CHAPTER

Elasticity

The Responsiveness of the

Quantity Demanded to Price
When price rises, quantity demanded
decreases.
The question is how much quantity
will decrease in response to a given
price increase.
We want a measure that is units free
and can be compared across
different commodities.

The Responsiveness of
Quantity Demanded to Price
The measure we will study that
meets the criteria we want is
the price elasticity of
demand.

Price Elasticity of Demand

Price elasticity of demand is a
measure of the responsiveness of
the quantity demanded of a good to a
change in its price (ceteris paribus).
Elastic Demand - means demand is
sensitive to price
Inelastic Demand - means demand is
insensitive to price

Elasticity: A Units-Free
Measure
Price elasticity of
=
demand

Percentage change
in quantity demanded
Percentage change in price

Calculating Elasticity
Negative sign is ignored for
convenience.
The changes in price and quantity
are expressed as percentages of the
average price and average quantity
between the two prices and
quantities being compared.
Avoids having two values for the price
elasticity of demand

Q
%

Calculating Elasticity
Price elasticity of demand =

Percentage change in quantity demanded

Percentage change in price

Q
/
Q
a
v
e

%
P/P
ave

Calculating Elasticity
Price elasticity of demand =

Percentage change in quantity demanded

Percentage change in price

Q
/
Q
a
v
e

%
P/P
ave

Calculating Elasticity
Price elasticity of demand =

Percentage change in quantity demanded

Percentage change in price

(Q2 - Q1)/Qave
(P2 - P1)/Pave

Calculating the Elasticity of

Demand - Example
P1 = 410
P2 = 390
Q1 = 36
Q2 = 44

Price (dollars per chip)

Calculating the
Elasticity of Demand
Original
point (P1, Q1)

410

400

390

Da
36

40
44
Quantity (millions of chips per year)

Price (dollars per chip)

Calculating the
Elasticity of Demand
Original
point (P1, Q1)

410

400
New
point (P2, Q2)
390

Da
36

40
44
Quantity (millions of chips per year)

Price (dollars per chip)

Calculating the
Elasticity of Demand
Original
point (P1, Q1)

410
P`=$20

400
New
point (P2, Q2)
390

Da
36

Q = 8

40
44
Quantity (millions of chips per year)

Price (dollars per chip)

Calculating the
Elasticity of Demand
Original
point (P1, Q1)

410

400

P= $20

Pave =
$400

New
point (P2, Q2)

390

Da
36

Q = 8

40
44
Quantity (millions of chips per year)

Price (dollars per chip)

Calculating the
Elasticity of Demand
Original
point (P1, Q1)

410

400

P= $20

Pave =
$400
Qave = 40

390

New
point (P1, Q1)
Da

36

Q = 8

40
44
Quantity (millions of chips per year)

Q
/
Q
a
v
e

%
P
/P
ave

P
/20/4400
8

Calculating Elasticity
Price elasticity of demand =

Percentage change in quantity demanded

Percentage change in price

(Q2 - Q1)/Qave
(P2 - P1)/Pave

Q
/
Q
a
v
e

%
P
/P
ave

P
/20/4400
8

Calculating Elasticity
Price elasticity of demand =

Percentage change in quantity demanded

Percentage change in price

(Q2 - Q1)/Qave
(P2 - P1)/Pave

= 4

Elasticity Using Different Bases

Use P1 and Q1 as base
E = ((44 36)/36)/((390 410)/410)
= (8/36)/(-20/410) = .222/.0488 = 4.55

Use P2 and Q2 as base

E = ((44 36)/44)/((390 410)/390)
= (8/44)/(-20/390) = .182/.051 = 3.57

Note that average of these two elasticities

is about 4, which is the elasticity obtained
using the average Ps and Qs
P1 = 410, Q1 = 36; P2 = 390, Q2 = 44

Inelastic and Elastic

Demand
Five demand curves that cover the
entire range of possible elasticities
of demand:

Perfectly inelastic (Elasticity=0)

Inelastic (0<Elasticity<1)
Unit elastic (Elasticity=1)
Elastic (1<Elasticity<
)
Perfectly elastic (Elasticity=
)

Price

Inelastic and Elastic

Demand
D
1

Elasticity = 0

12

Perfectly Inelastic
6

Quantity

Inelastic and Elastic

Demand
Perfectly inelastic demand
Implies that quantity demanded remains
constant when price changes occur.
Price elasticity of demand = 0

Price

Inelastic and Elastic

Demand
D
2

0<Elasticity<1

12

Inelastic
6

Quantity

Inelastic and Elastic

Demand
Inelastic demand
Implies the percentage change in quantity
demanded is less than the percentage change in
price.
Price elasticity of demand > 0 and < 1

Price

Inelastic and Elastic

Demand
D
3

Elasticity = 1

12

Unit Elasticity
6

Quantity

Inelastic and Elastic

Demand
Unit elastic demand
Implies that the percentage change in quantity
demanded equals the percentage change in
price.
Price elasticity of demand = 1

Price

Inelastic and Elastic

Demand
12

1<Elasticity<
D4

Elastic
6

Quantity

Inelastic and Elastic

Demand
Elastic demand

Implies the percentage change in quantity

demanded is greater than the percentage
change in price.
Price elasticity of demand > 1 and <

Price
12

Inelastic and Elastic

Demand
Elasticity =

D5

Perfectly Elastic

Quantity

Inelastic and Elastic

Demand

Perfectly elastic demand

Implies that if price changes by any percentage

quantity demanded will fall to 0.
Price elasticity of demand =

Examples of Elasticity
Calculation
(1)
Q1 = 10, P1 = 50, Q2 = 8, P2 = 60
Elasticity = ((8-10)/9)/(60-50)/55)
= (-2/9)/(10/55)=-1.22
Therefore demand over this range is
elastic

Examples of Elasticity
Calculation
(2)
Q1 = 30, P1 = 20, Q2 = 28, P2 = 26
Elasticity = ((28-30)/29)/(26-20)/23) =
(-2/29)/(6/23)=-.264
Therefore demand over this range is
inelastic

Examples of Elasticity
Calculation
(3)
Q1 = 55, P1 = 9, Q2 = 45, P2 = 11
Elasticity = ((45-55)/50)/(11-9)/10)
= (-10/50)/(2/10)=-1.00
Therefore demand over this range is
unitary elastic

The Factors that Influence

the Elasticity of Demand
The closer the substitutes for a
good, the more elastic is demand.
The higher the proportion of income
spent on a good, the more elastic is
demand.
The greater the time elapsed since a
price change, the more elastic is
demand.

Total Revenue Test

The total revenue test is a method of
estimating the price elasticity of
demand by observing the change in
total revenue that results from a
price change (all other things
remaining the same).

Unitary Elastic Demand

and Total Revenue
If demand is unitary elastic, an
increase in price results in an equal
percentage decrease in the quantity
demanded and total revenue remains
constant.

Elastic Demand and

Total Revenue
If demand is elastic, an increase in
price results in a larger percentage
decrease in the quantity demanded
and total revenue decreases.

Inelastic Demand and

Total Revenue
If demand is inelastic, an increase in
price results in a smaller percentage
decrease in the quantity demanded
and total revenue increases.

Example
of Total Revenue Test
Elasticity Calculation (1)
Q1 = 10, P1 = 50, Q2 = 8, P2 = 60
Elasticity = ((8-10)/9)/(60-50)/55)
= (-2/9)/(10/55)=-1.22 (elastic)
TR1 = P1xQ1 = 50x10 = 500
TR2 = P2xQ2 = 60x8 = 480
TR falls as P increases
Therefore demand is elastic

Example
of Total Revenue Test
Elasticity Calculation (2)
Q1 = 30, P1 = 20, Q2 = 28, P2 = 26
Elasticity = ((28-30)/29)/(26-20)/23)
= (-2/29)/(6/23)=-.264 (inelastic)
TR1 = P1xQ1 = 20x30 = 600
TR2 = P2xQ2 = 26x28 = 728
TR rises as P increases
Therefore demand is inelastic

Example
of Total Revenue Test
Elasticity Calculation (3)
Q1 = 55, P1 = 9, Q2 = 45, P2 = 11
Elasticity = ((45-55)/50)/(11-9)/10)
= (-10/50)/(2/10)=-1.00 (unitary elastic)
TR1 = P1xQ1 = 9x55 = 495
TR2 = P2xQ2 = 11x45 = 495
TR doesnt change as P increases
Therefore demand is unitary elastic

Elasticity Along a StraightLine Demand Curve

Elasticity is not the same as slope,
but the two are related.
As the price increases, demand
becomes more elastic.
Elasticity will equal 1.0 at the
midpoint of any linear demand curve.

Other Commonly Used

Elasticities
Income Elasticity of Demand
Cross Price Elasticity of Demand
Price Elasticity of Supply