Elasticity of Demand - Loudoun County Public Schools · Elasticity Areas of greater Inelasticity P...

Or the Price Elasticity of Demand

Law of Demand = there is an inverse or negative relationship between price and quantity demanded

Price Elasticity measures the effect on

Quantity Demanded due to changes in

Price

In other words, we want to know how big

a change in Qd will occur if we change

the Price.

Price Elasticity of Demand measures the

sensitivity of consumers to a price

change

1) Large changes in qty. demanded due to

price changes = ELASTIC demand

2) Small or no changes in qty. demanded

due to price changes = INELASTIC

demand

Elasticity of Demand =

Ignore the “minus” sign!!!!

= “change”

This is an alternative method if you have a hard time with percentages:

Ed =

∆ Qd ÷ [(Q1+Q2)/2]

∆P ÷ [(P1+P2)/2]

Elastic Demand• % ∆ in price is smaller than % ∆ in Qd, demand

is ELASTIC

OR

• If Ed > 1, then demand is ELASTIC

Inelastic Demand• % ∆ in price is larger than % ∆ in Qd, demand is

INELASTIC

OR

• If Ed < 1, then demand is INELASTIC

What if % ∆ in price EXACTLY equals %

∆ in Qd?

Or, in other words…

Ed = 1?

You have “UNIT ELASTICITY”

Elastic Product

D

D

Normally, a shallower

or less steep demand

curve

Inelastic Product

D

DNormally, a steep

demand curve

Unit elastic Product

D

DNormally, a rounded

demand curve

Perfectly Elastic Product

D

D

A horizontal demand

curve

Perfectly Inelastic Product

D

D

A vertical demand

curve

Another way of determining elasticity is

the Total Revenue Test

Elastic Demand:

Ed is elastic if:

Inelastic Demand:

Ed is inelastic if:

Unit elasticity of Demand:

Ed is unit elastic if:

Substitutability• If # of substitutes is large, then Ed is greater

Proportion of Income• If price increase in relation to consumer

incomes, then Ed is greater

Luxuries vs. Necessities• Luxury items have greater Ed

• Necessity items have a lower Ed

Time• The longer the time period involved, the more

elastic a product demand becomes

D

D

Areas of greater

Elasticity

Areas of greater

Inelasticity

P

Q

Income Elasticity of Demand• Measures the change in quantity demanded as

consumer incomes change

Cross-Price Elasticity of Demand• Measures how the quantity demanded of one

good responds to the change in price of another

good

Elasticity of Income Demand =

Normal goods and IEd = as income increases, Qd

increases, thus a positive income elasticity of demand

Inferior goods and IEd = as income increases, Qd

decreases, thus a negative income elasticity of demand

Cross-Price Elasticity of Demand =

Substitute goods and CPEd = as the price of Good 2

increases, Qd of Good 1 increases, thus a positive CPEd

Complementary goods and CPEd = as the price of Good 2

increases, Qd of Good 1 decreases, thus a negative CPEd

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