Elasticity of Demand & Supply

Businesses need to measure the responsiveness of quantity demanded to price so that they can:

• Make decisions on pricing of products

and/or

• Whether to develop new models of their product

They measure elasticity by means of a concept called

“elasticity”

Demand

• A curve indicating a sharp response to change in price is said to be “elastic”

• A curve involving a small response to change in price is called “inelastic”

(Price) Elasticity of Demand

• The ratio of the percentage change in quantity demanded to the percentage change in price

Elasticity of Demand = % change in quantity demanded

% change in price

ie. Gas station sells 10 million litres/month at $.50, raise price to $.54/litre, quantity demanded drops to 9.5 million litres

Calculating per cent change in quantity:

• Use the average between the original quantity sold and the quantity after the price change

ie. Demand fell from 10 to 9.5, the average quantity demanded is 9.75. Change in quantity is -0.5

Per cent change demanded is:

-0.5 x 100 = -5.128% or 5.13%

9.75

This number serves as the numerator

Calculating per cent change in price:

• Original price was $.50, increased to $.54

• Difference of $.04

• Average price is $.52

• The per cent change in price in this example is:

4 x 100 = 7.69%

52

This number serves as the denominator

Coefficient of Demand:

• Now we can use the formula to determine the coefficient of demand:

%QD = 5.13% = 0.667 or 0.67

%PD 7.69%

The answer is known as: the coefficient of demand

Can we use Slope as a Determinant of Elasticity?

• May seem that the slope of the demand curve conveys information we need

• But slope won’t do the job because it depends on the units of measurement

• Since there are no standardized units of measurement, economists use the elasticity measure because it deals with percentage changes in price & quantity

Elasticity Formula

• The elasticity formula solves the units problem because percentages are unaffected by units of measurement

• Ex. If your height doubles between ages 5 and 15, it goes up 100 percent whether measured in inches or in centimetres