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Thursday, October 1st, 2009.
Elasticity of Demand
Insight: If the choice is between A or B, you need information about A and B.
If you have decided on A, information about B (only) is required to identify the
opportunity cost of A if B is the next best alternative to A.
Total Revenue ± Price x Quantity
1) If Toronto Transit commission wished to increase Total Revenue, should it
increase price (fare)?
2) You own one of the 5 toll bridges across a river, each of which sets the price (toll)
If you wish to increase Total Revenue, should you increase price (toll)?
Fare increase: (1) For those who continue to ride the TTC, fares will be higher,
(2) There will be fewer riders (per the law of downward-sloping
Result: Law of downward-sloping demand is not sufficient to answer question.
(Price) Elasticity of Demand
Definition: Percent change in quantity demanded /
Percent change in price
¨3 (Ignore minus sign)
Measures responsiveness of quantity demanded to a change in price.
¨4 = ¨4
Q (Q = Average quantity)
P (P = average price)
Situation Price Quantity Demanded
A 0.90 1100
B 1.10 900
¨4XDQWLW\'HPDQGHG = 200 x 100
(1100 + 900)/2
= 200 x 100
¨3ULFH = 0.2 x 100
(0.9 + 1.10)/2
= 0.20 x 100
ELASTICITY = 20% = 1.0
Insight: same result if go up demand curve from A to B or down demand curve
from B to A!
perfectly inelastic: elasticity = 0
inelastic: 0 < elasticity < 1
unit elastic: elasticity = 1
elastic: 1 < elasticity <
#1 % ¨3
¨4D = 20 elasticity = 20 / 10 = 2
Æ Quantity demanded is very responsive to a change in price
#2 % ¨3
¨4D = 2 elasticity = 2 / 10 = 0.2
Æ Quantity demanded is not very responsive to a change in price