Unit 4.1 : price elasticity of demand
Elasticity
 measures how responsive Qd or Qs is to changes in P + other determinants
 if P changes, will Qd change by little or by a lot ?

this knowledge is useful to ﬁrms + policymakers whose decisions may affect price + therefore
affect Qd
 ﬁrms wants to maximize proﬁts
 other things being equal, it will want to maximize total revenue
 knowing price elasticity of demand tells ﬁrm whether it should raise or lower its price
Total revenue
 TR : price times the quantity traded
 TR = PQ Price elasticity of Demand
 measure of how much quantity demanded of good responds to change in price of that good
 price elasticity of demand is computed as percentage change in quantity demanded divided
by percentage change in price
 price elasticity = Ep
 number calculated is coefﬁcient elasticity
 size of coefﬁcient, Ep, tell us how elastic the good is — how responsive demand is to change
in price
 larger the coefﬁcient, the more responsive is demand to change in price of good
 elasticity will vary because how people respond to price changes will vary so we can deﬁne
different types of elasticity
Types of price elasticity of demand
Inelastic demand
 change in P leads to proportionately smaller change in Qd
 demand is not very responsive to price change
 percentage change in P > percentage change in Qd
 Ep < 1
 demand curve will be fairly steep

example : dentist visits Perfectly inelastic demand
 change in P does not change Qd whatsoever
 demand is not responsive to price change
 percentage change in P = zero change in Qd
 Ep = 0
 demand curve will be perfectly vertical
 example : heart medicine
Elastic demand
 change in P leads to proportionately larger change in Qd
 demand is very responsive to price change
 % change in Qd > % change in P
 Ep > 1
 demand curve will be fairly ﬂat
 example : manufactures Perfectly elastic demand
 change in P leads to inﬁnitely great change in Qd
 demand is extremely responsive to price change
 % change in Qd approaches inﬁnity
 Ep = inﬁnity

demand curve will be horizontal
 example : no real world example — or inﬁnite number of substitutes
Unit elastic
 change in P leads to a proportionately equal change in Qd
 % change in P = % change in Qd )
 Ep = 1
 demand curve will be non linear
 will be rectangular hyperbola

non linear so that no matter where on the curve, TR will always be same, max value
 example — wine in US Unit 4.2 : price elasticity of demand analysis
Calculating elasticity
 if given % changes in price + corresponding changes in Qd, use formula :
 when given 2 prices + their corresponding Qd values, we have to calculate % changes in P
and Qd

% change in Qd = (Qd — 2d ) 1
Qd 1
 % change in P = ( P 2P ) 1
P 1 point elasticity
 measures impact of marginal change in price on Qd
 formula for point elasticity is :
Ep = dQ x P
dP Q
 dQ/ dP is slope of linear demand curve when demand is in form of Q = f (P)
 in all 3 examples, elasticity coefﬁcient has negative sign
 law of demand — as P increases and Qd decreases , coefﬁcient will always be negative
number
 when calculating price elasticity, we drop negative sign ( use absolute value)
Some generalities about demand elasticity + their determinants
1) Goods that are necessities tend to have inelastic demand
 examples
 demand for insulin is perfectly inelastic
 demand for textbooks is inelastic — if price went up, you would still buy book to pass
course
2) goods that are luxuries tend to have elastic demand

example
 demand for plasma TV
 vacations abroad 3) goods that have close substitutes tend to have elastic demand
 example
 coke + pepsi
 eggs don't have close substitute, thus inelastic
4) goods tend to have more elastic demand over longer time horizons
 you can ﬁnd substitutes in long run where you cant in short run
5) how you deﬁne market makes different
 examples
 food — inelastic
 vegetables — more elastic
 broccoli — even more elastic
 the more narrowly deﬁned the market, the more elastic demand for that good
6) how much of your budget you spend on good determines elasticity
 if you spend large proportion of budget on good, demand for good will tend to be elastic
 if you only spend small proportion of budget, demand will tend to be inelastic
Some info
 elasticity is not constant along linear demand curve
 elasticity is not same as slope
 slope measures rates of change
 elasticity measures percentage changes
 can illustrate different elasticities along demand curve :  why does elasticity change along curve the way it does?
 our point elasticity formula for demand curve speciﬁed as Q = f (p)
Ep = dQ x P
dP Q
 slope dQ / dP is constant for linear demand curve
 but P + Q are different combo at different points on demand curve, so elasticity changes
along demand curve
 since dQ / dP is slope of demand curve thats why we can see elasticity by steepness (slope)
of curve
Price elasticity + total revenue
Inelastic
 with inelastic demand curve, an increase in price leads t
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