Price Elasticity of Demand

Price Elasticity of Demand
DEMAND ELASTICITY measures the degree of consumer’s

responsiveness or reaction to changes in the factors affecting
demand.
Values and Types of Elasticity
/E/ = 1 Unitary Elastic, that is when % ∆Q = % ∆P

/E/ > 1 Elastic, that is when % ∆Q > % ∆ P
/E/ < 1 Inelastic, that is when % ∆Q < % ∆P
/E/ = 0 Perfectly Inelastic
/E/ = α Perfectly Elastic
PRICE ELASTICITY OF DEMAND (PED) is the
responsiveness of buyers to changes in price. It measures how
much quantity demanded changes in response to a change in
price, other things staying the same.
Approaches to computing elasticity: Point elasticity and Arch or

Midpoint elasticity
Point elasticity
PED = % change in QDx

% change in Px
ΔQ Q2 – Q1
= Q1__ = Q1____
ΔP P2 – P1
P1 P1
•The sensitivity of quantity
demanded to price
•The percentage change in quantity
demanded caused by a 1 percent
change in price
Price
per
Laptop
D
3,500
C
3,000
2,500
2,000
B
1,500
A
1,000
100,000 200,000 300,000 400,000 500,000 600,000 Quantity

of Laptops
Elasticity and Straight-Line
Demand Curves
•Elasticity of demand varies along a

straight-line demand curve.
•More specifically, demand becomes
more elastic as we move upward and
leftward.
Comparison of slope and elasticity
Slope = Δ Q Price elasticity = % Δ Q

ΔP %ΔP
Example:
Let P1 = 2 Q1 = 10
P2 = 3 Q2 = 3
Slope = 3 - 10 =-7 =-7

3- 2 1
Price elasticity = - 1.40 = QD2 - QD1/ QD1

P2 - P1 / P1
= 3-10/10 / 3-2/ 2
Interpretation
Slope = -7 means for every one unit increase in the price, the quantity
demanded will decrease by 7 units.
Price elasticity = -1.4 means that for every one percent increase in the price of
commodity X, the quantity demanded will decrease by 1.4 percent. The
consumer is said to be highly responsive (elastic) to the changes in the price of
the commodity.
Why do we use elasticity instead of slope?
Slope = - 7 means that for every one unit increase in the price, the
quantity
demanded will decrease by 7 units.
For example, the commodities are Car and Pencil.
Car: a one peso (1P) increase in the price of car will mean a
decrease
in the demand for cars by 7 units.
Pencil: a one peso (1P) increase in the price of pencil will mean a
decrease in the demand for pencils by 7 units.
Analysis: The responsiveness of the consumer on a peso (1P)

increase for the two commodities cannot be compared because 7 units
of cars and 7 units of pencils are entirely different.
Elasticity and Straight-Line
Demand Curves
Price Since equal dollar
increases (vertical arrows)
are smaller and smaller
percentage increases . . .
. . . and since equal quantity
decreases (horizontal arrows)
3 are larger and larger
percentage decreases . . .
2
. . . demand becomes
more and more elastic
as we move leftward and
upward along a straight
line demand curve. D
Quantity
Inelastic Demand
Inelastic Demand
A price elasticity of demand
between 0 and -1
Perfectly Inelastic Demand
Perfectly Inelastic Demand

equal to 0
Perfectly Elastic Demand
Elastic Demand
greater than - 1
Extreme Cases of Demand
Perfectly Elastic Demand
Perfectly (Infinitely) Elastic Demand

approaching minus infinity
Unitary Elastic Demand
Unitary Elastic Demand

equal to -1
Arch or Midpoint elasticity
PED = % change in QDx

% change in Px
Q2 – Q1
= Q____
P2 – P1
P
Where:
Q = average Q
P = average P
Note that we will be using the method of Arch or Midpoint in

calculating for the elasticity.
Elasticity and Total Expenditure
• If demand is price inelastic, then total

expenditure moves in the same direction as
price.
• If demand is elastic, total spending moves
in the opposite direction from price.
• If demand is unitary elastic, total
expenditure remains the same as price
changes.
Effects of Price Changes on
Expenditure
Where Demand is: A price increase will: A price decrease will:
inelastic (|ED| < 1) increase expenditure decrease expenditure

unitary elastic (|ED| = 1) cause no change in cause no change in
expenditure expenditure
elastic (|ED| > 1) decrease expenditure increase expenditure
Effects of Price Changes on
Expenditure
At any point on a demand curve,

buyers’ total expenditures is the area of
a rectangle with width equal to
quantity demanded and height equal to
price.
Relations between demand elasticity and total revenue / total
expenditure
Elastic Unitary Inelastic

Demand Elasticity Demand
(% Δ D) > (% Δ P) (% Δ D) = (% Δ P) (% Δ D) < (% Δ P)
Price rises TR/TE falls No change in TE TR/TE rises

Price falls TR/TE rises No change in TE TR/TE falls
Short-run and Long-run
Elasticity
•Easier to find substitutes for an item in the
long run than in the short run
•Thus, demand is more elastic in the long
run than in the short run
•The more of their total budgets households
spend on an item, the more elastic the
demand for that item
•The more elastic the demand curve, the
more of an excise tax paid by sellers
•The more inelastic the demand curve,
the more of the tax paid by buyers
(a) (b)
Price Price
per per
Ticket Ticket
D S
' S
S '
$830 S
B
730 $730 D
A B A
Tickets Tickets
11.3 (Millions per Year) 7.0 11.3 (Millions per Year)
Other Demand Elasticities
•Income Elasticity of Demand

•Cross-Price Elasticity of
Demand
Income Elasticity of Demand
INCOME ELASTICITY OF DEMAND (IED) is the
responsiveness of buyers to changes in income.
IED = % Δ QD
%Δ I
As a broad rule of the thumb some people regard income
elasticity of demand as useful in classifying commodities into
‘luxury’ and ‘necessity’ groupings. A commodity is considered a
luxury if IED is > 1, and a necessity if IED is significantly <1.
Income Elasticity of Demand
Economic Necessity
A good with an income elasticity of demand
between 0 and 1
Economic Luxury
A good with an income elasticity of demand
greater than 1
Cross-Price Elasticity of
Demand
Cross-Price Elasticity of Demand

The percentage change in the the
quantity demanded of one good
caused by a 1-percent change in
the price of another good
CROSS-ELASTICITY OF DEMAND (CED)
CED = % Δ QDx
% Δ Py
In this case a change in the price of some other commodity (Y) will cause a shift in
the demand for commodity X (i.e., Dx). The cross-elasticity of demand will indicate
the direction and magnitude of that shift.
The direction of the shift will depend upon the relationship in consumption
between commodities X and Y. Where X and Y are substitutes in consumption, a fall
in Py will result in a decrease in demand for X i.e., a leftward shift in Dx. Here the
sign of CED will be a positive (- / - = + ).
Where X and Y are complements in consumption, a fall in Py will result in an

increase in demand for X i.e., rightward shift in Dx. Here the sign will be negative ( +
/ - = - ).
The magnitude of the shift in Dx will depend upon how close X and Y are as
substitutes or complements in consumption. The greater the degree of
substitutability or complementarity between the two commodities, the greater the
numerical value of CED, in other words, a given fall in price of Y will cause a larger
shift to the left in Dx for close substitutes, and a larger shift to the right for close
complements.
Compute the elasticity, use both point and midpoint
method and interpret your answer.
Mrs. A. Cruz used to buy P1,200 worth of meat per

month when her monthly income was P15,500.
When her monthly income increased to P30,000,
her purchase of meat went up also to P2,000.
What difference does the two methods made on

your interpretation?

Price Elasticity of Demand

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Price Elasticity of Demand

DEMAND ELASTICITY measures the degree of consumer’s

Values and Types of Elasticity

/E/ = 1 Unitary Elastic, that is when % ∆Q = % ∆P

Approaches to computing elasticity: Point elasticity and Arch or

PED = % change in QDx

100,000 200,000 300,000 400,000 500,000 600,000 Quantity

•Elasticity of demand varies along a

Slope = Δ Q Price elasticity = % Δ Q

Slope = 3 - 10 =-7 =-7

Price elasticity = - 1.40 = QD2 - QD1/ QD1

For example, the commodities are Car and Pencil.

Analysis: The responsiveness of the consumer on a peso (1P)

Perfectly Inelastic Demand

Perfectly (Infinitely) Elastic Demand

Unitary Elastic Demand

PED = % change in QDx

Note that we will be using the method of Arch or Midpoint in

• If demand is price inelastic, then total

Where Demand is: A price increase will: A price decrease will:

inelastic (|ED| < 1) increase expenditure decrease expenditure

At any point on a demand curve,

Elastic Unitary Inelastic

Price rises TR/TE falls No change in TE TR/TE rises

•Income Elasticity of Demand

Cross-Price Elasticity of Demand

Where X and Y are complements in consumption, a fall in Py will result in an

Mrs. A. Cruz used to buy P1,200 worth of meat per

What difference does the two methods made on

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