DepartmentEconomics for Management Studies
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Chapter 4: Elasticity
The laws of demand and supply predict the direction of changes in equilibrium price and
quantity in response to various shifts in demand and supply.
4.1 – PRICE ELASTICITY OF DEMAND
Demand is said to be elastic when quantity demanded is quite responsive to changes in
price. When quantity demanded is relatively unresponsive to change in price, demand is
said to be inelastic.
The more responsive the quantity demanded is to changes in price, the less the change in
equilibrium price and the greater the change in equilibrium quantity from any given
shifts in the supply curve.
The Measure of Price Elasticity
The slope of a demand curve tells us the amount by which price must change to cause a
unit change in quantity demanded.
If initial prices and quantities are the same in both cases, the larger absolute change is
also the larger percentage change.
The price elasticity of demand (demand elasticity) is a measure of the responsiveness of
quantity demanded to a change in the commodity’s own price.
Equation: % change in quantity demanded / % change in price
The Use of Average Price and Quantity in Computing Elasticity
Changes in price and quantity are measured in terms of the average values of each
because averages avoid the ambiguity caused by the fact that when a price or quantity
changes, the change is a different percentage of the original value than it is of the new
Using average values of price and quantity means that the measured elasticity demand
between any two points on the demand curve is pendent of whether the movement is
from 1 to 2 or 2 to 1.
Algebraic formulas: [(Q1 – Q2) / average Q] / [(P1 – P2) / average P]
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Unit free elasticity – even though prices are measure in dollars and quantity of cheese is
measure in kilograms, the elasticity of demand has no units.
Interpreting Numerical Elasticities
Because demand curves have negative slopes, an increase in price is associated with a
decrease in quantity demanded, and vice versa.
Because the percentage changes in price and quantity have opposite signs, demand
elasticity is a negative number.
The more responsive the quantity demanded to a change in price, the greater the
elasticity and the larger is eta.
Vertical demand curve – elasticity is zero when a change in price leads to no change in
Demand curve is very flat, almost horizontal – elasticity is very large when even a very
small change in price leads to an enormous change in quantity demanded.
Elasticity less than 1 = inelastic demand
Elasticity greater than 1 = elastic demand
Elasticity equal to 1 = unit elastic
A negatively sloped linear demand curve does not have a constant elasticity, even though
it does have a constant slope.
A linear demand curve has a constant elasticity only when it is vertical or horizontal.
Nonlinear demand curve also has a constant elasticity.
What Determines Elasticity of Demand?
One of the main determinants of demand elasticity is the availability of substitutes.
A fall in the price leads consumers to buy more of the product and less of the substitutes,
and a rise in price leads consumers to buy less of the product and more of the
Products with close substitutes tend to have elastic demands; products with no close
substitutes tend to have inelastic demands.
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