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The Elasticity of Demand
Chapter 7
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The Concept of Elasticity
• Elasticity is a measure of theresponsiveness of one variable to another.
•The greater the elasticity, the greater theresponsiveness.
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Laugher Curve
Q. What’s the difference between aneconomist and a befuddled old man withAlzheimer’s?
A. The economist is the one with acalculator.
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The Concept of Elasticity
• Elasticity is a measure of theresponsiveness of one variable to another.
•The greater the elasticity, the greater theresponsiveness.
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Price Elasticity
• The price elasticity of demand is thepercentage change in quantity demandeddivided by the percentage change in price.
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Sign of Price Elasticity
• According to the law of demand, whenever the price rises, the quantity demanded falls.Thus the price elasticity of demand isalways negative.
• Because it is always negative, economistsusually state the value without the sign.
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What Information PriceElasticity Provides
• Price elasticity of demand and supplygives the exact quantity response to achange in price.
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Classifying Demand and Supplyas Elastic or Inelastic
• Demand is elastic if the percentagechange in quantity is greater than thepercentage change in price.
E > 1
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Classifying Demand and Supplyas Elastic or Inelastic
• Demand is inelastic if the percentagechange in quantity is less than thepercentage change in price.
E < 1
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Elastic Demand
• Elastic Demand means that quantitychanges by a greater percentage than thepercentage change in price.
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Inelastic Demand
• Inelastic Demand means that quantitydoesn't change much with a change inprice.
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Defining elasticities
• When price elasticity is between zero and -1we 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 isunit elastic .
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Elasticity Is Independent of Units
• Percentages allow us to have a measureof responsiveness that is independent of units.
• This makes comparisons of responsiveness of different goods easier.
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Calculating Elasticities
• To determine elasticity divide thepercentage change in quantity by thepercentage change in price.
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The End-Point Problem
• The end-point problem – the percentagechange differs depending on whether youview the change as a rise or a decline in
price.
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The End-Point Problem
• Economists use the average of the endpoints to calculate the percentage change.
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Graphs of Elasticities
Pric
e
Quantity of software (in hundred thousands)
$26
24
22
20
18
16
14
0
D
B
A
10 12 14
C (midpoint)
Elasticity of
demand betweenA and B = 1.27
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Calculating Elasticities: Priceelasticity of Demand
D
P
Q
What is the price elasticity of demand between A and B?
$20
10
$26
14
MidpointB
A
ED = %ΔQ%ΔP
Q2–Q1
½(Q2+Q1)P2–P1
½(P2+P1)
=
C
12
$23
=
10–14
½(10+14)26–20½(26+20)
-.33.26= 1.27 =
7-18
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Price Elasticity: Supply
• Price elasticity of supply is the percentage change inquantity supplied divided by the percentage change in
• This tells us exactly how quantity supplied responds to
a change in price
ES =
• Elasticity is independent of units
% change in Quantity Supplied% change in Price
7-19
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Price Elasticity: Supply
• Supply is elastic if the percentagechange in quantity is greater than thepercentage change in priceElastic supply is when ES > 1
• Supply is inelastic if the percentage change in quantityis less than the percentage change in price
Inelastic supply is when ES < 1
7-20
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Calculating Elasticities: Price
elasticity of SupplyP
Q
What is the price elasticity of supply between A and B?
$4.50
476
$5.00
485
B
A
ES = %ΔQ%ΔP
Q2–Q1
½(Q2+Q1)P2–P1
½(P2+P1)
=
=
485–476
½(485+476)5–4.50½(5+4.50)
Midpoint
C
480.5
$4.75
0.01870.105= 0.18=
S
7-21
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Graphs of Elasticities
Elasticity of supply between Aand B = 0.18
Wage per hour
Quantity of workers
$6.00
5.50
5.00
4.504.00
3.50
3.00
0
C B
A
470
(midpoint)
480 490
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Calculating Elasticity
)PP(
PP)QQ(
P%Q% E
2121
12
2121
12
+−+−
=∆∆=
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Calculating Elasticity of Demand
Between Two Points
27.126.
33.
23
612
4
)2026(
2026
)1014(
1410
E
2
1
2
1
D=−=
−=
+−+−
=Price
Quantity of software (in hundred thousands)
$26
24
22
20
18
16
14
0
Demand
B
A
10 12 14
Cmidpoint
Elasticity of demandbetween A and
B:
P%
Q% E ∆
∆=
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Calculating Elasticity of SupplyBetween Two Points
P%
Q%
E ∆∆=
Wage pe
r hour
Quantity of workers
$6.00
5.50
5.00
4.504.00
3.50
3.00
0
C B
A
470 480 490
Elasticity of supply between
A and B:
2.105.
021.
75.4
50.480
10
)50.45(
50.45
)475485(
475485
E
21
21
S ===
+−
+−
=
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Calculating Elasticity at a Point
• Let us now turn to a method of calculatingthe elasticity at a specific point, rather thanover a range or an arc.
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Calculating Elasticity at a Point
• To calculate elasticity at a point, determinea range around that point and calculatethe arc elasticity.
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Calculating Elasticity at a Point
Price
Quantity
$10987654321
C
BA
24 402820
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Calculating Elasticity at a Point
Price
Quantity
$10987654
321
C
BA
24 402820
To calculate elasticity at a point determinea range around that point and calculatethe arc elasticity.
66.5.
33.
4
224
8
)35(
35
)2028(2028
E
21
21
Aat ===+−+−
=
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Elasticity and Demand Curves
• Two important points to consider:
– Elasticity is related (but is not the same as)slope.
– Elasticity changes along straight-line demandand supply curves.
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Calculating Elasticity at a Point
6 12 18 30 36 42 48
Price
Quantity
8
76543
21
$109
A
24 6054
D
B
C
Supply E A = 2.33
E B
= 0.11
Demand
E C = 0.75
E D = 0.86
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Elasticity and Demand Curves
• Two important points to consider:
– Elasticity is related (but is not the same as)slope.
– Elasticity changes along straight-line demandand supply curves.
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Elasticity Is Not the Same asSlope
• The steeper the curve at a given point, theless elastic is supply or demand.
• There are two limiting examples of this.
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Elasticity Is Not the Same asSlope
• When the curves are flat, we call thecurves perfectly elastic.
• The quantity changes enormously inresponse to a proportional change in price(E = ∞).
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Elasticity Is Not the Same asSlope
• When the curves are vertical, we call thecurves perfectly inelastic.
• The quantity does not change at all inresponse to an enormous proportionalchange in price (E = 0 ).
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Perfectly inelasticdemand curve
Price
0Quantity
Perfectly Inelastic DemandCurve
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Perfectly elasticdemand curve
Perfectly Elastic Demand Curve
Price
0Quantity
D d C
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Demand CurveShapes and Elasticity
• Perfectly Elastic Demand Curve– The demand curve is horizontal, any change in price can and
will cause consumers to change their consumption.
• Perfectly Inelastic Demand Curve– The demand curve is vertical, the quantity demanded is totally
unresponsive to the price. Changes in price have no effect onconsumer demand.
• In between the two extreme shapes of demand curvesare the demand curves for most products.
D d C
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Demand CurveShapes and Elasticity
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Elasticity Changes AlongStraight-Line Curves
• Elasticity is not the same as slope.
• Elasticity changes along straight linesupply and demand curves–slope doesnot.
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Elasticity Along a Demand Curve
Pric e
$1098
76543
21
0 1 2 3 4 5 6 7 8 9 10 Quantity
Elasticity declines alongdemand curve as we move
toward the quantity axis
Ed = 1
Ed = 0
Ed < 1
Ed > 1
Ed = ∞
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The Price Elasticity of Demand Along aStraight-line Demand Curve
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Substitution and Elasticity
• As a general rule, the more substitutes agood has, the more elastic is its supplyand demand.
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Substitution and Demand
• The less a good is a necessity, the moreelastic its demand curve.
• Necessities tend to have fewer substitutesthan do luxuries.
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Substitution and Demand
• Demand for goods that represent a largeproportion of one's budget are moreelastic than demand for goods that
represent a small proportion of one'sbudget.
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Substitution and Demand
• Goods that cost very little relative to your total expenditures are not worth spendinga 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 largeportion of one’s income.
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Substitution and Demand
• The larger the time interval considered, or the longer the run, the more elastic is thegood’s demand curve.
– There are more substitutes in the long runthan in the short run.
– The long run provides more options for
change.
Determinants of the
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Determinants of thePrice 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 theconsumer’s total budget
– The time period under consideration