Transcript The Elasticity of Demand Chapter 7 The Concept of Elasticity • Elasticity is a measure of the responsiveness of one variable to another. •

The Elasticity of Demand
Chapter 7
The Concept of Elasticity
• Elasticity is a measure of the
responsiveness of one variable to another.
• The greater the elasticity, the greater the
responsiveness.
Laugher Curve
Q. What’s the difference between an
economist and a befuddled old man with
Alzheimer’s?
A. The economist is the one with a
calculator.
The Concept of Elasticity
• Elasticity is a measure of the
responsiveness of one variable to another.
• The greater the elasticity, the greater the
responsiveness.
Price Elasticity
• The price elasticity of demand is the
percentage change in quantity demanded
divided by the percentage change in price.
Percentage change in quantity demanded
ED =
Percentage change in price
Sign of Price Elasticity
• According to the law of demand, whenever
the price rises, the quantity demanded
falls. Thus the price elasticity of
demand is always negative.
• Because it is always negative, economists
usually state the value without the sign.
What Information Price
Elasticity Provides
• Price elasticity of demand and supply
gives the exact quantity response to a
change in price.
Classifying Demand and Supply
as Elastic or Inelastic
• Demand is elastic if the percentage
change in quantity is greater than the
percentage change in price.
E>1
Classifying Demand and Supply
as Elastic or Inelastic
• Demand is inelastic if the percentage
change in quantity is less than the
percentage change in price.
E<1
Elastic Demand
• Elastic Demand means that quantity
changes by a greater percentage than the
percentage change in price.
Inelastic Demand
• Inelastic Demand means that quantity
doesn't change much with a change in
price.
Defining elasticities
• When price elasticity is between zero and
-1 we say demand is inelastic.
• When price elasticity is between -1 and
- infinity, we say demand is elastic.
• When price elasticity is -1, we say demand
is unit elastic.
Elasticity Is Independent of
Units
• Percentages allow us to have a measure
of responsiveness that is independent of
units.
• This makes comparisons of
responsiveness of different goods easier.
Calculating Elasticities
• To determine elasticity divide the
percentage change in quantity by the
percentage change in price.
The End-Point Problem
• The end-point problem – the percentage
change differs depending on whether you
view the change as a rise or a decline in
price.
The End-Point Problem
• Economists use the average of the end
points to calculate the percentage change.
(Q2 - Q1)
Elasticity = (P
2
- P1)
½Q2  Q1 
½P1 + P2 
Graphs of Elasticities
B
$26
24
22
20
18
16
14
0
C (midpoint)
A
D
Elasticity of demand
between A and B = 1.27
10
12
14
Quantity of software (in hundred thousands)
Calculating Elasticities: Price
elasticity of Demand
What is the price elasticity of
demand between A and B?
P
$26
$23
$20
B
Midpoint
C
A
10 12 14
Q2–Q1
½(Q2+Q1)
%ΔQ
ED = %ΔP =
P2–P1
½(P2+P1)
10–14
½(10+14)
-.33
= 26–20 = .26 = 1.27
½(26+20)
D
Q
7-18
Price Elasticity: Supply
• Price elasticity of supply is the
percentage change in quantity supplied
divided by the percentage change in
ES =
% change in Quantity Supplied
% change in Price
• This tells us exactly how quantity supplied responds to
a change in price
• Elasticity is independent of units
7-19
Price Elasticity: Supply
• Supply is elastic if the percentage
change in quantity is greater than the
Elastic supply
is when
ES > 1
percentage
change
in price
• Supply is inelastic if the percentage change in quantity
is less than the percentage change in price
Inelastic supply is when ES < 1
7-20
Calculating Elasticities: Price
elasticity
of
Supply
What is the price elasticity of
supply between A and B?
P
S
B
$5.00
Midpoint
C
$4.75
$4.50
A
476
480.5
485
Q2–Q1
%ΔQ ½(Q2+Q1)
ES = %ΔP = P2–P1
½(P2+P1)
485–476
½(485+476)
0.0187 0.18
= 5–4.50 = 0.105 =
½(5+4.50)
Q
7-21
Graphs of Elasticities
$6.00
5.50
5.00
4.50
4.00
3.50
3.00
0
A
B
C (midpoint)
Elasticity of supply
between A and B = 0.18
470 480 490
Quantity of workers
Calculating Elasticity
Q 2  Q1
1
%Q 2 (Q 1  Q 2 )
E

P2  P1
% P
1
2 (P1  P2 )
Calculating Elasticity of Demand
Between Two Points
$26
24
22
20
18
16
Elasticity of demand
between A and B:
B
midpoint
C
A
%Q
E
%P
10  14
4
1
 .33
2 (14  10)
ED 
 12 
 1.27
26  20
6
.26
1
23
2 (26  20)
Demand
14
0
10
12
14
Quantity of software (in hundred thousands)
Calculating Elasticity of Supply
Between Two Points
$6.00
5.50
5.00
4.50
4.00
3.50
3.00
0
A
C
Elasticity of supply
between A and B: E  % Q
B
%P
485  475
10
1
.021
480
2 ( 485  475)
ES 


 .2
5  4.50
.50
.105
1
4.75
2 (5  4.50)
470 480 490
Quantity of workers
Calculating Elasticity at a Point
• Let us now turn to a method of calculating
the elasticity at a specific point, rather than
over a range or an arc.
Calculating Elasticity at a Point
• To calculate elasticity at a point, determine
a range around that point and calculate
the arc elasticity.
Calculating Elasticity at a Point
$10
9
8
7
6
5
4
3
2
1
(28 - 20)
E
at A
=
C
½28  20 
 0.66
(5 - 3)
½5 + 3 
A
B
20 24 28
40
Quantity
Calculating Elasticity at a Point
$10
9
8
7
6
5
4
3
2
1
To calculate elasticity at a point determine
a range around that point and calculate
the arc elasticity.
C
E at A
A
B
20 24 28
Quantity
28  20
8
1
.33
2 (28  20)
24



 .66
53
2
.5
1
4
2 (5  3)
40
Elasticity and Demand Curves
• Two important points to consider:
– Elasticity is related (but is not the same as)
slope.
– Elasticity changes along straight-line demand
and supply curves.
Calculating Elasticity at a Point
$10
9
8
7
6
5
4
3
2
1
Demand
A
Supply
EA = 2.33
D
C E = 0.75
C
6
ED = 0.86
EB = 0.11
B
12 18 24 30 36 42 48 54 60 Quantity
Elasticity and Demand Curves
• Two important points to consider:
– Elasticity is related (but is not the same as)
slope.
– Elasticity changes along straight-line demand
and supply curves.
Elasticity Is Not the Same as
Slope
• The steeper the curve at a given point, the
less elastic is supply or demand.
• There are two limiting examples of this.
Elasticity Is Not the Same as
Slope
• When the curves are flat, we call the
curves perfectly elastic.
• The quantity changes enormously in
response to a proportional change in price
(E = ).
Elasticity Is Not the Same as
Slope
• When the curves are vertical, we call the
curves perfectly inelastic.
• The quantity does not change at all in
response to an enormous proportional
change in price (E = 0).
Perfectly Inelastic Demand
Curve
Perfectly inelastic
demand curve
0
Quantity
Perfectly Elastic Demand Curve
Perfectly elastic
demand curve
0
Quantity
Demand Curve
Shapes and Elasticity
• Perfectly Elastic Demand Curve
– The demand curve is horizontal, any change in price can and
will cause consumers to change their consumption.
• Perfectly Inelastic Demand Curve
– The demand curve is vertical, the quantity demanded is totally
unresponsive to the price. Changes in price have no effect on
consumer demand.
• In between the two extreme shapes of demand curves
are the demand curves for most products.
Demand Curve
Shapes and Elasticity
Elasticity Changes Along
Straight-Line Curves
• Elasticity is not the same as slope.
• Elasticity changes along straight line
supply and demand curves–slope does
not.
Elasticity Along a Demand Curve
Ed = ∞
$10
9
8
7
6
5
4
3
2
1
Elasticity declines along
demand curve as we move
toward the quantity axis
Price
Ed > 1
0
Ed = 1
Ed < 1
Ed = 0
1
2
3
4
5
6
7
8
9 10 Quantity
The Price Elasticity of Demand Along a
Straight-line Demand Curve
Substitution and Elasticity
• As a general rule, the more substitutes a
good has, the more elastic is its supply
and demand.
Substitution and Demand
• The less a good is a necessity, the more
elastic its demand curve.
• Necessities tend to have fewer substitutes
than do luxuries.
Substitution and Demand
• Demand for goods that represent a large
proportion of one's budget are more elastic
than demand for goods that represent a
small proportion of one's budget.
Substitution and Demand
• Goods that cost very little relative to your
total expenditures are not worth spending
a lot of time figuring out if there is a good
substitute.
• It is worth spending a lot of time looking for
substitutes for goods that take a large
portion of one’s income.
Substitution and Demand
• The larger the time interval considered, or
the longer the run, the more elastic is the
good’s demand curve.
– There are more substitutes in the long run
than in the short run.
– The long run provides more options for
change.
Determinants of the
Price Elasticity of Demand
• The degree to which the price elasticity of
demand is inelastic or elastic depends on:
– How many substitutes there are
– How well a substitute can replace the good or
service under consideration
– The importance of the product in the
consumer’s total budget
– The time period under consideration