BasicsofEleasticity ofDemand

1.1ElasticityofDemand
Measures responsiveness of demand (or supply) to changes in an underlying factor (e.g. price, income, other prices). Own-Price elasticity of demand = % change in quantity demanded % change in price

1.1.1ElasticDemand
eP >1inmagnitude(<1) SupposeeP =1.5andyouarecurrently buying30lbs.ofbeef/yr.at$3/lb. Ifbeefpricesincreaseto$3.15perpound(a 5%increase),howmuchbeefdoyou consume?

1.1.1ElasticDemand
Answer:The%changeinbeefconsumption is7.5%(1.5x5%) Theamountofbeefconsumedfalls2.25 poundsto27.75

1.1.1ElasticDemand
Whathappenstoyourexpendituresonbeef? Theyfallfrom$90($3x30)to$87.40($3.15x 27.75)

1.1.1ElasticDemand
RULE: Elastic:P Revenue

1.1.1PerfectlyElasticDemand
Price D

Quantity

1.1.1InelasticDemand
eP <1inmagnitude(>1) SupposeeP =.5andyouarecurrentlybuying 1500gals.ofgasoline/yr.at$1/gal. Ifgasolinepricesincreaseto$1.05pergallon (a5%increase),howmuchgasolinedoyou consume?

1.1.1InelasticDemand
Answer:The%changeingasoline consumptionis2.5%(.5x5%) Theamountofgasolineconsumedfalls37.5 gallonsto1462.5gallons

1.1.1InelasticDemand
Whathappenstoyourexpenditureson gasoline? Theyrisefrom$1500($1x1500)to $1525.625($1.05x1462.5)

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1.1.1InelasticDemand
RULE: Inelastic:PRevene

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1.1.1PerfectlyInelasticDemand
Price D

Quantity

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1.1.2LINEARDEMAND
Asyoumovealongalineardemandcurve,the priceelasticityofdemandchanges.
Price elasticity of demand =

= (Q/Q)/(P/P) = (Q/P) x (P/Q) = eP

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1.1.2LINEARDEMANDCURVE
Price
8

eP = - Q=16 - 2P

eP = - 1
4

eP = 0
Quantity
8 16
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1.1.2GroupStudy
Ifyourmarginalcostis0,whatpricewillyou setifyouarefacingademandQ=162P? Whatistheelasticityofdemandatthatprice?

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1.1.3Pointelasticity
Whenthedemandfunctionisknown,wecancalculate preciselytheelasticityateachpoint. Whenthedemandfunctionisnotknown,andweonly havetwopointsofthedemandcurve,therearetwo waystocalculateelasticity.
Pointelasticity:useoriginalP,Qwhencalculatingpercentage change Arcelasticity:useaverageP,Qwhencalculatingpercentage change

Thepreviouselasticitieshaveallbeen point elasticities. TheseworkwellforsmallpricechangesButhowabout biggerchanges?

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1.1.3PointElasticity
Ifpriceincreasesfrom$40to$50,quantity demandedfallsfrom30to20. Usingpointelasticitieswegetthata25% increaseinpriceleadstoa33.33%decreasein demand.Thepointelasticityis .3333/.25= 1.333

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1.1.3PointElasticity
Goingintheoppositedirection:Ifprice decreasesfrom$50to$40,quantity demandedrisesfrom20to30. Here,a20%decreaseinpriceleadstoa50% increaseindemand.Thepointelasticityof .50/.20=2.5

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1.1.3ArcElasticity
Whyarethesetwoanswersdifferent? Whilethereisnorightwaytodothis, conventionistousethearcelasticityof demandwheretheaveragepriceandquantity isused.

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1.1.3ArcElasticity
Forourexample,thiswouldworkthe followingway: the%changeinpriceis(10/45)=.2222 the%changeinquantityis(10/25)=.4 thearcelasticityis .4/.2222= 1.8

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