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**preview**shows page 1. to view the full**5 pages of the document.**ECON 101 Lec 7 – Price Elasticity of Demand

Price Elasticity of Demand

- To measure responsiveness we need a measure that is independent of units of

measurement.

- Elasticity is such a measure.

- price elasticity of demand - a units-free measure of the responsiveness of the

quantity demanded of a good to a change in its price when all other influences on

buying plans remain the same

Calculating price elasticity of demand

Formula:

To calculate the price elasticity of demand:

- We express the change in price as a percentage of the average price—the average

of the initial and new price, …

- and we express the change in the quantity demanded as a percentage of the

average quantity demanded—the average of the initial and new quantity.

Figure calculates the price elasticity of demand for pizza.

- Initially, the price of a pizza is $20.50 and the

quantity demanded is 9 pizzas an hour.

- The price of a pizza falls to $19.50 and the quantity

demanded increases to 11 pizzas an hour.

- The price falls by $1 and the quantity demanded

increases by 2 pizzas an hour.

- The average price is $20 and the

average quantity demanded is 10 pizzas

an hour.

- The percentage change in quantity

demanded, %ΔQ, is calculated as …

ΔQ/Qave × 100, which is

(2/10) × 100 = 20%.

- The percentage change in price, %ΔP, is

calculated as ΔP/Pave × 100, which is

($1/$20) × 100 = 5%.

- The price elasticity of demand is

%ΔQ/%ΔP = 20%/5%

= 4

Average Price and Quantity

- By using the average price and average quantity, we get the same elasticity value

regardless of whether the price rises or falls.

Percentage change in the quantity demanded

Percentage change in the price

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o Percentages and Proportions

- The ratio of two proportionate changes is the same as the ratio of two percentage

changes.

- %ΔQ/%ΔP = ΔQ/ΔP

A Units-Free Measure

- Elasticity is a ratio of percentages, so a change in the units of measurement of price

or quantity leaves the elasticity value the same.

Minus Sign and Elasticity

- The formula yields a negative value, because price and quantity move in opposite

directions.

- But it is the magnitude, or absolute value, that reveals how responsive the quantity

change has been to a price change.

Inelastic and Elastic Demand

- Demand can be inelastic, unit elastic, or elastic, and can range from zero to infinity.

- If the quantity demanded doesn’t change when the price changes, the price

elasticity of demand is zero and the good has a perfectly inelastic demand.

1) Figure (a) illustrates the case of a good that has a perfectly inelastic demand.

- The demand curve is vertical.

2) Figure (b) illustrates this case—a demand curve with ever declining slope.

- If the percentage change in the quantity demanded equals the percentage change

in price, the price elasticity of demand equals 1 and the good has unit elastic

demand.

· Note:

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