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Chia-Hui Chen

Lecture 3

Elasticities of Demand

other variable, namely the percentage change in one variable resulting a

one percentage change in another variable. (The percentage change is

independent of units.)

Outline

1. Chap 2: Price Elasticity of Demand

3. Chap 2: Cross Price Elasticity of Demand

4. Chap 2: Comparison of Elasticity Over Short Run and Long Run

Price elasticity of demand. Price elasticity of demand measures the per

centage change in quantity demanded resulting from one percentage change

in price.

△Q

D %△QP Q

EE = = △P

.

%△P P

Example Calculation

Figure 1 shows a demand curve:

Q(P ) = 8 − 2P.

When the price changes from 2 to 1, the price elasticity of demand is:

ΔQ 2

Q

EPD |p=2→1 = ΔP

= 4

−1 = −1.

P 2

Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT

OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month

YYYY].

1 Price Elasticity of Demand 2

demand is:

ΔQ −2

D Q 1

EP |P =1→2 = ΔP = 61 = − .

P 1

3

The two quantities are diﬀerent. To solve this conﬂict, consider small changes

in P and Q, and deﬁne:

dQ

Q P dQ

EPD = dP = .

P

Q dP

Thus, at the point P = 2, the price elasticity of demand is:

P dQ 2

EPD |P =2 = = × (−2) = −1.

Q dP 4

1. Price elasticity of demand is usually a negative number.

2. |EP | > 1 indicates that the good is price elastic, perhaps because the good

has many substitutes; |EP | < 1 indicates that the good is price inelastic,

perhaps because the good has few substitutes.

3. Given a linear demand curve, EP is not a constant along the curve. For

example, for curve in Figure 1, EP = −∞ at top portion, but zero at

bottom portion.

4. Discuss two extreme situations: |EP | = 0, quantity independent of price

Figure 2 and |EP | = ∞, quantity very sensitive to price. See Figure 3.

Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT

OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month

YYYY].

2 Income Elasticity of Demand 3

ticity. |EP | = 0, quantity inde- ticity. |EP | = −∞, quantity very

pendent of price. sensitive to price.

Q = aP b ,

since

dQ P P aP b

EP = = abP b−1 = b = b.

dP Q Q Q

Refer to Figure 4.

6. How do total consumer expenditure change when the price of a good

changes?

dExp d(P QD (P )) dQ

= =Q+P = Q(1 + EP ) = Q(1 − |EP |).

dP dP dP

• If |EP | > 1, total expenditure decreases when price increases;

• If |EP | < 1, total expenditure increases when price increases.

Example (Cell phone). People need to do business in the morning, so EP is

low, so cell phone companies increase the rate while customers will expend

more; but EP is high in the evening since people do not have to talk, so

cell phone companies lower the rate to encourage customer expenditure.

Income elasticity of demand. Income elasticity of demand measures the per

centage change in quantity demanded resulting from one percentage change

in income. Similarly,

dQ

Q I dQ

EI = dI = .

I

Q dI

The income elasticity of demand is usually positive.

Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT

OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month

YYYY].

3 Cross Price Elasticity of Demand 4

Cross price elasticity of demand. Cross price elasticity of demand measures

the percentage change in quantity demanded of a good (x) resulting from

one percentage change in price of another good (y).

dQx

Qx Py dQx

EQxP y = dPy

= .

Qx dPy

Py

• If y is a complement of x, the cross price elasticity of demand is negative.

and Long Run

Is demand more elastic in the long run or short run?

Consumption goods. For consumption goods, the demand is more elastic in

the long run. Because people need goods for daily life and buy them

constantly, the short run demand is inelastic. Faced with high prices in

the long run, they may change habits or ﬁnd more substitutes.

Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT

OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month

YYYY].

4 Comparison Between Elasticity Over Short Run and Long Run 5

Durable goods. For durable goods, the demand is more elastic in the short

run. Consider cars. If price of of cars increase, in the short run people

might use their current cars longer. In the long run, though, people have

to replace their cars.

Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT

OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month

YYYY].

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