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Elasticity and Its Application
Elasticity . . .
… is a measure of how much buyers and sellers respond to changes in market conditions
… allows us to analyze supply and demand with greater precision.
Price Elasticity of Demand
Price Elasticity of Demand Price elasticity of demand is the percentage
change in quantity demanded given a percent change in the price.
Determinants of Price Elasticity of Demand
P-Proportion of income spent on the good A-Availability of Close Substitutes I-Importance (luxury vs. necessity)D-Delaying of good being possible or not
Determinants of Price Elasticity of Demand
Demand tends to be more elastic : if you do not spend a lot on the good the larger the number of close substitutes if the good is a luxury the longer the time period
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.
Price Elasticity of Demand=
Percentage Changein Quantity Demanded
Percentage Changein Price
Price Elasticity of Demand=
Percentage Changein Quantity Demanded
Percentage Changein Price
This is about to get ugly… Do not give up, get the notes, do the activity problems, and know it will make sense to you by the end
Remember, no calculator
Price Elasticity of Demand Using the Midpoint Formula
The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change…
2
)P(P
)P(P
2
)Q(Q
)Q(Q
= Demand of Elasticity Price
12
12
12
12
(
(
)
)
Price Elasticity of Demand Using the Midpoint Formula
2
)P(P
)P(P
2
)Q(Q
)Q(Q
= Demand of Elasticity Price
12
12
12
12
(
(
)
)
What do Q2 and P2 mean?
Ranges of ElasticityInelastic 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.
1Necessity Luxury
Inelastic Elastic
0
Price Elasticity of Demand
*This means we are talking about absolute value
Example 1:
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.
Your elasticity of demand would be calculated via the midpoint formula as:
Example 2: 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 the your elasticity of demand, using the midpoint formula, would be calculated as:
Example2 : 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 the your elasticity of demand, using the midpoint formula, would be calculated as:
%3.25.9
22
2/)20.200.2()00.220.2(
2/)810()810(
percent
percent
Computing the Price Elasticity of Demand
$5
4 Demand
Quantity1000
Price
50
Example 3
What is the price elasticity from point A to B?
AB
Ranges of Elasticity
Perfectly InelasticQuantity demanded does not respond to price
changes. Perfectly ElasticQuantity demanded changes infinitely with any
change in price. Unit ElasticQuantity demanded changes by the same
percentage as the price.
Perfectly Inelastic Demand- Elasticity equals 0
Quantity
Price
4
$5
Demand
1002. ...leaves the quantity demanded unchanged.
1. Anincreasein price...
Perfectly Elastic Demand- Elasticity equals infinity
Quantity
Price
Demand$4
1. At any priceabove $4, quantitydemanded is zero.
2. At exactly $4,consumers willbuy any quantity.
3. At a price below $4,quantity demanded is infinite.
Inelastic Demand- Elasticity is less than 1
Quantity
Price
4
$51. A 25%increasein price...
Demand
100902. ...leads to a 10% decrease in quantity.
Unit Elastic Demand- Elasticity equals 1
Quantity
Price
4
$51. A 25%increasein price...
Demand
100802. ...leads to a 25% decrease in quantity.
Elastic Demand- Elasticity is greater than 1
Quantity
Price
4
$51. A 25%increasein price...
Demand
100502. ...leads to a 50% decrease in quantity.
Let’s figure this out (absolute value)
Let’s figure this out (absolute value)
Elasticity and Total Revenue
Total revenue is the amount paid by buyers and received by sellers of a good.
Computed as the price of the good times the quantity sold.
TR = P x Q
$4
Demand
Quantity
P
0
Price
P x Q = $400 (total revenue)
100Q
Elasticity and Total Revenue
Elasticity and Total RevenueWith an inelastic demand curve, an
increase in price leads to a decrease in quantity that is proportionately smaller.
Thus, total revenue increases.
Inelastic Demand sees more TR with an increase in price; Elastic Demand
lessens TR when prices increases
Elasticity and Total Revenue: Inelastic Demand
$3
Quantity0
Price
80
Revenue = $240 Demand$1 Demand
Quantity0
Revenue = $100
100
PriceAn increase in price from $1
to $3...
…leads to an increase in total revenue from$100 to $240
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