Elasticity

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Elasticity
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A Market Equilibrium
Price
S
6
5
4
3
2
1
D
0 2 4 6 8 10
Quantity
3
A Market Equilibrium
Price
6
5
4
3
2
1
DA
DB
0 2 4 6 8 10
Quantity
4
Elastic and Inelastic Demand Curves

• Elastic demand - quantity demanded is sensitive
  to small price changes.

• Easy to substitute away from good.
• Inelastic demand - quantity demanded is not
  sensitive to price changes.
• Difficult to substitute away from good.

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Measure of Elasticity

• A percent change in X ?X/X
• Elasticity Percent change in quantity-demanded
• Percent change in
  price
• (Q2 - Q1)/Q1
• (P2 - P1)/P1

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Example Cut price from 7.00 to 5.50 and
quantity sold goes from 100 to 130. Elasticity
(Q2 - Q1)/Q1 (P2 - P1)/P1
(130 - 100) / 100
(5.50 - 7.00) / 7.00
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If demand is perfectly inelastic (elasticity0),
the demand curve will be
a vertical line.
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If demand is perfectly elastic (elasticityinfinit
y), the demand curve will be
a horizontal line.
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• Elasticity ? (Q2 - Q1)/Q1
• (P2 - P1)/P1
• Categorizing Elasticities
• 1) Inelastic
• If the absolute value of demand elasticity is
  less than one,
• then demand is inelastic. ? lt 1
• or if
• change in Qd lt change in P
• for example, P increases by 10 and Qd
  only falls by 6
• 2) Elastic
• If the absolute value of demand elasticity is
  greater than
• one, then demand is elastic. ? gt 1
• or if
• change in Qd gt change in P
• for example, P increases by 10 and Qd
  falls by 14

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Determinants of Price Elasticity

• 1. Availability of Substitutes
• the better the substitutes available, the more
  elastic the demand

• 2. Share of the total budget expended
• the larger the share of ones budget spent on a
  good, the more
• elastic the demand

• 3. Time to adjust to price change
• the longer the time period for adjusting to a
  price change, the
• greater will be the responsiveness of quantity
  demanded

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Long-run v. Short-run
Price
DLONG-RUN
DSHORT-RUN
Quantity