Chapter 4:

Demand Elasticity

Demand Elasticity

The Economic Concept of Elasticity

The Price Elasticity of Demand
The Cross-Elasticity of Demand
Income Elasticity
Other Elasticity Measures
Elasticity of Supply

Learning Objectives
Define and measure elasticity
Apply concepts of price elasticity,
cross-elasticity, and income elasticity
Understand determinants of
elasticity
Show how elasticity affects revenue

The Economic Concept of

Elasticity
Elasticity: the percentage change in
one variable relative to a percentage
change in another.

percent change in A
Coefficien t of Elasticity
percent change in B

The Price Elasticity of

Demand
Price elasticity of demand: The
percentage change in quantity
demanded caused by a 1 percent
change in price.

% Quantity
Ep
% Price
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The Price Elasticity of

Demand
Arc elasticity: Elasticity which is
measured over a discrete interval of
a demand (or a supply) curve.
Q2 Q1
P2 P1
Ep

(Q1 Q2 ) / 2 ( P1 P2 ) / 2

Ep = Coefficient of arc price elasticity

Q1 = Original quantity demanded

Q2 = New quantity demanded

P1 = Original price

P2 = New price
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The Price Elasticity of

Demand
Point elasticity: Elasticity
measured at a given point of a
demand (or a supply) curve.

dQ P1
P =
x
dP Q1
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The Price Elasticity of

Demand
The point elasticity of a linear
demand function can be expressed
as:

Q P1
p

P Q1

The Price Elasticity of

Demand
Some demand curves have constant
elasticity over the relevant range
Such a curve would look like:
Q = aP-b

where b is the elasticity coefficient

This equation can be converted to
linear by expressing it in logarithms:
log Q = log a b(log P)

The Price Elasticity of Demand

Elasticity differs
along a linear
demand curve.

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The Price Elasticity of

Demand
Categories of Elasticity
Relative elasticity of demand: EP > 1
Relative inelasticity of demand: 0 < EP <
1
Unitary elasticity of demand: EP = 1
Perfect elasticity: EP =
Perfect inelasticity: EP = 0

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The Price Elasticity of

Demand
Factors affecting demand elasticity
Ease of substitution
Proportion of total expenditures
Durability of product
Possibility of postponing purchase
Possibility of repair
Used product market

Length of time period

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The Price Elasticity of

Demand
Derived demand: The demand for
products or factors that are not
directly consumed, but go into the
production of a final product.
The demand for such a product or
factor exists because there is
demand for the final product.

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The Price Elasticity of

Demand
The derived demand curve will be
more inelastic:
the more essential is the component in
question.
the more inelastic is the demand curve
for the final product.
the smaller is the fraction of total cost
going to this component.
the more inelastic is the supply curve of
cooperating factors.
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The Price Elasticity of Demand

A long-run demand
curve will generally
be more elastic
than a short-run
curve.
As the time period
lengthens
consumers find
way to adjust to
the price change,
via substitution or
shifting
consumption

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The Price Elasticity of

Demand
There is a relationship between the
price elasticity of demand and
revenue received.
Because a demand curve is downward
sloping, a decrease in price will increase
the quantity demanded
If elasticity is greater than 1, the
quantity effect is stronger than the price
effect, and total revenue will increase
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The Price Elasticity of Demand

As price
decreases
Revenue rises
when demand is
elastic.
Revenue falls
when it is
inelastic.
Revenue reaches
it peak when
elasticity of

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The Price Elasticity of

Demand
Marginal Revenue: The change in
total revenue resulting from
changing quantity by one unit.

Total Revenue
MR
Quantity

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The Price Elasticity of Demand

For a straightline demand
curve the
marginal
revenue curve is
twice as steep
as the demand.

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The Price Elasticity of Demand

At the point
where marginal
revenue crosses
the X-axis, the
demand curve is
unitary elastic
and total
revenue reaches
a maximum.
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The Price Elasticity of

Demand
Some sample elasticities
Coffee: short run -0.2, long run -0.33
Kitchen and household appliances:
-0.63
Meals at restaurants: -2.27
Airline travel in U.S.: -1.98
Beer: -0.84, Wine: -0.55

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The Cross-Elasticity of
Demand
Cross-elasticity of demand: The
percentage change in quantity
consumed of one product as a result
of a 1 percent change in the price of
a related product.

%QA
EX
%PB

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The Cross-Elasticity of
Demand
Arc Elasticity

Q2 A Q1 A
P2 B P1B
Ex

(Q1 A Q2 A ) / 2 ( P1B P2 B ) / 2

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The Cross-Elasticity of
Demand
Point Elasticity

QA PB
EX

QA
PB

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The Cross-Elasticity of
Demand
The sign of cross-elasticity for
substitutes is positive.
The sign of cross-elasticity for
complements is negative.
Two products are considered good
substitutes or complements when
the coefficient is larger than 0.5.

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Income Elasticity
Income Elasticity of Demand: The
percentage change in quantity
demanded caused by a 1 percent
change in income.
Y is shorthand for Income

%Q
EY
%Y
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Income Elasticity
Arc Elasticity
Q2 Q1
Y2 Y1
EY

(Q1 Q2 ) / 2 (Y1 Y2 ) / 2

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Income Elasticity
Categories of
income elasticity
Superior goods: EY
>1
Normal goods: 0
>EY >1
Inferior goods
demand decreases
as income
increases: EY < 0

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Other Elasticity Measures

Elasticity is encountered every time
a change in some variable affects
quantities.
Advertising expenditure
Interest rates
Population size

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Elasticity of Supply
Price Elasticity of Supply: The
percentage change in quantity
supplied as a result of a 1 percent
change in price.
% Quantity Supplied
ES
% Price
If the supply curve slopes upward
and to the right, the coefficient of
supply elasticity is a positive
number.
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Elasticity of Supply
Arc elasticity
Q2 Q1
P2 P1
Es

(Q1 Q2 ) / 2 ( P1 P2 ) / 2

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Elasticity of Supply
When the supply curve is more
elastic, the effect of a change in
demand will be greater on quantity
than on the price of the product.
With a supply curve of low elasticity,
a change in demand will have a
greater effect on price than on
quantity.
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Copyright
Keat and Young 2005

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