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**preview**shows half of the first page. to view the full**2 pages of the document.**Adrienne Pacini ECON 208 WEEK: September 22, 2009

ELASTICITY

- Elasticity: the sensitivity of quantity demanded to change in price

Price Elasticity of Demand

- Elasticity is related to the slope of the demand curve

o The steeper the line, the less sensitive or elastic the demand

As a curve shifts outward with the same slope, elasticity at each price falls

o The slope only gives absolute changes

Measuring Price Elasticity: η = elasticity

- η = %ΔP ÷ %ΔQ

- Demand elasticity is negative but we focus on absolute values

- Measures the change in price and quantity relative to some base values of price and

quantity

- To get point elasticity at a given price where P = Paverage: η = (P/Q) ÷ (ΔP/ΔQ)

o Can also be seen as: (slope of ray) ÷ (slope of curve)

- If the slope of the ray is greater than the slope of the curve, %ΔQ is greater than %ΔP

o Demand is elastic

- Elasticity falls as you move down a straight line demand curve

- When η = ∞ (perfectly elastic, horizontal line); when η = 0 (perfectly inelastic, vertical line)

- Parabola curve: concave upward; unit elastic (η = 1)

- When demand is elastic, total expenditure increases as price falls (and vice-versa)

- Total expenditure reaches a maximum when demand is unitary

Calculating Elasticity of Demand

- For any price you can find the quantity demanded and get the slope of the ray

- The equation tells you the slope of the curve: 1/b

- Elasticity of a straight line demand curve: η = (P) ÷ (a/b – P)

- QD = a – bP or P = (a/b) – (1/b)QD

Interpreting Numerical Elasticities

- Inelastic demand: following a given percentage change in price, there is a smaller

percentage change in quantity demanded (elasticity is less than 1)

- Elastic demand: following a given percentage change in price, there is a greater percentage

change in quantity demanded (elasticity is greater than 1)

What determines elasticity of demand?

- Availability of substitutes: one of the main determinants of elasticity of demand

o Products with close substitutes tend to have more elastic demands

- Definition of the product: any one of a group of related products will have a more elastic

demand than the group as a whole (e.g. a certain type of cereal vs. all cereal)

- Is the good a necessity or a luxury?

- Short run and long run: the response to a price change, and thus the measured price

elasticity of demand, will tend to be greater the longer the time span

Elasticity and Total Expenditure

- Total expenditure depends on the price elasticity of demand

o Total expenditure = price × quantity

- If the %ΔP is greater than %ΔQ, price change will dominate and total expenditure will

change in the same direction as price (and vice-versa)

- Unit elasticity: total expenditure remains unchanged

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