Microeconomics Elasticity By Shakeel Abbasi

Economics

The Price Elasticity of Demand

(Commonly known as just price elasticity) Measures the rate of response of quantity demanded due to a price change. The formula for the Price Elasticity of Demand (PEoD) is: PEoD = (% Change in Quantity Demanded) (% Change in Price)

If PEoD > 1 then Demand is Price Elastic (Demand is sensitive to price changes) If PEoD = 1 then Demand is Unit Elastic If PEoD < 1 then Demand is Price Inelastic (Demand is not sensitive to price changes)

A measure of the sensitivity of demand for goods or services to changes in price or other marketing variables, such as advertising

Applications of Price Elasticity of Demand

The price elasticity of demand can be applied to a variety of problems in which one wants to know the expected change in quantity demanded or revenue given a contemplated change in price. For example, a state automobile registration authority considers a price hike in personalized "vanity" license plates. The current annual price is 135 per year, and the registration office is considering increasing the price to 140 per year in an effort to increase revenue. Suppose that the registration office knows that the price elasticity of demand from 135 to 140 is 1.3. Because the elasticity is greater than one over the price range of interest, we know that an increase in price actually would decrease the revenue collected by the automobile registration authority, so the price hike would be unwise.

Factors Influencing the Price Elasticity of Demand

The price elasticity of demand for a particular demand curve is influenced by the following factors:

Availability of substitutes: the greater the number of substitute products, the greater the elasticity. By Shakeel Abbasi

Microeconomics Elasticity

Economics

Degree of necessity or luxury: luxury products tend to have greater elasticity than necessities. Some products that initially have a low degree of necessity are habit forming and can become "necessities" to some consumers. Proportion of income required by the item: products requiring a larger portion of the consumer's income tend to have greater elasticity. Time period considered: elasticity tends to be greater over the long run because consumers have more time to adjust their behavior to price changes. Permanent or temporary price change: a one-day sale will result in a different response than a permanent price decrease of the same magnitude. Price points: decreasing the price from 12.00 to 11.99 may result in greater increase in quantity demanded than decreasing it from 11.99 to 11.98.

Point Elasticity
It sometimes is useful to calculate the price elasticity of demand at a specific point on the demand curve instead of over a range of it. This measure of elasticity is called the point elasticity. Because point elasticity is for an infinitesimally small change in price and quantity, it is defined using differentials, as follows: dQQ

dPP

And can be written as: dQ P dP Q

The point elasticity can be approximated by calculating the arc elasticity for a very short arc, for example, a 0.01% change in price.

Arc Elasticity
The average elasticity for discrete changes in two variables. The distinguishing characteristic of arc elasticity is that percentage changes are calculated based on the average of initial and ending values of each variable, rather than initial values. Arc elasticity is generally calculated using the midpoint elasticity formula. The contrast to arc elasticity is point elasticity. For infinitesimally small changes in two variables, arc elasticity is the same as point elasticity. Arc elasticity is best considered the average elasticity over a range of values for a relation. Like any average, some values within the range are likely to be greater and

Microeconomics Elasticity

Economics

some less. However, it provides a quick approximation of elasticity when more precise and sophisticated calculation techniques are not possible.

Cross Elasticity
The cross elasticity of demand for substitute goods will always be positive, because the demand for one good will increase if the price for the other good increases. For example, if the price of coffee increases (but everything else stays the same), the quantity demanded for tea (a substitute beverage) will increase as consumers switch to an alternative. An economic concept that measures the responsiveness in the quantity demand of one good when a change in price takes place in another good. The measure is calculated by taking the percentage change in the quantity demanded of one good, divided by the percentage change in price of the substitute good:

Stages of elasticity
Unitary elasticity
Situation where a change in the market price of a good results in no change in the total amount spent for the good within the market. It means unitary elasticity is equal to one

U.E =1 High elasticity H.E=>1 Less elasticity

L.E=<1 It means change occur is less than 1 It mean when the change occurs is more than one

In elasticity
I.E =0

It means no change

Infinite elasticity

Microeconomics Elasticity

Economics

Unlimited demand at a restricted price: the economic situation that exists when there is almost unlimited demand for a product or service at one price, but no demand at a higher one. U.E= unlimited