EC120 Chapter 5-Elasticity and its Application Week 3
-Elasticity is a measure of how much buyers and sellers respond to changes in market conditions
The Elasticity of Demand
-To measure how much consumers respond to the changes of supply and demand, economists use
-Elasticity-a measure of the responsiveness of quantity demanded or quantity supplied to one of its
The Price Elasticity of Demand and 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, computed as the percentage change in quantity demanded divided by
the percentage change in price.
-Demand for a good is said to be elastic if the quantity demanded responds substantially to changes in
-Demand is said to be inelastic if the quantity demanded responds only slightly to changes in the price.
-The elasticity reflects the many economic, social, and psychological forces that shape consider tastes.
-General rules about what determines the price elasticity of demand:
Availability of Close Substitutes:
-Goods with close substitutes tend to have more elastic demand because it is easier for consumers to
switch from that good to others
Ex. Butter is elastic because a price change will drop sales since margarine is a close substitute
Necessities vs. Luxuries
-Necessities have inelastic demands
-Luxuries have elastic demands
Definition of the Market
-Narrowly defined markets tend to have more elastic demand than broadly defined markets because it
is easier to find close substitutes for narrowly defined goods.
-Ex. Food, a broad category has a fairly inelastic demand because there are no good substitutes for food.
Ice cream, is a more narrow category and has an elastic demand because it has substitutes.
-Goods tend to have more elastic demand over longer time horizons. For example as the price of gas
starts to rise, people try to have more fuel efficient cars and the demand drops.
Computing the Price Elasticity of Demand
-Price elasticity of demand=Percentage change in quantity demanded
Percentage change in price
The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities
-Point A: Price $4 Quantity 120
-Point B: Price $6 Quantity 80
-Midpoint price $5
-Midpoint Quantity 100
-Therefore (6-4)/5x100 = 40. EC120 Chapter 5-Elasticity and its Application Week 3
The Variety of Demand Curves
-Demand is elastic when the elasticity is greater than 1 and inelastic when it is less than 1.
-If the elasticity is exactly 1, the demand is said to have unit elasticity.
-The flatter the demand curve that passes through a given point, the greater the price elasticity of
demand. The steeper the demand curve that passes through a given point, the smaller the price
elasticity of demand.
-Inelastic curves look like the letter I. Elastic curves look like the letter E.
Total Revenue and the Price Elasticity of Demand
-Total revenue (in a market)-the amount paid by buyers and received by sellers of a good, computed as
the price of the good times the quantity sold
-Total revenue is calculated by price x quantity
-When demand is inelastic, price and total revenue move in the same direction
-When demand is elastic, price and total revenue move in opposite directions
-When demand is unit elastic, total revenue remains constant when price changes EC120 Chapter 5-Elasticity and its Application Week 3
Elasticity and Total Revenue along a Linear Demand Curve
-A linear demand curve has a constant slope
-Even though the slope of a demand curve is constant, the elasticity is not.
Other Demand Elasticities
The Income Elasticity of Demand
-Income elasticity of demand-a measure of how much the quantity demanded of a good responds to a
change in consumer’s income, computed as the percentage change in quantity demanded divided by the
percentage change in income.
-Income Elasticity of Demand=Percentage change in quantity demanded
Percentage change in income EC120 Chapter 5-Elasticity and its Application Week 3
-Inferior goods (bus rides) have negative income elasticities because quantity demanded and income
move in opposite directions
-Necessities such as food and clothing have small income elasticies because consumers choose to buy
some of these goods regardless of