CHAPTER 4 Elasticity
Elasticity = sensitivity. How sensitive is demand or supply to changes in price etc?
If price goes up by 10% and quantity demanded went down by 10% the elasticity is 1 (it’s the ratio)
The Responsiveness of the Quantity Demanded to Price
When price rises, quantity demanded decreases.
The question is how much quantity will decrease in response to a given price increase.
We want a measure that is units free and can be compared across different commodities.
You can say one good is more sensitive than another
The Responsiveness of Quantity Demanded to Price
The measure we will study that meets the criteria we want is the price elasticity of demand.
Price Elasticity of Demand
Price elasticity of demand is a measure of the responsiveness of the quantity demanded of a good to a change in
its price (ceteris paribus).
Elastic Demand - means demand is sensitive to price
Inelastic Demand - means demand is insensitive to price
Negative sign is ignored for convenience.
The changes in price and quantity are expressed as percentages of the average price and average quantity
between the two prices and quantities being compared.
Avoids having two values for the price elasticity of demand
Calculating Elasticity Calculating the Elasticity of Demand - Example
Q 1 36
Q 2 44
Q2-Q1 = 8________ 8/40
P2-P1 = 20_______ 20/400
Calculating the Elasticity of Demand
Calculating Elasticity Elasticity Using Different Bases
Use P 1nd Q as1base
E = ((44 – 36)/36)/((390 – 410)/410)
= (8/36)/(-20/410) = .222/.0488 = 4.55
Use P 2nd Q as2base
E = ((44 – 36)/44)/((390 – 410)/390)
= (8/44)/(-20/390) = .182/.051 = 3.57
Note that average of these two elasticities is about 4, which is the elasticity obtained using the average Ps & Qs
P1= 410, Q = 16; P = 320, Q = 44 2
Inelastic and Elastic Demand
Five demand curves that cover the entire range of possible elasticities of demand:
Perfectly inelastic (Elasticity=0)