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Elasticity |
A measure of how much one economic variable responds to changes in another economic value |
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Equation of Price Elasticity of Demand |
Percentage change in quantity demanded/ Percentage change in price |
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Price Elasticity of Supply |
The responsiveness of the quantity supplied to a change in price, measured by dividing the percentage change in the quantity supplied of a product by the percentage change in the product’s price |
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Price Elasticity of Demand |
The responsiveness of the quantity demanded to a change in price, measured by dividing the percentage change in the quantity demanded of a product by the percentage change in the product’s price |
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Formula for Price Elasticity of Demand |
Percentage change in quantity demanded/ Percentage change in price |
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Remember that the price elasticity of demand is… |
Not the same as the slope of the demand curve |
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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 |
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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 |
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Elastic Demand |
Demand is elastic when the percentage change in the quantity demanded is greater than the percentage change in price, so the price elasticity is greater than 1 in absolute value |
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Inelastic Demand |
Demand is inelastic when the percentage change in quantity demanded is less than the percentage change in price, so the price elasticity is less than 1 in absolute value |
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Unit-Elastic Demand |
Demand is unit elastic when the percentage change in quantity demanded is equal to the percentage change in price, so the price elasticity is equal to 1 in absolute value |
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Equation of Price Elasticity of Demand – Also known as the Midpoint Formula |
(Q2-Q1)/[(Q1+Q2)/2] / (P2-P1)/[(P1+P2)/2] |
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Perfectly Inelastic Demand |
The case where the quantity demanded is completely unresponsive to price and the price elasticity of demand equals zero. The graph is a vertical line Example: The drug insulin. If the price of insulin declines, it will not affect the required dose and therefore it will not increase the quantity demanded. Similarly, a price increase will not affect the required dose or decrease the quantity demanded |
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When it comes to a demand curve being perfectly inelastic, |
The quantity demanded is completely unresponsive to price, and the price elasticity of demand equals zero |
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Perfectly Elastic Demand |
The case where the quantity demanded is infinitely responsive to price and the price elasticity of demand equals infinity. The graph is a horizontal line |
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If demand is elastic, |
Then the absolute value of price elasticity is greater than 1 |
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If demand is inelastic, |
Then the absolute value of price elasticity is less than 1 |
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If demand is unit elastic, |
Then the absolute value of price elasticity is equal to 1 |
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If demand is perfectly elastic, |
Then the absolute value of price elasticity is equal to infinity (Horizontal line) |
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If demand is perfectly inelastic, |
Then the absolute value of price elasticity is equal to 0 (Vertical line) |
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Key Determinants of the Price Elasticity of Demand |
1. Availability of close substitutes to the good 2. The passage of time 3. Whether the good is a luxury or a necessity 4. The definition of the market 5. The share of the good in the consumer’s budget |
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What is the most important determinant of price elasticity of demand? |
The availability of substitutes |
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If a product has more substitutes available, |
It will have more elastic demand |
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If a product has fewer substitutes available, |
It will have less elastic demand |
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The more time that passes, |
The more elastic the demand for a product becomes |
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The demand curve for a luxury is more elastic than |
The demand curve for a necessity |
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In a narrowly defined market, |
Consumers have more substitutes available |
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The more narrowly we define a market, |
The more elastic demand will be |
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The demand for a good will be more elastic… |
The larger the share of the good in the average consumer’s budget |
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Total Revenue |
The total amount of funds a seller receives from selling a good or service, calculated by multiplying price per unit by the number of units sold |
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When demand is inelastic, price and total revenue move… |
In the same direction |
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When demand is elastic, price and total revenue move… |
Inversely |
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If demand is elastic, then an increase in price reduces revenue because |
The decrease in quantity demanded is proportionally greater than the increase in price |
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If demand is elastic, then a decrease in price increases revenue because |
The increase in quantity demanded is proportionally greater than the decrease in price |
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If demand is inelastic, then an increase in price increases revenue because |
The decrease in quantity demanded is proportionally smaller than the increase in price |
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If demand is inelastic, then a decrease a price reduces revenue because |
The increase in quantity demanded is proportionally smaller than the decrease in price |
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If demand is unit elastic, then an increase in price does not affect revenue because |
The decrease in quantity demanded is proportionally the same as the increase in price |
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If demand is unit elastic, then a decrease in price does not affect revenue because |
The increase in quantity demanded is proportionally the same as the decrease in price |
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Cross-price Elasticity of Demand |
The percentage change in the quantity demanded of one good divided by the percentage change in the price of another good |
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Equation of Cross-Price Elasticity of Demand |
Percentage change in quantity demanded of one good/ Percentage change in price of another good |
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The cross-price elasticity of demand is positive or negative, depending on… |
Whether the two products are substitutes or compliments |
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An increase in the price of a substitute will lead to an increase in the quantity demanded, |
So the cross-price elasticity of demand will be positive |
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An increase in the price of a complement will lead to a decrease in the quantity demanded, |
So the cross-price elasticity of demand will be negative |
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If the products are unrelated, then the cross-price elasticity of demand will be |
Zero |
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If the income elasticity of demand is positive but less than 1, |
Then the good is normal and a necessity |
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If the income elasticity of demand is positive and greater than 1, |
Then the good is normal and a luxury |
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If the income elasticity of demand is negative, |
Then the good is inferior |
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Income Elasticity of Demand |
A measure of the responsiveness of the quantity demanded to changes in income, measured by the percentage change in the quantity demanded divided by the percentage change in income |
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Equation of Income Elasticity of Demand |
Percentage change in quantity demanded/ Percentage change in income |
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We know that from the law of supply that when the price of a product increase, |
The quantity supplied increases |
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Equation of Price Elasticity of Supply |
Percentage change in quantity supplied/ Percent change in price |
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If the price elasticity of supply is less than 1, |
Then supply is inelastic |
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If the price elasticity of supply is greater than 1, |
Then supply is unit elastic |
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Whether supply is elastic or inelastic depends on… |
The ability and willingness of firms to alter the quantity they produce as price increases |
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If a supply curve is a vertical line, |
It is perfectly inelastic The quantity supplied is completely unresponsive to price, and the price elasticity of supply equals zero Example: A parking lot may have only a fixed number of parking spaces. If a demand increases, the price to park in the lot may rise, but no more spaces will become available |
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If a supply curve is a horizontal line, |
It is perfectly elastic The quantity supplied is infinitely responsive to price, and the price elasticity of supply equals infinity |
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If supply is elastic, |
Then the value of price elasticity is greater than 1 |
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If supply is inelastic, |
Then the value of price elasticity is less than 1 |
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If supply is unit elastic, |
Then the value of price elasticity is equal to 1 |
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If supply is perfectly elastic, |
Then the value of price elasticity is equal to infinity |
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If the supply is perfectly inelastic, |
Then the value of price elasticity is equal to 0 |
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