ELASTICITY

How quantity demanded or supplied changes with changes in price

Determinants of Price Elasticity of Demand

Necessities versus Non-necessities

Availability of Close Substitutes

Definition of the Market

Time Horizon

Price Elasticity of Demand

pricein change Percentage

ddemandequantity in change PercentageEd

dP %

dQ %Ed

How to calculate the Price Elasticity of Demand

i

if

i

if

PPP

QQQ

dP %

dQ %

i = initial and f = final

ExampleIf the price of a unit of the good increases from $4 to $5 and the amount you buy falls from 100 to 50 units/week then your elasticity of demand would be calculated as:

2.25

50.

44)(5

100100)(50

PiPi - Pf

QiQi - Qf

How to Interpret Elasticity

A price elasticity of –2 means that: if price increases by 1%, quantity demanded decreases by 2%.

Unit Elastic Demand: Elasticity equals -1

Quantity

Price

$5A 25%increasein price...

Demand

75...leads to a 25% decrease in quantity demanded.

100

$4

Ed = %dQ %dP

-.25 .25

= -1

Elastic Demand: Elasticity is greater than –1

Quantity

Price价格

$5A 25%increasein price...

Demand

50...leads to a 50% decrease in quantity demanded.

100

$4

Ed = %dQ %dP = -.50

.25 = -2

Inelastic Demand: Elasticity is less than –1

Quantity

Price

$4

$5A 25%increasein price...

Demand

90...leads to a 10% decrease in quantity demanded.

100

Ed = %dQ %dP -.10 .25 = -.4

Elasticity and Total Revenue: Inelastic demand

Quantity

Price

$4

$5A 25%increasein price...

Demand

10090...leads to a 10% decrease in quantity demanded.

P Revenue increases

Revenue = $400

Revenue = $450

Elasticity and Total Revenue: Elastic demand

Quantity

Price价格

$4

$5A 25%increasein price...

Demand

10050...leads to a 50% decrease in quantity demanded.

P Revenue decreases

Revenue = $400

Revenue = $250

Crude Oil Prices $/

bar

rel

Nominal $ Inflation-adjusted 2011 US$

Supply: Crude Oil Production

000s

bar

rels

/day

0.25.5

125.

2020) - (30

6464)(56

P%

Q%

Estimating Demand Elasticity for Oil1979-80

Year

19791980

Price$/barrel

$20 $30

QuantityBarrels/day (millions)

64 56

and a proportionately smaller decrease (12.5%) in quantity sold.

Effect of Decrease in Supply in Oil Market with Inelastic Demand

30

Barrels/day (millions) 560

$/barrel When demand is inelastic, a decrease in supply...

Demand

S2 S1

20

64

leadsto a large increase in price (50%)

Revenue= $1280

Revenue = $1680

and a proportionately larger decrease (22%) in quantity sold.

Effect of Decrease in Supply in Oil Market with Elastic Demand

22

Barrels/day (millions)

500

$/barrel When demand is elastic, a decrease in supply...

Demand

S2 S1

20

64

leadsto a small increase in price (10%) Revenue = $1280

Revenue = $1100

and a proportionately smaller increase (10%) in quantity sold.

Effect of Increase in Supply in Wheat Market with Inelastic Demand

3

Bushels per day (millions) 3000

$/bushelWhen demand is inelastic,an increase in supply...

Demand

S1

S2

2

330

leadsto a large decrease in price (50%)

Revenue= $900

Revenue = $660

Elastic SupplyElasticity is greater than 1

Quantity

Price

4

$5A 25%increasein price...

200100

Supply

...leads to a 100% increase in quantity supplied.

Es = %dQ %dP = 1.00 .25 = 4

Inelastic SupplyElasticity is less than 1

Quantity

Price

4

$5A 25%increasein price...

110100

Supply

...leads to a 10% increase in quantity supplied.

Es = %dQ %dP = .10 .25 = 0.4