APPLIED ECONOMICS-

5.1 Price Elasticity of Demand and Price

Elasticity of Supply
Learning Objectives

By the end of this section, you will be able to:

 Calculate the price elasticity of demand
 Calculate the price elasticity of supply

Both the demand and supply curve show the relationship between price and the number of units
demanded or supplied. Price elasticity is the ratio between the percentage change in the quantity
demanded (Qd) or supplied (Qs) and the corresponding percent change in price. The price
elasticity of demand is the percentage change in the quantity demanded of a good or service
divided by the percentage change in the price. The price elasticity of supply is the percentage
change in quantity supplied divided by the percentage change in price.

Elasticities can be usefully divided into three broad categories: elastic, inelastic, and unitary. An
elastic demand or elastic supply is one in which the elasticity is greater than one, indicating a
high responsiveness to changes in price. Elasticities that are less than one indicate low
responsiveness to price changes and correspond to inelastic demand or inelastic supply.
Unitary elasticities indicate proportional responsiveness of either demand or supply, as
summarized in Table 1.

If . . . Then . . . And It Is Called . . .

Elastic
Unitary
Inelastic
Table 1. Elastic, Inelastic, and Unitary: Three Cases of Elasticity
To calculate elasticity, instead of using simple percentage changes in quantity and price,
economists use the average percent change in both quantity and price. This is called the Midpoint
Method for Elasticity, and is represented in the following equations:

The advantage of the is Midpoint Method is that one obtains the same elasticity between two
price points whether there is a price increase or decrease. This is because the formula uses the
same base for both cases.

Calculating Price Elasticity of Demand

Let’s calculate the elasticity between points A and B and between points G and H shown in
Figure 1.

Figure 1. Calculating the Price Elasticity of Demand. The price elasticity of demand is calculated as the
percentage change in quantity divided by the percentage change in price.

First, apply the formula to calculate the elasticity as price decreases from $70 at point B to $60 at

point A:

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Therefore, the elasticity of demand between these two points is  which is 0.45, an amount
smaller than one, showing that the demand is inelastic in this interval. Price elasticities of
demand are always negative since price and quantity demanded always move in opposite
directions (on the demand curve). By convention, we always talk about elasticities as positive
numbers. So mathematically, we take the absolute value of the result. We will ignore this detail
from now on, while remembering to interpret elasticities as positive numbers.

This means that, along the demand curve between point B and A, if the price changes by 1%, the
quantity demanded will change by 0.45%. A change in the price will result in a smaller
percentage change in the quantity demanded. For example, a 10% increase in the price will
result in only a 4.5% decrease in quantity demanded. A 10% decrease in the price will result in
only a 4.5% increase in the quantity demanded. Price elasticities of demand are negative
numbers indicating that the demand curve is downward sloping, but are read as absolute values.
The following Work It Out feature will walk you through calculating the price elasticity of
demand.

Finding the Price Elasticity of Demand

Calculate the price elasticity of demand using the data in Figure 1 for an increase in price from G
to H. Has the elasticity increased or decreased?

Step 1. We know that:

Step 2. From the Midpoint Formula we know that:

Step 3. So we can use the values provided in the figure in each equation:

Step 4. Then, those values can be used to determine the price elasticity of demand:

Therefore, the elasticity of demand from G to H 1.47. The magnitude of the elasticity has
increased (in absolute value) as we moved up along the demand curve from points A to B.
Recall that the elasticity between these two points was 0.45. Demand was inelastic between
points A and B and elastic between points G and H. This shows us that price elasticity of demand
changes at different points along a straight-line demand curve.

Calculating the Price Elasticity of Supply

Assume that an apartment rents for $650 per month and at that price 10,000 units are rented as
shown in Figure 2. When the price increases to $700 per month, 13,000 units are supplied into
the market. By what percentage does apartment supply increase? What is the price sensitivity?

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Figure 2. Price Elasticity of Supply. The

price elasticity of supply is calculated as the percentage change in quantity divided by the percentage
change in price.

Using the Midpoint Method,

Again, as with the elasticity of demand, the elasticity of supply is not followed by any units.
Elasticity is a ratio of one percentage change to another percentage change—nothing more—and
is read as an absolute value. In this case, a 1% rise in price causes an increase in quantity
supplied of 3.5%. The greater than one elasticity of supply means that the percentage change in
quantity supplied will be greater than a one percent price change. If you’re starting to wonder if
the concept of slope fits into this calculation, read the following Clear It Up box.

Is the elasticity the slope?

It is a common mistake to confuse the slope of either the supply or demand curve with its
elasticity. The slope is the rate of change in units along the curve, or the rise/run (change in y
over the change in x). For example, in Figure 1, each point shown on the demand curve, price
drops by $10 and the number of units demanded increases by 200. So the slope is –10/200 along
the entire demand curve and does not change. The price elasticity, however, changes along the
curve. Elasticity between points A and B was 0.45 and increased to 1.47 between points G and
H. Elasticity is the percentage change, which is a different calculation from the slope and has a
different meaning.

When we are at the upper end of a demand curve, where price is high and the quantity demanded
is low, a small change in the quantity demanded, even in, say, one unit, is pretty big in
percentage terms. A change in price of, say, a dollar, is going to be much less important in
percentage terms than it would have been at the bottom of the demand curve. Likewise, at the
bottom of the demand curve, that one unit change when the quantity demanded is high will be
small as a percentage.

So, at one end of the demand curve, where we have a large percentage change in quantity
demanded over a small percentage change in price, the elasticity value would be high, or demand
would be relatively elastic. Even with the same change in the price and the same change in the
quantity demanded, at the other end of the demand curve the quantity is much higher, and the
price is much lower, so the percentage change in quantity demanded is smaller and the
percentage change in price is much higher. That means at the bottom of the curve we’d have a
small numerator over a large denominator, so the elasticity measure would be much lower, or
inelastic.

As we move along the demand curve, the values for quantity and price go up or down, depending
on which way we are moving, so the percentages for, say, a $1 difference in price or a one unit
difference in quantity, will change as well, which means the ratios of those percentages will
change.

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Key Concepts and Summary

Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a
change in its price. It is computed as the percentage change in quantity demanded (or supplied)
divided by the percentage change in price. Elasticity can be described as elastic (or very
responsive), unit elastic, or inelastic (not very responsive). Elastic demand or supply curves
indicate that quantity demanded or supplied respond to price changes in a greater than
proportional manner. An inelastic demand or supply curve is one where a given percentage
change in price will cause a smaller percentage change in quantity demanded or supplied. A
unitary elasticity means that a given percentage change in price leads to an equal percentage
change in quantity demanded or supplied.

Self-Check Questions

1. From the data shown in Table 2 about demand for smart phones, calculate the price elasticity of
demand from: point B to point C, point D to point E, and point G to point H. Classify the elasticity
at each point as elastic, inelastic, or unit elastic.

Points P Q

A 60 3,000

B 70 2,800

C 80 2,600

D 90 2,400

E 100 2,200

F 110 2,000

G 120 1,800

H 130 1,600

Table 2.

2. From the data shown in Table 3 about supply of alarm clocks, calculate the price elasticity of
supply from: point J to point K, point L to point M, and point N to point P. Classify the elasticity
at each point as elastic, inelastic, or unit elastic.

Point Price Quantity Supplied

J $8 50

K $9 70

L $10 80

M $11 88

N $12 95

P $13 100

Table 3.

Review Questions

1. What is the formula for calculating elasticity?

2. What is the price elasticity of demand? Can you explain it in your own words?
3. What is the price elasticity of supply? Can you explain it in your own words?

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Critical Thinking Questions

1. Transatlantic air travel in business class has an estimated elasticity of demand of 0.40 less than
transatlantic air travel in economy class, with an estimated price elasticity of 0.62. Why do you
think this is the case?
2. What is the relationship between price elasticity and position on the demand curve? For
example, as you move up the demand curve to higher prices and lower quantities, what
happens to the measured elasticity? How would you explain that?

Problems

1. The equation for a demand curve is P = 48 – 3Q. What is the elasticity in moving from a quantity
of 5 to a quantity of 6?
2. The equation for a demand curve is P = 2/Q. What is the elasticity of demand as price falls from
5 to 4? What is the elasticity of demand as the price falls from 9 to 8? Would you expect these
answers to be the same?
3. The equation for a supply curve is 4P = Q. What is the elasticity of supply as price rises from 3 to
4? What is the elasticity of supply as the price rises from 7 to 8? Would you expect these
answers to be the same?
4. The equation for a supply curve is P = 3Q – 8. What is the elasticity in moving from a price of 4 to
a price of 7?

Glossary
elastic demand

when the elasticity of demand is greater than one, indicating a high responsiveness of quantity
demanded or supplied to changes in price

elastic supply

when the elasticity of either supply is greater than one, indicating a high responsiveness of
quantity demanded or supplied to changes in price

elasticity

an economics concept that measures responsiveness of one variable to changes in another

variable

inelastic demand

when the elasticity of demand is less than one, indicating that a 1 percent increase in price paid
by the consumer leads to less than a 1 percent change in purchases (and vice versa); this
indicates a low responsiveness by consumers to price changes

inelastic supply

when the elasticity of supply is less than one, indicating that a 1 percent increase in price paid to
the firm will result in a less than 1 percent increase in production by the firm; this indicates a
low responsiveness of the firm to price increases (and vice versa if prices drop)

price elasticity

the relationship between the percent change in price resulting in a corresponding percentage
change in the quantity demanded or supplied

price elasticity of demand

percentage change in the quantity demanded of a good or service divided the percentage
change in price

price elasticity of supply

percentage change in the quantity supplied divided by the percentage change in price

unitary elasticity

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when the calculated elasticity is equal to one indicating that a change in the price of the good or
service results in a proportional change in the quantity demanded or supplied

Solutions

Answers to Self-Check Questions

1. From point B to point C, price rises from $70 to $80, and Qd decreases from 2,800 to
2,600. So:

The demand curve is inelastic in this area; that is, its elasticity value is less than one.

Answer from Point D to point E:

The demand curve is inelastic in this area; that is, its elasticity value is less than one.

Answer from Point G to point H:

The demand curve is elastic in this interval.

2. From point J to point K, price rises from $8 to $9, and quantity rises from 50 to 70. So:

The supply curve is elastic in this area; that is, its elasticity value is greater than one.

From point L to point M, the price rises from $10 to $11, while the Qs rises from 80 to
88:

The supply curve has unitary elasticity in this area.

From point N to point P, the price rises from $12 to $13, and Qs rises from 95 to 100:

The supply curve is inelastic in this region of the supply curve.

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