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The Elasticity of Demand

Chapter 7



The Concept of Elasticity

• Elasticity is a measure of theresponsiveness of one variable to another.

•The greater the elasticity, the greater theresponsiveness.



Laugher Curve

Q. What’s the difference between aneconomist and a befuddled old man withAlzheimer’s?

A. The economist is the one with acalculator.



The Concept of Elasticity

• Elasticity is a measure of theresponsiveness of one variable to another.

•The greater the elasticity, the greater theresponsiveness.



Price Elasticity

• The price elasticity of demand is thepercentage change in quantity demandeddivided by the 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 isalways negative.

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



What Information PriceElasticity Provides

• Price elasticity of demand and supplygives the exact quantity response to achange in price.



Classifying Demand and Supplyas Elastic or Inelastic

• Demand is elastic if the percentagechange in quantity is greater than thepercentage change in price.

E > 1



Classifying Demand and Supplyas Elastic or Inelastic

• Demand is inelastic if the percentagechange in quantity is less than thepercentage change in price.

E < 1



Elastic Demand

• Elastic Demand means that quantitychanges by a greater percentage than thepercentage change in price.



Inelastic Demand

• Inelastic Demand means that quantitydoesn't change much with a change inprice.



Defining elasticities

• When price elasticity is between zero and -1we 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 isunit elastic .



Elasticity Is Independent of Units

• Percentages allow us to have a measureof responsiveness that is independent of units.

• This makes comparisons of responsiveness of different goods easier.



Calculating Elasticities

• To determine elasticity divide thepercentage change in quantity by thepercentage change in price.



The End-Point Problem

• The end-point problem – the percentagechange differs depending on whether youview the change as a rise or a decline in

price.



The End-Point Problem

• Economists use the average of the endpoints to calculate the percentage change.



Graphs of Elasticities

Pric

e

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 betweenA and B = 1.27



Calculating Elasticities: Priceelasticity of Demand

D

P

Q

What is the price elasticity of demand between A and B?

$20

10

$26

14

MidpointB

A

ED = %ΔQ%ΔP

Q2–Q1

½(Q2+Q1)P2–P1

½(P2+P1)

=

C

12

$23

=

10–14

½(10+14)26–20½(26+20)

-.33.26= 1.27 =

7-18



Price Elasticity: Supply

• Price elasticity of supply is the percentage change inquantity 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 percentagechange in quantity is greater than thepercentage change in priceElastic supply is when ES > 1

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

Inelastic supply is when ES < 1

7-20



Calculating Elasticities: Price

elasticity of SupplyP

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)5–4.50½(5+4.50)

Midpoint

C

480.5

$4.75

0.01870.105= 0.18=

S

7-21



Graphs of Elasticities

Elasticity of supply between Aand B = 0.18

Wage per hour

Quantity of workers

$6.00

5.50

5.00

4.504.00

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

2

1

2

1

D=−=

−=

+−+−

=Price

Quantity of software (in hundred thousands)

$26

24

22

20

18

16

14

0

Demand

B

A

10 12 14

Cmidpoint

Elasticity of demandbetween A and

B:

P%

Q% E ∆

∆=



Calculating Elasticity of SupplyBetween Two Points

P%

Q%

E ∆∆=

Wage pe

r hour

Quantity of workers

$6.00

5.50

5.00

4.504.00

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 calculatingthe elasticity at a specific point, rather thanover a range or an arc.




• To calculate elasticity at a point, determinea range around that point and calculatethe arc elasticity.




Price

Quantity

$10987654321

C

BA

24 402820




Price

Quantity

$10987654

321

C

BA

24 402820

To calculate elasticity at a point determinea range around that point and calculatethe 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 demandand supply curves.




6 12 18 30 36 42 48

Price

Quantity

8

76543

21

$109

A

24 6054

D

B

C

Supply E A = 2.33

E B

= 0.11

Demand

E C = 0.75

E D = 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 demandand supply curves.



Elasticity Is Not the Same asSlope

• The steeper the curve at a given point, theless elastic is supply or demand.

• There are two limiting examples of this.




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

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




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

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



Perfectly inelasticdemand curve

Price

0Quantity

Perfectly Inelastic DemandCurve



Perfectly elasticdemand curve

Perfectly Elastic Demand Curve

Price

0Quantity

D d C



Demand CurveShapes 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 onconsumer demand.

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

D d C



Demand CurveShapes and Elasticity



Elasticity Changes AlongStraight-Line Curves

• Elasticity is not the same as slope.

• Elasticity changes along straight linesupply and demand curves–slope doesnot.



Elasticity Along a Demand Curve

Pric e

$1098

76543

21

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

Elasticity declines alongdemand curve as we move

toward the quantity axis

Ed = 1

Ed = 0

Ed < 1

Ed > 1

Ed = ∞



The Price Elasticity of Demand Along aStraight-line Demand Curve



Substitution and Elasticity

• As a general rule, the more substitutes agood has, the more elastic is its supplyand demand.



Substitution and Demand

• The less a good is a necessity, the moreelastic its demand curve.

• Necessities tend to have fewer substitutesthan do luxuries.




• Demand for goods that represent a largeproportion of one's budget are moreelastic than demand for goods that

represent a small proportion of one'sbudget.




• Goods that cost very little relative to your total expenditures are not worth spendinga 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 largeportion of one’s income.




• The larger the time interval considered, or the longer the run, the more elastic is thegood’s demand curve.

– There are more substitutes in the long runthan in the short run.

– The long run provides more options for

change.

Determinants of the



Determinants of thePrice 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 theconsumer’s total budget

– The time period under consideration

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