Econ 201
Chpt. 5
Demand Elasticity
Own & Cross-price
What Does Elasticity Measure
• Price sensitivity of demand
– Own price:
• measures how much qty demanded changes as
(own) good’s price changes
– Cross price: measures how much qty
demanded changes as another good’s price
(substitute or complement) changes
• For “close” substitutes -> larger change in quantity
demanded (larger shift in own good’s demand
curve)
Demand Curves
Key Points About Demand Curves
• How much is demanded at what price?
– Signals to firms how much customers are willing to
pay for a good or service
• How responsive is demand to price?
– For the short term: what is the slope of the demand
curve
y2  y1
y
slope (b) 

x
x2  x1
Calculating the Slope
y y2  y1
slope (b) 

x x2  x1
A Hypothetical Demand Curve
Demand & Marginal Value (in use)
Price
MV of 1st unit
consumed =
$10
Qty Demanded
$10
$12
1
$9
2
$8
3
$7
4
$6
5
$5
6
$4
Demand or MV (in $)
$10
$10
$9
$8
$8
$7
$6
$6
$4
Price = $5 =>
$5 buy 6 units
$4
$3
$2
$2
$1
7
$0
$3
8
$2
9
$1
10
1
2
3
4
5
6
7
Quantity Demanded
8
9
10
Calculating the Slope
y y2  y1 $10  $9 $1
slope (b)  

  1
x x2  x1
1  2 1
Price Sensitivity of Demand
• Economist use the price elasticity of demand to
summarize how responsive quantity demanded is to
price
• Demand curves are not always linear; and
responsiveness can change with price
% change in Qd
elasticity 
% change in price
Calculating Elasticity
• Elasticity is calculated at a point on the demand curve
– Several choices:
• Initial point, final point, average (arc) elasticity
– At $5 -> Qd = 6; At $6 ->Qd = 7
– Elasticity of demand (intital point):
(Q1  Q2 ) / Q1
(6  7) / 6
(1/ 6)
5
 



( P1  P2 ) / P1 ($5  $4) / $5 (1/ 5)
6
d
Own-Price Elasticity
Price
Qty Demanded
$10
$9
$8
$7
$6
$5
$4
$3
$2
$1
1
2
3
4
5
6
7
8
9
10
Elasticity
-10.00
-4.50
-2.67
-1.75
-1.20
-0.83
-0.57
-0.38
-0.22
Demand and Own-price Elasticity
0.00
$12
1
2
3
4
5
6
7
8
9
1
-2.00
$10
-4.00
$8
-6.00
$6
-8.00
$4
-10.00
$2
-12.00
$0
Elasticity
Price
Demand Elasticity
Own Price
• Always negative
– First law of demand
• Talk about it in absolute terms
– Less than |1| -> inelastic
– Equal to |1| -> unit elastic
– More than |1| -> (highly) elastic
Demand Elasticity
Cross-price
• Substitutes
– Demand (schedule) shifts right if price of
substitute increases
• Quantity demanded will increase
• cross-price elasticity is always (+) positive
• Complements
– Demand shifts left with increase in price of a
substitute
• Cross-price elasticity is always (-) negative
What Does the Magnitude of the
Elasticity Tell Us?
• Own-price
– Larger absolute value (|e| > 1)
• Large changes in Qd with small changes in price
– Close substitutes exist (pepsi/coke)
– Or much consumption is discretionary (micro-brews)
– Cross-price
• Large value (e >1)
– Close (or good) substitute for good exists
– Complements
• Large absolute value (|e| > 1)
• Consumption in fixed proportions