price elasticity of demand we know from the law of demand the when the price of a product falls, the...

Price Elasticity of Demand

• We know from the law of demand the when the price of a product falls, the QD of the product increases– But the law of demand only tells firms that the

demand curves for their products slope downward

• A more useful measure of responsiveness of the QD to a change in price is the price elasticity of demand

• We might measure the price elasticity of demand using the slope of the demand curve because it tells us how much quantity changes as price changes– Drawback: the measurement of slope is sensitive

to the units chosen for quantity and price

Measuring the Price Elasticity of Demand

• To avoid confusion over units, economists use percentage changes when measuring the price elasticity of demand– Percentage changes are not dependent on units

• No matter what units we use to measure the quantity of wheat, 10 % more wheat is 10% more wheat


• Price Elasticity of Demand is measured by dividing the percentage change in the quantity demanded by the percentage change in the price

• It is important to note that the price elasticity of demand is not the same as the slope of the demand curve


• If we calculate the price elasticity of demand for a price cut, the percentage change in price will be negative and the percentage change in quantity demanded will be positive

• If we calculate the price elasticity of demand for a price increase, the percentage change in price will be positive and the percentage change in quantity demanded will be negative


• In comparing elasticities we are usually interested in their relative size– Drop the minus sign and compare their absolute

values


• If the QD is responsive to changes in price, the % change in QD with be greater than the % change in price– The price elasticity of demand will be greater than

1 in absolute value• Demand is elastic

Elastic and Inelastic Demand

• When the QD is not very responsive to price, however, the % change in QD will be less than the % change in price– The price elasticity of demand will be less than 1

in absolute value• Demand is inelastic


• In the special case in which the % change in QD is equal to the % change in price, the price elasticity of demand equals 1– Demand is unit-elastic


• Used to ensure that we have only one value of the price elasticity of demand between the same two points on the same demand curve– It uses the average of the initial and final quantity

and the initial and final price

The Arc Midpoint Formula

• Remember elasticity is not the same thing as slope!– Slope is calculated using changes in quantity and

price, whereas elasticity is calculated using percentage changes

Demand Curves

• But it is true that when two demand curves intersect, the one with the smaller slope (in absolute value) – the flatter demand curve – is more elastic

• The one with the larger slope (in absolute value) – the steeper demand curve – is less elastic

Demand Curves

• Polar Cases of price elasticity do not occur often

• If a demand curve is a vertical line it is perfectly inelastic– The QD is completely unresponsive to price and

the price elasticity of demand = 0

Polar Cases of Price Elasticity

• If the demand curve is a horizontal line, it is perfectly elastic– The QD is infinitely responsive to price, and the

price elasticity of demand = infinity– If a demand curve is perfectly elastic, an increase

in price causes the QD to fall to zero

Polar Cases of Price Elasticity

Straight Line Demand Curve

1. Time Horizon2. Availability of

Substitutes (Market Definition)

3. Necessities vs. Luxuries4. Importance of the good

in relation to one’s budget

Determinants of Price Elasticity ofDemand

1. Time horizon– The short-run

supply curve is inelastic

– In the long run, significant substitution is possible; the supply curve becomes very elastic

Determinants of the Price Elasticity of Supply

• When two goods are substitutes, cross elasticity of demand will be Positive

• When two goods are complements, cross elasticity of demand will be Negative

E > 0E > 0

E < 0E < 0

Cross Price Elasticity

• Income elasticity of demand will be Positive for normal goods

• Income elasticity of demand will be Negative for inferior goods

Income Elasticity

** Inelastic – Price and TR move in the same direction**** Elastic – Price and TR move in opposite directions**

**Unit – TR does not change when price changes**

Elasticity and Total Revenue

price elasticity of demand we know from the law of demand the when the price of a product falls, the...

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