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Chapter 5

Chapter 5 Elasticity and its Applications.docx

Course Code
ECON 1000

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Elasticity and its Applications
Elasticity: A measure of the responsiveness of quality demanded or quantity supplied to
one of its determinants.
Price Elasticity of Demand: A measure of how much the quantity demanded of a good
responds to a change in the price of that good. Calculated as the percentage change in
quantity demanded divided by the percentage change in price.
A good is said to be Elastic if the quantity demanded responds substantially to changes in
price. On the other hand a good is said to be Inelastic if the quantity demanded responds
only slightly.
General Rules
Close Substitutes
Goods with close substitutes tend to have a higher elasticity. Take for example butter and
margarine, as close substitutes a change in price of one will cause a steeper change in
quantity sold. Whereas eggs, with no close substitute will be more inelastic because even
with a change in price there is no alternative to substitute and quantity sold will have a
smaller change.
Necessities and Luxuries
Necessities tend to be much more inelastic and luxuries tend to be very elastic. If there is
a change in price of going to the dentist there will not be much change in the number of
times one goes because it is more of a necessity. On the other hand if the price of a
movie ticket goes up there is going to be a greater change in the number of times people
go to the movies because it is not a necessity people go to the movies.
Time Horizon
Goods tend to have more elastic demands over longer time horizons. For example
gasoline, initially gas in inelastic because at the current moment consumers cant do a
whole lot about it as it is needed to fuel their cars if the price rises. However, over a
longer period of time people will buy more fuel-efficient cars or switch to public transit.
Thus, as time goes on the demand changes more drastically.
Calculating Percentage Change and Elasticity
Midpoint Method
Due to the fact that the price elasticity s going to be different if you are calculating it
from an increase or back to the original point there is a method of calculating elasticity
that will eliminate this problem, it is called the midpoint method. The formula is as
Where Q2 is the new quantity point and Q1 is the original
Where P2 is the new price point and P1 is the original
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