Explanation of Price Elasticity of Demand

1. The Elasticity of Demand
Chapter 7

2. The Concept of Elasticity
• Elasticity is a measure of the
responsiveness of one variable to another.
• The greater the elasticity, the greater the
responsiveness.

3. Laugher Curve
Q. What’s the difference between an
economist and a befuddled old man with
Alzheimer’s?
A. The economist is the one with a
calculator.

4. The Concept of Elasticity
• Elasticity is a measure of the
responsiveness of one variable to another.
• The greater the elasticity, the greater the
responsiveness.

5. Price Elasticity
• The price elasticity of demand is the
percentage change in quantity demanded
divided by the percentage change in price.

6. Sign of Price Elasticity
• According to the law of demand, whenever
the price rises, the quantity demanded
falls. Thus the price elasticity of
demand is always negative.
• Because it is always negative, economists
usually state the value without the sign.

7. What Information Price
Elasticity Provides
• Price elasticity of demand and supply
gives the exact quantity response to a
change in price.

8. Classifying Demand and Supply
as Elastic or Inelastic
• Demand is elastic if the percentage
change in quantity is greater than the
percentage change in price.
E > 1

9. Classifying Demand and Supply
as Elastic or Inelastic
• Demand is inelastic if the percentage
change in quantity is less than the
percentage change in price.
E < 1

10. Elastic Demand
• Elastic Demand means that quantity
changes by a greater percentage than the
percentage change in price.

11. Inelastic Demand
• Inelastic Demand means that quantity
doesn't change much with a change in
price.

12. Defining elasticities
• When price elasticity is between zero
and -1 we say demand is inelastic.
• When price elasticity is between -1 and
- infinity, we say demand is elastic.
• When price elasticity is -1, we say demand
is unit elastic.

13. Elasticity Is Independent of
Units
• Percentages allow us to have a measure
of responsiveness that is independent of
units.
• This makes comparisons of
responsiveness of different goods easier.

14. Calculating Elasticities
• To determine elasticity divide the
percentage change in quantity by the
percentage change in price.

15. The End-Point Problem
• The end-point problem – the percentage
change differs depending on whether you
view the change as a rise or a decline in
price.

16. The End-Point Problem
• Economists use the average of the end
points to calculate the percentage change.

17. Graphs of Elasticities
Price
Quantity of software (in hundred thousands)
$26
24
22
20
18
16
14
0
D
B
A
10 12 14
C (midpoint)
Elasticity of demand
between A and B = 1.27

18. Calculating Elasticities: Price
elasticity of Demand
D
P
Q
What is the price elasticity of
demand between A and B?
$20
10
$26
14
MidpointB
A
ED =
%ΔQ
%ΔP
Q2–Q1
½(Q2+Q1)
P2–P1
½(P2+P1)
=
C
12
$23
=
10–14
½(10+14)
26–20
½(26+20)
-.33
.26
= 1.27=
7-18

19. Price Elasticity: Supply
• Price elasticity of supply is the
percentage change in quantity supplied
divided by the percentage change in
• This tells us exactly how quantity supplied responds to
a change in price
ES =
• Elasticity is independent of units
% change in Quantity Supplied
% change in Price
7-19

20. Price Elasticity: Supply
• Supply is elastic if the percentage
change in quantity is greater than the
percentage change in priceElastic supply is when ES > 1
• Supply is inelastic if the percentage change in quantity
is less than the percentage change in price
Inelastic supply is when ES < 1
7-20

21. Calculating Elasticities: Price
elasticity of Supply
P
Q
What is the price elasticity of
supply between A and B?
$4.50
476
$5.00
485
B
A
ES =
%ΔQ
%ΔP
Q2–Q1
½(Q2+Q1)
P2–P1
½(P2+P1)
=
=
485–476
½(485+476)
5–4.50
½(5+4.50)
Midpoint
C
480.5
$4.75
0.0187
0.105
= 0.18=
S
7-21

22. Graphs of Elasticities
Elasticity of supply
between A and B = 0.18
Wageperhour
Quantity of workers
$6.00
5.50
5.00
4.50
4.00
3.50
3.00
0
C
B
A
470
(midpoint)
480 490

23. Calculating Elasticity
)PP(
PP
)QQ(
QQ
P%
Q%
E
212
1
12
212
1
12
+
−
+
−
=
∆
∆
=

24. Calculating Elasticity of Demand
Between Two Points
27.1
26.
33.
23
6
12
4
)2026(
2026
)1014(
1410
E
2
1
2
1
D =
−
=
−
=
+
−
+
−
=
Price
Quantity of software (in hundred thousands)
$26
24
22
20
18
16
14
0
Demand
B
A
10 12 14
Cmidpoint
Elasticity of demand
between A and B: P%
Q%
E
∆
∆
=

25. Calculating Elasticity of Supply
Between Two Points
P%
Q%
E
∆
∆
=
Wageperhour
Quantity of workers
$6.00
5.50
5.00
4.50
4.00
3.50
3.00
0
C
B
A
470 480 490
Elasticity of supply
between A and B:
2.
105.
021.
75.4
50.
480
10
)50.45(
50.45
)475485(
475485
E
2
1
2
1
S ===
+
−
+
−
=

26. Calculating Elasticity at a Point
• Let us now turn to a method of calculating
the elasticity at a specific point, rather than
over a range or an arc.

27. Calculating Elasticity at a Point
• To calculate elasticity at a point, determine
a range around that point and calculate
the arc elasticity.

28. Calculating Elasticity at a PointPrice
Quantity
$10
9
8
7
6
5
4
3
2
1
C
B
A
24 402820

29. Calculating Elasticity at a Point
Price
Quantity
$10
9
8
7
6
5
4
3
2
1
C
B
A
24 402820
To calculate elasticity at a point determine
a range around that point and calculate
the arc elasticity.
66.
5.
33.
4
2
24
8
)35(
35
)2028(
2028
E
2
1
2
1
Aat ===
+
−
+
−
=

30. Elasticity and Demand Curves
• Two important points to consider:
– Elasticity is related (but is not the same as)
slope.
– Elasticity changes along straight-line demand
and supply curves.

31. Calculating Elasticity at a Point
6 12 18 30 36 42 48
Price
Quantity
8
7
6
5
4
3
2
1
$10
9
A
24 6054
D
B
C
Supply
EA = 2.33
EB = 0.11
Demand
EC = 0.75
ED = 0.86

32. Elasticity and Demand Curves
• Two important points to consider:
– Elasticity is related (but is not the same as)
slope.
– Elasticity changes along straight-line demand
and supply curves.

33. Elasticity Is Not the Same as
Slope
• The steeper the curve at a given point, the
less elastic is supply or demand.
• There are two limiting examples of this.

34. Elasticity Is Not the Same as
Slope
• When the curves are flat, we call the
curves perfectly elastic.
• The quantity changes enormously in
response to a proportional change in price
(E = ∞).

35. Elasticity Is Not the Same as
Slope
• When the curves are vertical, we call the
curves perfectly inelastic.
• The quantity does not change at all in
response to an enormous proportional
change in price (E = 0).

36. Perfectly inelastic
demand curve
Price
0
Quantity
Perfectly Inelastic Demand
Curve

37. Perfectly elastic
demand curve
Perfectly Elastic Demand Curve
Price
0
Quantity

38. Demand Curve
Shapes and Elasticity
• Perfectly Elastic Demand Curve
– The demand curve is horizontal, any change in price can and
will cause consumers to change their consumption.
• Perfectly Inelastic Demand Curve
– The demand curve is vertical, the quantity demanded is totally
unresponsive to the price. Changes in price have no effect on
consumer demand.
• In between the two extreme shapes of demand curves
are the demand curves for most products.

39. Demand Curve
Shapes and Elasticity

40. Elasticity Changes Along
Straight-Line Curves
• Elasticity is not the same as slope.
• Elasticity changes along straight line
supply and demand curves–slope does
not.

41. Elasticity Along a Demand Curve
Price
$10
9
8
7
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 Quantity
Elasticity declines along
demand curve as we move
toward the quantity axis
Ed = 1
Ed = 0
Ed < 1
Ed > 1
Ed = ∞

42. The Price Elasticity of Demand Along a
Straight-line Demand Curve

43. Substitution and Elasticity
• As a general rule, the more substitutes a
good has, the more elastic is its supply
and demand.

44. Substitution and Demand
• The less a good is a necessity, the more
elastic its demand curve.
• Necessities tend to have fewer substitutes
than do luxuries.

45. Substitution and Demand
• Demand for goods that represent a large
proportion of one's budget are more
elastic than demand for goods that
represent a small proportion of one's
budget.

46. Substitution and Demand
• Goods that cost very little relative to your
total expenditures are not worth spending
a lot of time figuring out if there is a good
substitute.
• It is worth spending a lot of time looking
for substitutes for goods that take a large
portion of one’s income.

47. Substitution and Demand
• The larger the time interval considered, or
the longer the run, the more elastic is the
good’s demand curve.
– There are more substitutes in the long run
than in the short run.
– The long run provides more options for
change.

48. Determinants of the
Price Elasticity of Demand
• The degree to which the price elasticity of
demand is inelastic or elastic depends on:
– How many substitutes there are
– How well a substitute can replace the good or
service under consideration
– The importance of the product in the
consumer’s total budget
– The time period under consideration