THE ELASTICITY OF DEMAND (AND
JUST ABOUT ANYTHING)
THE CONCEPT: THE ELASTICITY OF STEEL VS.
RUBBER
HOW MUCH DOES ONE THING CHANGE IN
RESPONSE TO A CHANGE IN SOMETHING ELSE?
THE CONCEPT OF ELASTICITY IS USED IN
ENGINEERING & MANY BUSINESS FIELDS &
ECONOMISTS USE SEVERAL DIFFERENT TYPES OF
ELASTICITY MEASURES
1.
(OWN) PRICE ELASTICITY OF DEMAND
Ed = ELASTICITY COEFFICIENT
% Δ IN QUANTITY DEMANDED
= ---------------------------------------------% Δ IN PRICE
A NOTE ABOUT THE SIGN (NEGATIVE VS. POSITIVE): FOR
OWN PRICE ELASTICITY, THE SIGN IS ALWAYS
NEGATIVE, SO WE IGNORE IT. (CAN’T DO THAT WITH
OTHER KINDS OF ELASTICITY)
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TERMINOLOGY
INELASTIC
Ed < 1
THIS MEANS QUANTITY DOES NOT CHANGE
MUCH RELATIVE TO PRICE
UNIT ELASTIC
Ed = 1
THIS MEANS QUANTITY DEMANDED CHANGES
PROPORTIONALLY TO PRICE
ELASTIC
Ed > 1
THIS MEANS QUANTITY DEMANDED CHANGES
MORE THAN PRICE
A CAUTION ABOUT SAYING DEMAND IS “ELASTIC” OR
“INELASTIC” (ELASTICITY IS NOT THE SAME AS
SLOPE)
ELASTICITY IS ALWAYS RELATIVE TO WHERE
YOU ARE ON A DEMAND CURVE OR BETWEEN
TWO OR MORE DEMAND CURVES.
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WHY DO WE CARE?
KNOWING PRICE ELASTICITY ALLOWS US TO BE ABLE
TO PREDICT

CHANGES IN THE QUANTITY DEMANDED IN
RESPONSE TO PRICE CHANGES

CHANGES IN REVENUES
Demand
30
25
20
15
10
5
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
Total Revenue
180
160
140
120
100
80
60
40
20
0
3
3–4
3
- 1/3 - 0.33
Ed = ------ = ---------- = ----- = ------ =- - 1.65
%Δ P 10 – 8 2/10 0.20
10
%Δ Q
P
$10
%Δ Q 9 – 10
9
- 1/9 - 0.11
Ed = ------ = ---------- = ----- = ------ =- - 0.22
%Δ P 2 - 1
1/2
0.50
2
$8
$2
$1
D
3
4
9
10
IF DEMAND IS ELASTIC LOWER THE PRICE TO
MAKE MORE REVENUE
IF DEMAND IS INELASTIC RAISE THE PRICE TO
MAKE MORE REVENUE
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Q
ELASTICITY: SOME ADDITIONAL
COMMENTS
AVAILABILITY OF SUBSTITUTES (MORE CONSUMER
CHOICE) INCREASES ELASTICITY
DEFINING MARKETS AND PRODUCT LINES, E.G.,
THE DEMAND FOR PEPSI IS MUCH MORE ELASTIC
THAN THE DEMAND FOR “COLA”
THE DEMAND FOR BUDWEISER IS MUCH MORE
ELASTIC THAN THE DEMAND FOR “BEER”
ELASTICITY AND TIME: THE LONGER THE PERIOD
THAT CONSUMERS HAVE TO ADJUST, THE
MORE ELASTIC DEMAND.
EXAMPLES: GASOLINE, ELECTRICITY
THE BIGGER THE PRICE INCREASE, THE MORE
ELASTIC THE DEMAND.
MOVING TO A MORE ELASTIC PART OF THE
DEMAND CURVE
MAKES CONSUMERS MORE WILLING TO BEAR
SEARCH AND TRANSACTIONS COSTS TO FIND
SUBSTITUTES, ETC.
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CALCULATING ELASTICITY
MEASURING ELASTICITY IS SENSITIVE TO HOW YOU
DO IT & INFORMATION AVAILABLE
IF ALL YOU KNOW IS THAT Q CHANGED X% & P
CHANGED Y%, THEN ALL YOU CAN DO IS:
Ed = (X%)/(Y%)
FOR EXAMPLE, IF THE PRICE OF GASOLINE RISES 10%
AND QUANTITY DEMANDED FALLS 1%:
Ed = (1%)/(10%) = 0.1, I.E., INELASTIC
IF WE KNOW PRICES AND QUANTITIES THEN WE CAN
BE MORE PRECISE:
Q2-Q1
P1
Ed = --------- X ---------Q1
P2-P1
THE PROBLEM WITH THIS METHOD IS THAT YOU WILL
GET DIFFERENT ANSWERS DEPENDING ON
WHETHER YOU START AT (Q1 P1) OR (Q2 P2)
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ARC ELASTICITY (MIDPOINT
METHOD)
THE PROBLEM OF MEASURING ELASTICITY IS
RESOLVED BY USING AN AVERAGING METHOD
Q2 - Q1
P2 – P1
Ed = -------------- ÷ -------------(Q1 + Q2)/2
(P2 + P1)/2
Q2 - Q1
P2 + P1
Ed = --------- x ---------Q1 + Q2
P2 – P1
AN EXAMPLE: SELLING 2X4s
@ 49¢ ea. WE SOLD 12,000 PER WEEK
WE DROPPED THE PRICE TO 39¢, SALES INCREASED TO
14,000
WHAT IS THE PRICE ELASTICITY OF DEMAND AND
WHAT DOES IT IMPLY FOR PRICING POLICY?
14,000 - 12,000
.39 + .49
Ed = -------------------- x ------------12,000 + 14,000 .39 - .49
2,000
.88
Ed = --------- x ------- = (.0769) X (-8.8) = - 0.69
26,000
-.10
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IN OTHER WORDS, DEMAND WAS INELASTIC, AND
YOU SHOULD RAISE PRICES TO INCREASE
REVENUES.
PROBLEM: THE MARK-UP ON MOST LUMBER WAS 10 20%. THE MARK-UP ON HARDWARE, PAINTS, ETC.
THAT WE ALSO SOLD RANGED FROM 50 - 250%.
WE DON’T CARE IF WE LOSE MONEY ON 2X4s WE
WANT TO GET THEM IN THE STORE AND SELL
THEM OTHER STUFF (LOSS LEADER)
CROSS-PRICE ELASTICITY
HOW DOES THE CHANGE IN THE PRICE OF ONE GOOD,
LIKE 2X4s, CHANGE THE QUANTITY DEMANDED
(SHIFT THE DEMAND CURVE) FOR OTHER GOODS,
LIKE HARDWARE?
EC
% Δ IN THE QUANTITY
DEMANDED OF GOOD “A”
= -----------------------------------------% Δ IN THE PRICE OF GOOD “B”
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NOW, THE SIGN OF THE COEFFICIENT IS IMPORTANT
IF EC > 0 ---> SUBSTITUTE GOODS
IF EC < 0 ---> COMPLEMENTARY GOODS
IF EC = 0 ---> UNRELATED GOODS
MONOPOLY? THE ALCOA CASE
INCOME ELASTICITY
MEASURES THE CHANGE IN QUANTITY DEMANDED
(SHIFT IN THE DEMAND CURVE) RESULTING
FROM A CHANGE IN CONSUMERS’ INCOMES
EY
% Δ IN THE QUANTITY DEMANDED
= -------------------------------------------------------------% Δ IN CONSUMERS’ INCOMES
AGAIN, THE SIGN MATTERS, IT TELLS WHETHER THE
DEMAND CURVE IS SHIFTING OUT (+) OR IN (-)
IF EY > 0  “NORMAL GOOD”
EXAMPLES: CLOTHING, CD’s, GASOLINE
IF EY > 0 AND LARGE (EY > 1)  “LUXURY GOOD”
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EXAMPLES: VARIETAL WINES (IN U.S.), FILET
MIGNON, CHICKEN (IN THE 1930’s)
IF EY < 0  “INFERIOR GOOD”
EXAMPLES: ROOT VEGATABLES, GRITS
WHAT IS A NORMAL GOOD IN ONE PLACE AND TIME
MAY NOT BE IN ANOTHER
THE ELASTICITY OF JUST ABOUT
ANYTHING
ADVERTISING
ORE BODIES
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