THE ELASTICITY OF DEMAND (AND
JUST ABOUT ANYTHING)
THE CONCEPT: THE ELASTICITY OF STEEL VS.
RUBBER
HOW MUCH DOES ONE THING CHANGE IN
RESPONSE TO A CHANGE IN SOMETHING
ELSE?
THE CONCEPT OF ELASTICITY IS USED IN
ENGINEERING & MANY BUSINESS FIELDS &
ECONOMISTS USE SEVERAL DIFFERENT
TYPES OF ELASTICITY MEASURES
1.
(OWN) PRICE ELASTICITY OF DEMAND
Ed = ELASTICITY COEFFICIENT
% CHANGE IN QUANTITY DEMANDED
= --------------------------------------------------------% CHANGE IN PRICE
A NOTE ABOUT THE SIGN (NEGATIVE VS.
POSITIVE): FOR OWN PRICE ELASTICITY, THE
SIGN IS ALWAYS NEGATIVE, SO WE IGNORE
IT. (CAN’T DO THAT WITH OTHER KINDS OF
ELASTICITY)
TERMINOLOGY
INELASTIC
Ed < 1
THIS MEANS QUANTITY DOES NOT CHANGE
MUCH RELATIVE TO PRICE
UNIT ELASTIC
Ed = 1
THIS MEANS QUANTITY DEMANDED
CHANGES PROPORTIONALLY TO PRICE
ELASTIC
Ed > 1
THIS MEANS QUANTITY DEMANDED
CHANGES MORE THAN PRICE
A CAUTION ABOUT SAYING DEMAND IS
“ELASTIC” OR “INELASTIC” (ELASTICITY IS
NOT THE SAME AS SLOPE)
ELASTICITY IS ALWAYS RELATIVE TO
WHERE YOU ARE ON A DEMAND CURVE OR
BETWEEN TWO OR MORE DEMAND CURVES.
P
%Δ Q
3–4
%Δ P
10 – 8
- 1/3
- 0.33
Ed = ------ = ---------- = ----- = ------ =- - 1.65
2/10
0.20
$10
$8
%Δ Q
9 – 10
%Δ P
2-1
- 1/9
- 0.11
1/2
0.50
Ed = ------ = ---------- = ----- = ------ =- - 0.22
$2
$1
D
3
4
9
10
Q
WHY DO WE CARE?
KNOWING PRICE ELASTICITY ALLOWS US TO BE
ABLE TO PREDICT

CHANGES IN THE QUANTITY DEMANDED IN
RESPONSE TO PRICE CHANGES

CHANGES IN REVENUES
ELASTICITY: SOME ADDITIONAL
COMMENTS
AVAILABILITY OF SUBSTITUTES (MORE
CONSUMER CHOICE) INCREASES
ELASTICITY
DEFINING MARKETS AND PRODUCT LINES,
E.G.,
THE DEMAND FOR PEPSI IS MUCH MORE ELASTIC
THAN THE DEMAND FOR “COLA”
THE DEMAND FOR BUDWEISER IS MUCH MORE
ELASTIC THAN THE DEMAND FOR “BEER”
ELASTICITY AND TIME: THE LONGER THE
PERIOD THAT CONSUMERS HAVE TO
ADJUST, THE MORE ELASTIC DEMAND.
EXAMPLES: GASOLINE, ELECTRICITY
THE BIGGER THE PRICE INCREASE, THE MORE
ELASTIC THE DEMAND.
MOVING TO A MORE ELASTIC PART OF THE
DEMAND CURVE
MAKES CONSUMERS MORE WILLING TO
BEAR SEARCH AND TRANSACTIONS COSTS
TO FIND SUBSTITUTES, ETC.
CALCULATING ELASTICITY
MEASURING ELASTICITY IS SENSITIVE TO HOW
YOU DO IT & INFORMATION AVAILABLE
IF ALL YOU KNOW IS THAT Q CHANGED X% & P
CHANGED Y%, THEN ALL YOU CAN DO IS:
Ed = (X%)/(Y%)
FOR EXAMPLE, IF THE PRICE OF GASOLINE RISES
10% AND QUANTITY DEMANDED FALLS 1%:
Ed = (1%)/(10%) = 0.1, I.E., INELASTIC
IF WE KNOW PRICES AND QUANTITIES THEN WE
CAN BE MORE PRECISE:
Q2-Q1
P1
Ed = --------- X ---------Q1
P2-P1
ARC ELASTICITY
THE PROBLEM OF MEASURING ELASTICITY IS
RESOLVED BY USING AN AVERAGING
METHOD
Q2 - Q1
P2 – P1
Ed = -------------- ÷ -------------(Q1 + Q2)/2
(P2 + P1)/2
Q2 - Q1
P2 + P1
Ed = --------- x ---------Q1 + Q2
P2 – P1
AN EXAMPLE: SELLING 2X4s
@ 49¢ ea. WE SOLD 12,000 PER WEEK
WE DROPPED THE PRICE TO 39¢, SALES
INCREASED TO 14,000
WHAT IS THE PRICE ELASTICITY OF DEMAND
AND WHAT DOES IT IMPLY FOR PRICING
POLICY?
14,000 - 12,000
.39 + .49
Ed = -------------------- x ------------12,000 + 14,000 .39 - .49
2,000
.88
Ed = --------- x ------- = (.0769) X (-8.8) = - 0.69
26,000
-.10
IN OTHER WORDS, DEMAND WAS INELASTIC, AND
YOU SHOULD RAISE PRICES TO INCREASE
REVENUES.
PROBLEM: THE MARK-UP ON MOST LUMBER WAS
10 - 20%. THE MARK-UP ON HARDWARE,
PAINTS, ETC. THAT WE ALSO SOLD RANGED
FROM 50 - 250%.
WE DON’T CARE IF WE LOSE MONEY ON 2X4s WE
WANT TO GET THEM IN THE STORE AND SELL
THEM OTHER STUFF (LOSS LEADER)
CROSS-PRICE ELASTICITY
HOW DOES THE CHANGE IN THE PRICE OF ONE
GOOD, LIKE 2X4s, CHANGE THE QUANTITY
DEMANDED (SHIFT THE DEMAND CURVE)
FOR OTHER GOODS, LIKE HARDWARE?
% CHANGE IN THE QUANTITY
DEMANDED OF GOOD “A”
EC = -------------------------------------------------------% CHANGE IN THE PRICE OF GOOD “B”
NOW, THE SIGN OF THE COEFFICIENT IS
IMPORTANT
IF EC > 0 ---> SUBSTITUTE GOODS
IF EC < 0 ---> COMPLEMENTARY GOODS
IF EC = 0 ---> UNRELATED GOODS
MONOPOLY? THE ALCOA CASE
INCOME ELASTICITY
MEASURES THE CHANGE IN QUANTITY
DEMANDED (SHIFT IN THE DEMAND CURVE)
RESULTING FROM A CHANGE IN
CONSUMERS’ INCOMES
% CHANGE IN THE QUANTITY DEMANDED
EY = -------------------------------------------------------------% CHANGE IN CONSUMERS’ INCOMES
AGAIN, THE SIGN MATTERS, IT TELLS WHETHER
THE DEMAND CURVE IS SHIFTING OUT (+) OR
IN (-)
IF EY > 0 ---> “NORMAL GOOD”
EXAMPLES: CLOTHING, CD’s, GASOLINE
IF EY > 0 AND LARGE ---> “LUXURY GOOD”
EXAMPLES: VARIETAL WINES (IN U.S.), FILET
MIGNON, CHICKEN (IN THE 1930’s)
IF EY < 0 ---> “INFERIOR GOOD”
EXAMPLES: ROOT VEGATABLES, GRITS
WHAT IS A NORMAL GOOD IN ONE PLACE AND
TIME MAY NOT BE IN ANOTHER
THE ELASTICITY OF JUST ABOUT
ANYTHING
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