DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS ECONOMICS 1

Dartmouth College, Department of Economics: Economics 1, Spring ‘03

Topic 5
Elasticity of Demand

Economics 1, Spring 2003

Katerina Simons

Elasticity of Demand
XPriceElasticity of Demand
XCross-Price Elasticity of Demand

XIncome Elasticity of Demand

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DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS ECONOMICS 1

Price Elasticity of Demand

⇒ Measures the responsiveness of demand to
changes in price.

% change in quantity demanded

price elasticity of demand =
% change in price

⇒ Its value is always negative, but stated in absolute terms.

⇒ The value of the line of the slope and the value of

elasticity are not the same.

Price Elasticity of Demand

X The price elasticity of demand measures the
responsiveness of demand for a good with
respect to changes in the price of that good.
X Definition: The price elasticity of demand is the
percentage change in the quantity demanded
that results from a 1 percent change in price.
∆
X Precisely, it is: η = q / q
∆p / p
∆q / q ∆q p dq p  dp  p
X or, rewritten: η = = ⋅ = ⋅ = 1/  ⋅
∆p / p ∆p q dp q  dq  q
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Price Elasticity of Demand, cont’d

 dp  p
X η = 1/  ⋅ says that:
 dq  q
– The price elasticity of demand at some point on the
demand curve is
» the inverse of the slope of the (inverse) demand curve,
» times the ratio of price to quantity at that point on the
demand curve.
X Implications: the price elasticity of demand is
– (probably) different at every point on the demand
curve;
– nonpositive.
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Elasticity Changes along a Straight-Line

Demand Curve
Price elasticity
of demand
decreases as we
move downward
along a linear
demand curve.
⇒ Demand is
elastic on the
upper part of
the demand
curve and
inelastic on the
lower part.

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DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS ECONOMICS 1

Elasticity Changes along a Straight-Line

Demand Curve

− 6.4 Along the inelastic

range, elasticity
values are less than
one.
− .29
⇒Along the elastic
range, elasticity
values are greater
than one.

Price Elasticity of Demand, cont’d

X We call demand (at some point) elastic, if the quantity
demanded is relatively responsive to changes in price.
– Definition: demand is elastic whenever η < -1.
X We call demand (at some point) inelastic, if the
quantity demanded is relatively unresponsive to
changes in price.
– Definition: demand is inelastic whenever -1 < η < 0.
X We call demand (at some point) unit elastic, if the
quantity demanded changes proportionately to
changes in price.
– Definition: demand is unit elastic whenever η = -1.

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DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS ECONOMICS 1

Price Elasticity of Demand

Price Elasticity of Demand, cont’d

X Two extreme cases:
X Perfectly elastic demand X Perfectly inelastic
(η = -∞) demand (η = 0)
Demand curve with slope Demand curve with slope
dp/dq = 0 dp/dq = ∞
price price
D

quantity quantity

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DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS ECONOMICS 1

Using Price Elasticity of Demand

X Example: Suppose you know that the price
elasticity of demand for pizza at Thayer is -2.
– That is, every 1% increase in price results in a 2%
reduction in the quantity demanded.
X Currently, 100 slices of pizza are sold, at
$1.75 each. So revenue from pizza is $175.

X If the price of pizza increased to $2.10, would

total revenue increase or decrease?

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Using Price Elasticity, cont’d

X An increase from $1.75 to $2.10 is an increase
of 20%.
– Since the elasticity is -2, we know that demand will
fall by 40%.
X Only 60 slices of pizza will be sold after the
price increase.
– 60 slices of pizza at $2.10 each create revenue of
$126, which is less than $175.
X Total revenue would decrease.

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DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS ECONOMICS 1

Buzz Group
X What effect does a 20% increase in price have
on total revenue from pizza if the price
elasticity of demand were -0.5?

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Determinants of Demand Elasticity

⇒ Availability of substitutes -- demand is
more elastic when there are more
substitutes for the product.

⇒ Importance of the item in the budget -- demand

is more elastic when the item is a more
significant portion of the consumer’s budget.

⇒Time frame -- demand becomes more elastic over time.

Examples: elastic or not?

Insulin, bananas, basic telephone service, beef

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DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS ECONOMICS 1

Price Elasticity of Supply

⇒ Elasticity of supply: A measure of the response
of quantity of a good supplied to a change in price
of that good. Likely to be positive in output
markets.

Elasticity of Demand and Supply Curves

Whether a demand
or supply shift has
a comparably
larger price than
quantity effect or
vice versa,
depends on
whether the non-
shifted curve is
elastic or inelastic.

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DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS ECONOMICS 1

Cross-Price Elasticity of Demand

X We have already seen that prices of other
goods may influence demand for a good.
– Example: If tea and coffee are substitutes, an
increase in the price of coffee will increase your
demand for tea.
X The cross-price elasticity of demand measures
the responsiveness of demand for a good with
respect to changes in the price of some other
good.

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Cross-Price Elasticity, cont’d

X Definition: The cross-price elasticity of demand
is the percentage change in the quantity
demanded of one good that results from a 1
percent change in price of some other good.
X Precisely, for two goods, x and y, it is:
∆q x / q x
ηxy =
∆p y / p y

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DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS ECONOMICS 1

Cross-Price Elasticity, cont’d

X We can now be specific about substitutes and
complements:
X Two goods, x and y, are substitutes if an
increase in price of good y increases demand
for good x.
– Definition: x and y are substitutes if ηxy > 0.
X Two goods, x and y, are complements if an
increase in price of good y decreases demand
for good x.
– Definition: x and y are complements if ηxy < 0.
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Cross-Price Elasticity, cont’d

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DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS ECONOMICS 1

Income Elasticity of Demand

X We have also seen that changes in
income/wealth may have an effect on the
quantity demanded of some good.
– Example: As your income/wealth rises, you can
afford to buy more of everything.
X The income elasticity of demand measures the
responsiveness of demand for a good with
respect to changes in a consumer’s
income/wealth.

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Income Elasticity, cont’d

X Definition: The income elasticity of demand is
the percentage change in the quantity
demanded of some good that results from a 1
percent change in a consumer’s
income/wealth.
X Precisely, it is:
∆q / q
ε=
∆m / m
(where m is income/wealth).

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DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS ECONOMICS 1

Income Elasticity, cont’d

X Income elasticity of demand is usually positive
(normal goods).
X But there are goods of which you want to buy
less as your income increases (inferior goods).

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Income Elasticity, cont’d

X We can now be specific about which goods
are necessities and which are luxuries:
X A good is a necessity if quantity demanded is
relatively unresponsive to changes in
income/wealth.
– Definition: a good is a necessity if 0 < ε < 1.
X A good is a luxury if quantity demanded is
relatively responsive to changes in
income/wealth.
– Definition: a good is a luxury if ε > 1.
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