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Explanation of Price Elasticity of Demand

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- 1. The Elasticity of Demand Chapter 7
- 2. The Concept of Elasticity • Elasticity is a measure of the responsiveness of one variable to another. • The greater the elasticity, the greater the responsiveness.
- 3. 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.
- 4. The Concept of Elasticity • Elasticity is a measure of the responsiveness of one variable to another. • The greater the elasticity, the greater the responsiveness.
- 5. Price Elasticity • The price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price.
- 6. 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.
- 7. What Information Price Elasticity Provides • Price elasticity of demand and supply gives the exact quantity response to a change in price.
- 8. 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
- 9. 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
- 10. Elastic Demand • Elastic Demand means that quantity changes by a greater percentage than the percentage change in price.
- 11. Inelastic Demand • Inelastic Demand means that quantity doesn't change much with a change in price.
- 12. 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.
- 13. 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.
- 14. Calculating Elasticities • To determine elasticity divide the percentage change in quantity by the percentage change in price.
- 15. 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.
- 16. The End-Point Problem • Economists use the average of the end points to calculate the percentage change.
- 17. Graphs of Elasticities Price Quantity of software (in hundred thousands) $26 24 22 20 18 16 14 0 D B A 10 12 14 C (midpoint) Elasticity of demand between A and B = 1.27
- 18. Calculating Elasticities: Price elasticity of Demand D P Q What is the price elasticity of demand between A and B? $20 10 $26 14 MidpointB A ED = %ΔQ %ΔP Q2–Q1 ½(Q2+Q1) P2–P1 ½(P2+P1) = C 12 $23 = 10–14 ½(10+14) 26–20 ½(26+20) -.33 .26 = 1.27= 7-18
- 19. Price Elasticity: Supply • Price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in • This tells us exactly how quantity supplied responds to a change in price ES = • Elasticity is independent of units % change in Quantity Supplied % change in Price 7-19
- 20. Price Elasticity: Supply • Supply is elastic if the percentage change in quantity is greater than the percentage change in priceElastic supply is when ES > 1 • 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
- 21. Calculating Elasticities: Price elasticity of Supply P Q What is the price elasticity of supply between A and B? $4.50 476 $5.00 485 B A ES = %ΔQ %ΔP Q2–Q1 ½(Q2+Q1) P2–P1 ½(P2+P1) = = 485–476 ½(485+476) 5–4.50 ½(5+4.50) Midpoint C 480.5 $4.75 0.0187 0.105 = 0.18= S 7-21
- 22. Graphs of Elasticities Elasticity of supply between A and B = 0.18 Wageperhour Quantity of workers $6.00 5.50 5.00 4.50 4.00 3.50 3.00 0 C B A 470 (midpoint) 480 490
- 23. Calculating Elasticity )PP( PP )QQ( QQ P% Q% E 212 1 12 212 1 12 + − + − = ∆ ∆ =
- 24. Calculating Elasticity of Demand Between Two Points 27.1 26. 33. 23 6 12 4 )2026( 2026 )1014( 1410 E 2 1 2 1 D = − = − = + − + − = Price Quantity of software (in hundred thousands) $26 24 22 20 18 16 14 0 Demand B A 10 12 14 Cmidpoint Elasticity of demand between A and B: P% Q% E ∆ ∆ =
- 25. Calculating Elasticity of Supply Between Two Points P% Q% E ∆ ∆ = Wageperhour Quantity of workers $6.00 5.50 5.00 4.50 4.00 3.50 3.00 0 C B A 470 480 490 Elasticity of supply between A and B: 2. 105. 021. 75.4 50. 480 10 )50.45( 50.45 )475485( 475485 E 2 1 2 1 S === + − + − =
- 26. 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.
- 27. Calculating Elasticity at a Point • To calculate elasticity at a point, determine a range around that point and calculate the arc elasticity.
- 28. Calculating Elasticity at a PointPrice Quantity $10 9 8 7 6 5 4 3 2 1 C B A 24 402820
- 29. Calculating Elasticity at a Point Price Quantity $10 9 8 7 6 5 4 3 2 1 C B A 24 402820 To calculate elasticity at a point determine a range around that point and calculate the arc elasticity. 66. 5. 33. 4 2 24 8 )35( 35 )2028( 2028 E 2 1 2 1 Aat === + − + − =
- 30. 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.
- 31. Calculating Elasticity at a Point 6 12 18 30 36 42 48 Price Quantity 8 7 6 5 4 3 2 1 $10 9 A 24 6054 D B C Supply EA = 2.33 EB = 0.11 Demand EC = 0.75 ED = 0.86
- 32. 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.
- 33. 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.
- 34. 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 = ∞).
- 35. 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).
- 36. Perfectly inelastic demand curve Price 0 Quantity Perfectly Inelastic Demand Curve
- 37. Perfectly elastic demand curve Perfectly Elastic Demand Curve Price 0 Quantity
- 38. 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.
- 39. Demand Curve Shapes and Elasticity
- 40. 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.
- 41. Elasticity Along a Demand Curve Price $10 9 8 7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 Quantity Elasticity declines along demand curve as we move toward the quantity axis Ed = 1 Ed = 0 Ed < 1 Ed > 1 Ed = ∞
- 42. The Price Elasticity of Demand Along a Straight-line Demand Curve
- 43. Substitution and Elasticity • As a general rule, the more substitutes a good has, the more elastic is its supply and demand.
- 44. 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.
- 45. 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.
- 46. 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.
- 47. 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.
- 48. 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

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