
other gas stations in town that sell a very similar product,
thus the gas at a particular station tends to be elastic.
 However, if we look at the entire market for gas, there are few
substitutes and the own price elasticity is inelastic.

Income Elasticity of Demand
 Income elasticity of demand measures how much the quantity
demanded of a good responds to a change in consumers’ income.
 It is computed as the percentage change in the quantity
demanded divided by the percentage change in income.
 Goods consumers regard as necessities tend to be income inelastic.
 Examples include food, fuel, clothing, utilities, and medical
services.
 Goods consumers regard as luxuries tend to be income elastic.
Examples include sports cars, furs, and expensive foods.
Income Elasticity
of Demand
Percentage Change
in Quantity Demanded
Percentage Change
in Income
=

The End
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Elasticity of Demand

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Elasticity of Demand