the elasticity of demand

The Elasticity of Demand

Chapter 7

The Concept of Elasticity

• Elasticity is a measure of the

responsiveness of one variable to another.

• The greater the elasticity, the greater the

responsiveness.

Laugher 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.

The Concept of Elasticity

• Elasticity is a measure of the

responsiveness of one variable to another.

• The greater the elasticity, the greater the

responsiveness.

Price Elasticity

• The price elasticity of demand is the

percentage change in quantity demanded

divided by the percentage change in price.

price in change Percentage

demanded quantity in change Percentage=ED

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.

21

12

12

12

P+P)P-(P

QQ)Q-(Q

=Elasticity½

½

Graphs of Elasticities

Quantity of software (in hundred thousands)

$26

24

22

20

18

16

14

0

D

B

A

10 12 14

C (midpoint)

Elasticity of demand

between A and B = 1.27

Calculating Elasticities: Price

elasticity of Demand

D

P

Q

What is the price elasticity of

demand between A and B?

$20

10

$26

14

Midpoint B

A

ED = %ΔQ

%ΔP

Q2–Q1

½(Q2+Q1)

P2–P1

½(P2+P1)

=

C

12

$23

=

10–14

½(10+14)

26–20

½(26+20)

-.33

.26

= 1.27 =

7-18

Price Elasticity: Supply

• Price elasticity of supply is the

percentage change in quantity supplied

divided by the percentage change in

• This tells us exactly how quantity supplied responds to

a change in price

ES =

• Elasticity is independent of units

% change in Quantity Supplied

% change in Price

7-19

Price Elasticity: Supply

• Supply is elastic if the percentage

change in quantity is greater than the

percentage change in price Elastic supply is when ES > 1

• Supply is inelastic if the percentage change in quantity

is less than the percentage change in price

Inelastic supply is when ES < 1

7-20

Calculating Elasticities: Price

elasticity of Supply

P

Q

What is the price elasticity of

supply between A and B?

$4.50

476

$5.00

485

B

A

ES = %ΔQ

%ΔP

Q2–Q1

½(Q2+Q1)

P2–P1

½(P2+P1)

=

=

485–476

½(485+476)

5–4.50

½(5+4.50)

Midpoint

C

480.5

$4.75

0.0187

0.105

= 0.18 =

S

7-21

Graphs of Elasticities

Elasticity of supply

between A and B = 0.18

Quantity of workers

$6.00

5.50

5.00

4.50

4.00

3.50

3.00

0

C B

A

470

(midpoint)

480 490

Calculating Elasticity

)PP(

PP

)QQ(

QQ

P%

Q% E

2121

12

2121

12

Calculating Elasticity of Demand

Between Two Points

27.126.

33.

23

612

4

)2026(

2026

)1014(

1410

E

21

21

D

Quantity of software (in hundred thousands)

$26

24

22

20

18

16

14

0

Demand

B

A

10 12 14

C midpoint

Elasticity of demand

between A and B: P%

Q% E

Calculating Elasticity of Supply

Between Two Points

P%

Q% E

Quantity of workers

$6.00

5.50

5.00

4.50

4.00

3.50

3.00

0

C B

A

470 480 490

Elasticity of supply

between A and B:

2.105.

021.

75.4

50.480

10

)50.45(

50.45

)475485(

475485

E

21

21

S

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.


Quantity

$10 9 8 7 6 5 4 3 2 1

C

B A

24 40 28 20

0.66

3+53)-(5

202820)-(28

=A atE

½

½


Quantity

$10 9 8 7 6 5 4 3 2 1

C

B A

24 40 28 20

To calculate elasticity at a point determine

a range around that point and calculate

the arc elasticity.

66.5.

33.

4

224

8

)35(

35

)2028(

2028

E

21

21

Aat

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.


6 12 18 30 36 42 48 Quantity

8 7 6 5 4 3 2 1

$10 9

A

24 60 54

D

B

C

Supply EA = 2.33

EB = 0.11

Demand

EC = 0.75

ED = 0.86

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.

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

0 Quantity

Perfectly Inelastic Demand

Curve

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 P

rice

$10 9 8 7 6 5 4 3 2 1

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

Elasticity declines along demand curve as we move

toward the quantity axis

Ed = 1

Ed = 0

Ed < 1

Ed > 1

Ed = ∞

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

the elasticity of demand

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