Elasticity

1. A definition & determinants of elasticity

• Price elasticity
2. Elasticity & consumer expenditure

3. Measurement of elasticity
• Arc method
• Point method
4. Other measures of elasticity
 1. Definitions and determinants

 If price rises, demand will fall

• By how much?
• Responsiveness of demand – elasticity
 Definitions

 ‘the responsiveness of demand and

supply to changes in price’

Price elasticity of demand (P∈d):
• ‘The responsiveness of quantity demanded
to a change in price’
 Market supply and demand
S1
Price

a
P1

D
O Q2 Q1
fig
Quantity
 Market supply and demand
S2
S1

b
P2
Price

a
P1

D
O Q2 Q1
Quantity
 Market supply and demand
S2
S1

b
P2
Price

c
P3
a
P1
D'

D
O Q3 Q2 Q1
fig
Quantity
 Determinants of P∈d
 Why does the price elasticity vary?
• 1. number and closeness of substitute goods
 The larger the number of substitute goods (that satisfy the
same need), the greater (P∈d) will be

E.g. holidays v. electricity
• 2. the proportion of income spent on the good

If this is high, a price rise will force a substantial reduction in
demand
• 3. Time

Time to adjust spending patterns

Short run – inelastic
 Long run - elastic
 2. Elasticity and consumer expenditure
 Total expenditure (TE)

=PxQ

= Total Revenue (TR)

See figure
 4 Total expenditure

P(£)

1 Consumers’ total expenditure

=
firms’ total revenue
0 = D
0 1£2 x 3m2= £6m 3 4 5

Q (millions of units per period of time)

 Elasticity & consumer expenditure

 What happens to TE (and TR) as price

changes?

 A) elastic demand

• P↑, Q↓ proportionately more (TE↓)

• P ↓, Q ↑ proportionately more (TE ↑)

 Elastic demand between two points

P(£)

a
4
D

0 20
Q (millions of units per period of time)
 Elastic demand between two points
Expenditure falls
as price rises

P(£)
b
5
a
4
D

0 10 20
Q (millions of units per period of time)
Elasticity & consumer expenditure
 B) inelastic demand

• P↑, Q↓ proportionately less (TE ↑)

• P ↓, Q ↑ proportionately less (TE ↓)

 Inelastic demand between two points

P(£)

a
4

0 20
Q (millions of units per period of time)
 Inelastic demand between two points
Expenditure rises
as price rises
c
8

P(£)

a
4

0 15 20
Q (millions of units per period of time)
P Totally inelastic demand (P∈D = 0)
D

P2 b

P1 a

O Q1 Q
P Infinitely elastic demand (P∈D = ∞)

a b
P1 D

O Q1 Q2
Q
P Unit elastic demand (P∈D = -1)

a
20

b
8
D

O 40 100 Q
 3. Measurement of elasticity
 Elasticity varies along the demand ( & supply)
curve
 Price-elastic (>1)

price-inelastic(0-1)

unitary (=1)
 (1) arc method (between two points on D)
 price elasticity of demand: ∆ Q/Q ÷ ∆ P/P
 using the average or 'mid-point' method
∀ ∆ Q/average Q ÷ ∆ P/average P
 Measuring elasticity using the arc method
10
∆Q ∆P
Pε d = ÷ mid P
mid Q
m
8

n
6

P (£)

2 Demand

0
0 10 20 30 40 50
Q (000s)
 Measuring elasticity using the arc method
10
∆Q ∆P
Pε d = ÷ mid P
mid Q
m
8 10 −2
=
15
÷ 7
= 10/15 x −7/2
n
6 = −70/30
= −7/3 = −2.33
P (£)

2 Demand

0
0 10 20 30 40 50
Q (000s)
 Measurement of elasticity

 (2) The Point Method

• Price elasticity of demand
 dQ / dP x P / Q

• ‘d’ – infinitesimally small change (see calculus)

• dQ / dP – rate of change of quantity demanded

with respect to price
 Measuring elasticity at a point
50
Pε d = (1 / slope) x P/Q

r
30
P

0 40 100
Q
 Measuring elasticity at a point
50
Pε d = (1 / slope) x
P/Q

= dQ/dP i.e. invert

dP/dQ (-50/100)
r = −100/50 =-2
30
= −2 (30/40)
P
= -2 (0.75)
= −1.5

0 40 100
Q
 4. Other measures of elasticity
 Income elasticity of demand
 ‘…the responsiveness of demand to a change in
consumer income, Y.’
• Luxuries (>1), necessities (0-1),inferior goods(<0)

 Cross-price elasticity of demand

 ‘…responsiveness of demand for one product to a
change in the price of another product.’
 Substitutes or complements
 Price elasticity of supply

Definition & determinants?