Elasticity: Measuring the Responsiveness of Demand

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ElasticityMeasuring the Responsiveness of Demand

• Dr. D. Foster - Microeconomics

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Elasticity

• A measure of responsiveness . . .
• Price elasticity of demand P and QD
• Income elasticity of demand Y and QD
• Cross price elasticity of demand PZ and QD-X
• Price elasticity of supply P and QS

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Price Elasticity of Demand

• ?D E(Qd,P) ?QD/ ?P
• Responsive if ?D gt 1 and demand is elastic.
• Unresponsive if ?D lt 1 and demand is inelastic.
• Note Technically, calculated ?D is always lt0.

? percentage change in
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Price Elasticity of Demand

• ?D E(Qd,P) ?QD/ ?P
• Perfectly elastic
• ?D ?
• Perfectly inelastic
• 
  ?D 0

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Price Elasticity of Demand

• ?D E(Qd,P) ?QD/ ?P
• How to calculate this . . .
• Easy if the ? is given for both.
• or, find the ? from the base.
• or, find the ? from the average.

?D 5/97.5 .10/1.05 .538
What is elasticity if price rises by 10 and
quantity demanded falls by 5?
What is elasticity if price rises from 1 to
1.10 and quantity demanded falls from 100 to 95?
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Price Elasticity of Demand

• Determinants of elasticity . . .
• The degree of substitutes available more
  substitutes more elastic
• Amount of budget spent on this good higher
  proportion spent more elastic
• Relative importance of this good more of a
  luxury more elastic
• Time to respond to price change more time
  more elastic

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Income Elasticity of Demand

• ?Y E(Qd,I) ?QD/ ?Income
• Responsive if ?Y gt 1 and demand is elastic.
• Unresponsive if ?D lt 1 and demand is inelastic.
• Note ?Y can be positive or negative.
• Positive normal goods
• Negative inferior goods
• Factor affecting elastic/inelastic luxury vs.
  necessity

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Cross Price Elasticity of Demand

• ?XZ E(Qd,Pog) ?QD-X/ ?PZ
• X Z are substitutes if ?XZ gt 0 (positive)
• X Z are complements if ?XZ lt 0 (negative)
• Note We still refer to demand as elastic if the
  value (in absolute terms) exceeds 1.(or
  inelastic if between 0 and 1, respectively)

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Price Elasticity of Supply

• ?S E(Qs,P) ?QS/ ?P
• Responsive if ?S gt 1 and supply is elastic.
• Unresponsive if ?S lt 1 and supply is inelastic.
• Note ?S is most likely to be positive, since the
  supply curve has a positive slope.
• Factors affecting elastic vs. inelastic
• time to adjust ease of storage cost of ?output

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ElasticityMeasuring the Responsiveness of Demand

• Dr. D. Foster - Microeconomics