The Concept of Elasticity
The Elasticity of Demand
• Elasticity is a measure of the
responsiveness of one variable to another.
• The greater the elasticity, the greater the
responsiveness.
Chapter 6-1
Laugher Curve
The Concept of Elasticity
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.
• Elasticity is a measure of the
responsiveness of one variable to another.
• The greater the elasticity, the greater the
responsiveness.
Price Elasticity
Sign of Price Elasticity
• The price elasticity of demand is the
percentage change in quantity demanded
divided by the percentage change in price.
• According to the law of demand, whenever
the price rises, the quantity demanded
falls. Thus the price elasticity of
demand is always negative.
Percentage change in quantity demanded
ED =
Percentage change in price
• Because it is always negative, economists
usually state the value without the sign.
1
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.
Elastic Demand
• Elastic Demand means that quantity
changes by a greater percentage than the
percentage change in price.
E<1
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.
2
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 end-point problem – the percentage
change differs depending on whether you
view the change as a rise or a decline in
price.
• Economists use the average of the end
points to calculate the percentage change.
(Q2 - Q1)
Elasticity = (P
$26
24
22
20
18
16
14
B
C (midpoint)
A
D
Elasticity of demand
between A and B = 1.27
0
10
12
14
Quantity of software (in hundred thousands)
- P1 )
½(Q2 + Q1 )
½(P1 + P2 )
Graphs of Elasticities
Wage per hour
Price
Graphs of Elasticities
2
$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
3
Calculating Elasticity
Calculating Elasticity of Demand
Between Two Points
Q 2 − Q1
%∆Q 21 (Q 1 + Q 2 )
E=
=
P2 − P1
%∆P
1
2 (P1 + P2 )
Price
22
Wage per hour
0
A
C
midpoint
ED =
C
20
A
18
16
E=
%∆Q
%∆ P
10 − 14
−4
− .33
(14 + 10)
= 12 =
= 1.27
6
26 − 20
.26
1
+
23
(
26
20
)
2
1
2
Demand
14
Calculating Elasticity of Supply
Between Two Points
Elasticity of supply
between A and B: E = %∆Q
B
B
24
0
$6.00
5.50
5.00
4.50
4.00
3.50
3.00
Elasticity of demand
between A and B:
$26
10
12
14
Quantity of software (in hundred thousands)
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.
%∆P
485 − 475
10
1
(485 + 475 )
.021
ES = 2
= 480 =
= .2
5 − 4.50
.50
.105
1
(
5
4
.
50
)
+
4
.
75
2
470 480 490
Quantity of workers
• 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
Price
Calculating Elasticity at a Point
(28 - 20)
E
at A
=
(5 - 3)
C
½(28 + 20 )
= 0.66
½(5 + 3 )
A
B
20 24 28
40
Quantity
4
Calculating Elasticity at a Point
To calculate elasticity at a point determine
a range around that point and calculate
the arc elasticity.
Price
$10
9
8
7
6
5
4
3
2
1
Eat A =
C
A
1
2
B
20 24 28
Quantity
28 − 20
8
(28 + 20) 24 .33
=
=
= .66
5−3
2
.5
1
4
2 (5 + 3)
Price
• Two important points to consider:
– Elasticity is related (but is not the same as)
slope.
– Elasticity changes along straight-line demand
and supply curves.
40
Calculating Elasticity at a Point
$10
9
8
7
6
5
4
3
2
1
Elasticity and Demand Curves
Elasticity and Demand Curves
• Two important points to consider:
Demand
A
Supply
EA = 2.33
D
C E = 0.75
C
6
ED = 0.86
– Elasticity is related (but is not the same as)
slope.
– Elasticity changes along straight-line demand
and supply curves.
EB = 0.11
B
12 18 24 30 36 42 48 54 60 Quantity
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 = ∞).
5
Elasticity Is Not the Same as
Slope
Perfectly Inelastic Demand
Curve
• When the curves are vertical, we call the
curves perfectly inelastic.
Price
• The quantity does not change at all in
response to an enormous proportional
change in price (E = 0).
Perfectly inelastic
demand curve
0
Perfectly Elastic Demand Curve
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.
Price
• Perfectly Inelastic Demand Curve
0
Perfectly elastic
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.
Quantity
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.
6
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
Ed > 1
Price
0
The Price Elasticity of Demand Along a
Straight-line Demand Curve
Ed = 1
Ed < 1
Ed = 0
1
2
3
4
5
6
7
8
9 10 Quantity
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.
7
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
8