ELASTICITY OF DEMAND
Dr.
Khurram Iftikhar
Elasticities of Demand and Supply
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MICROECONOMICS
Lecture 09
Elasticities of Demand and Supply
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Elasticity
 Elasticity measure the responsiveness between
two variables.
 Three types of Elasticity.
Price Elasticity
Income Elasticity
Cross Elasticity
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Price Elasticity of Demand
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PRICE ELASTICITY OF DEMAND
 Price Elasticity of Demand
Definition
The price elasticity of demand is the ratio of the percentage change
in the quantity demanded to the percentage change in price.
Price elasticity of
=
demand
Percentage change in quantity demanded
Percentage change in price
It is a measure of the extent to which the quantity demanded of a
good changes when the price of the good changes.
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PRICE ELASTICITY OF DEMAND
 Calculating the Price Elasticity of Demand
Problem
Suppose Superstore raises the price of Tea from $3 to $5 a cup. The
price increase is 66.67 percent of the initial $3 price.
Now, suppose Superstore lowers the price from $5 to $3. The price
decrease is 40 percent of the initial $5 price.
The same price change, $2, over the same interval, $3 to $5, is a
different percentage change depending on whether the price rises or
falls.
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PRICE ELASTICITY OF DEMAND
 Calculating the Price Elasticity of Demand
Solution
We need a measure of percentage change that does not depend on the
direction of the price change.
We use the average of the initial price and the new price to measure
the percentage change in price.
Similarly, we use the average of the initial quantity and the new
quantity to measure the percentage change in quantity.
This is called the midpoint method for computing the elasticity.
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PRICE ELASTICITY OF DEMAND
Calculating Demand
Elasticity: Example
If Superstore raises the price of a
Tea from $3 to $5 a cup, the
quantity demanded decreases from
15 to 5 cups per hour.
The quantity decrease is 100% of
the average quantity.
The price increase is 50% of the
average price.
The price elasticity of demand
equals 100% divided by 50%, or 2.
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5.1 THE PRICE ELASTICITY OF
DEMAND
 Percentage Change in Price
Suppose Starbucks raises the price of a latte from $3 to $5 a
cup. What is the percentage change in price?
New price – Initial price
Percent change in price =
x 100
Initial Price
$5 – $3
Percent change in price =
x 100 = 66.67 percent
$3
5.1 THE PRICE ELASTICITY OF
DEMAND
Suppose Starbucks cuts the price of a latte from $5 to $3
a cup. What is the percentage change in price?
New price – Initial price
Percent change in price =
x 100
Initial Price
$3 – $5
Percent change in price =
$5
x 100 = – 40 percent
PRICE ELASTICITY OF DEMAND
 Comment
Minus sign
Because of the Law of Demand, when the price rises, the quantity
demanded decreases. Price and quantity demanded always change in
opposite directions.
Therefore, the elasticity of demand calculated by the midpoint
formula is always negative. So we ignore the minus sign and use
absolute values.
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PRICE ELASTICITY OF DEMAND
 Elastic and Inelastic Demand
Based on the coefficient of elasticity, the demand for
any good can be classified into one of five categories
•
•
•
•
•
Elastic
Unit elastic
Inelastic
Perfectly elastic
Perfectly inelastic
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PRICE ELASTICITY OF DEMAND
 Elastic and Inelastic Demand
Demand is elastic if
• the percentage change in quantity demanded is greater than
the percentage change in price
• the coefficient of the elasticity of demand is greater than 1.
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PRICE ELASTICITY OF DEMAND
Elastic Demand
When the price of a Sony
Playstation rises by 10%, . . .
the quantity demanded decreases by
20%.
The decrease in quantity demanded
is greater than the increase in price.
Therefore, demand for Sony
Playstations is elastic.
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PRICE ELASTICITY OF DEMAND
 Elastic and Inelastic Demand
Demand is unit elastic if
• the percentage change in quantity demanded is the same as the
percentage change in price
• the coefficient of the elasticity of demand equals 1.
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PRICE ELASTICITY OF DEMAND
Unit Elastic Demand
When the price of a trip rises by
10%, . . .
the quantity demanded of trips
decreases by 10%.
The decrease in quantity demanded
is the same as the increase in price.
Therefore, the demand for trips is
unit elastic.
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PRICE ELASTICITY OF DEMAND
 Elastic and Inelastic Demand
Demand is inelastic if
• the percentage change in quantity demanded is smaller than the
percentage change in price
• the coefficient of the elasticity of demand is less than 1.
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PRICE ELASTICITY OF DEMAND
Inelastic Demand
When the price of gum rises by
20%, . . .
the quantity demanded decreases by
10%.
The decrease in quantity demanded
is smaller than the increase in price.
Therefore, the demand for gum is
inelastic.
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PRICE ELASTICITY OF DEMAND
 Elastic and Inelastic Demand
Demand is perfectly elastic if
• the quantity demanded changes by a very large percentage in
response to an almost zero percentage change in price.
• the coefficient of the elasticity of demand is infinite (the
numerator is very large and the denominator is infinitesimally
small).
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PRICE ELASTICITY OF DEMAND
Special Case: Perfectly
Elastic Demand
For even a very small change in the
price of spring water, . . .
the quantity demanded of spring
water changes by a very large
amount.
The change in the quantity
demanded is much (infinitely)
larger than the change in price.
Therefore, the demand for spring
water is perfectly elastic.
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PRICE ELASTICITY OF DEMAND
 Elastic and Inelastic Demand
Demand is perfectly inelastic if
• the percentage change in quantity demanded is zero when the
price changes.
• the coefficient of the elasticity of demand equals 0.
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PRICE ELASTICITY OF DEMAND
Special Case: Perfectly
Inelastic Demand
When the price rises, . . .
the quantity demanded does not
change.
There is no change in the quantity
demanded when price changes.
Therefore, demand is perfectly
inelastic.
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PRICE ELASTICITY OF DEMAND
 Comments
Elasticity is independent of units of measurement
Elasticity is independent of the units used to measure price and
quantity.
Because it is the ratio of two percentages, it is a number with no
units. For example, the elasticity of demand for Tea is simply 2.
Elasticity allows us to compare the demands for different goods. For
example, we can compare the elasticity of demand for latte with the
elasticity of demand for baseball tickets.
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PRICE ELASTICITY OF DEMAND
 Comments
Elasticity is not the same as slope
Unlike elasticity, slope depends on the units of measurement of price
and quantity. For example, the slope of the demand curve for latte
has the units “dollars per cup”.
Slope cannot be used to compare the demands for different goods
because the slopes have different units.
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PRICE ELASTICITY OF DEMAND
Elasticity and Slope:
Example
Along a linear (straight-line)
demand curve, the slope is constant
but the elasticity decreases as the
price falls.
At any price above the midpoint,
demand is elastic.
At the midpoint, demand is unit
elastic.
At any price below the midpoint,
demand is inelastic.
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