LN04 Keat020827 07 Me LN04

Demand
Elasticity
Outline
• The economic concept of elasticity

• The price elasticity of demand
• The cross-elasticity of demand
• Income elasticity
• Other elasticity measures
• Elasticity of supply
Learning Objectives
• Define and measure elasticity
• Apply the concepts of price elasticity, cross-elasticity, and income

elasticity
• Understand the determinants of elasticity
• Show how elasticity affects revenue

The Economic Concept of Elasticity
• Elasticity: the percentage change in one variable relative to a

percentage change in another.
percent change in A
Elasticity 
percent change in B
Types Of Elasticity Of Demand
Price
Elasticity
Cross Price
Advertisement
Elasticity Demand Elasticity
Income
Elasticity
Price Elasticity of Demand
• Price elasticity of demand: the percentage change in quantity

demanded divided by the percentage change in price
% Quantity
Ep 
% Price
• Arc price elasticity: elasticity which is measured over a discrete interval of
the demand curve
Q2  Q1 P2  P1
Ep  
(Q1  Q2 ) / 2 ( P1  P2 ) / 2
Ep = arc price elasticity
Q1 = original quantity demanded
Q2 = new quantity demanded
P1 = original price
P2 = new price
• Point elasticity: elasticity measured at a given point of a demand (or

supply) curve. Instead of estimating over a range of prices, it is the
elasticity at a specific price. The point elasticity of a linear demand
function can be expressed as:
Q P1
p  
P Q1
• When demand is nonlinear, the calculation of ΔQ/ΔP is

somewhat more complicated because the slope of a curve
changes. This slope is obtained using the calculus concept
of derivative. In this instance,
Ed= dQ/dP * P1/Q1
• The derivative of Q with respect to P (i.e., dQ/dP) is simply

the instantaneous version of slope.
• An example of a nonlinear demand curves is one with constant
elasticity
• such a curve has a nonlinear equation:
Q = aP-b
• where –b is the elasticity coefficient

• Categories of elasticity
• Relative elasticity of demand: Ep > 1

• Relative inelasticity of demand: 0 < Ep < 1
• Unitary elasticity of demand: Ep = 1
• Perfect elasticity: Ep = ∞
• Perfect inelasticity: Ep = 0
• Factors affecting demand elasticity

• ease of substitution
• proportion of total expenditures
• length of time period
• durability of product
• possibility of postponing purchase
• possibility of repair
• used product market
• Derived demand: the demand for items that go into the production
of a final commodity, such as materials, machinery, and labor.
• The demand for such components of a final product is called derived
demand.
• The demand for such a product or factor exists because there is demand for
the final product.
• The derived demand curve will be more inelastic:

• the more essential is the component
• the more inelastic is the demand curve for the final product
• the smaller is the fraction of total cost going to this component
• the more inelastic is the supply curve of cooperating factors
Short Run vs. Long Run
•A long-run demand curve will
generally be more elastic than a
short-run curve.
•As the time period lengthens
consumers find ways to adjust to
the price change, via substitution
or shifting consumption.
• The relationship between price and revenue depends on elasticity

• Marginal revenue: the change in total revenue resulting from
changing quantity by one unit
Total Revenue
MR 
Quantity
• As price decreases
• revenue rises when demand is elastic
• revenue falls when it is inelastic
• revenue reaches its peak if elasticity
=1
The lower chart shows the effect of

elasticity on total revenue.
• Marginal revenue curve is
twice as steep as the demand
curve
• At the point where
marginal revenue crosses
the X-axis, the demand
curve is unitary elastic and
total revenue reaches a
maximum.
• Elasticity examples
• coffee: short run -0.2, long run -0.33

• kitchen and household appliances: -0.63
• meals at restaurants: -2.27
• airline travel in U.S.: -1.98
• U.S. oil demand: short run -.06, long run -.45
Cross-price Elasticity of Demand
• Cross-price elasticity of demand: the percentage change in quantity

consumed of one product as a result of a 1 percent change in the
price of a related product
%QA
Ex 
%PB
• Arc cross-elasticity-relates the percentage change in quantity to the

percentage change in the price of another product (either a
substitute or a complement).
Q2 A  Q1 A P2 B  P1B
EX  
(Q1 A  Q2 A ) / 2 ( P1B  P2 B ) / 2
• The sign of cross-elasticity for substitutes is positive
• The sign of cross-elasticity for complements is negative.
• Two products are considered good substitutes or complements when the

coefficient is larger than 0.5 (in ab. value).
• Cross-price elasticity of demand examples:

• Residential demand for electric energy with respect to prices of gas energy
was low, about +0.13.
• The cross-elasticity of demand for beef with respect to pork prices was
calculated to be about +0.25. With respect to prices of chicken, it was about
+0.12. Both numbers indicate that the products are substitutes.
Role of Price Elasticity of Demand in
Decision-Making
• Important in judging the effect of devaluation or
depreciation of a currency on its export earnings.
• used in fiscal policy because the Finance Minister

has to keep in view the price elasticity of demand
when it considers to impose taxes on various
commodities.
Income Elasticity
• Income elasticity of demand: the percentage change in quantity

demanded caused by a 1 percent change in income
%Q
EY 
%Y
(Y is shorthand for income)
Income Elasticity
• Categories of income elasticity
• superior goods:
EY > 1
• normal goods:
0 ≤ EY ≤ 1
• inferior goods:
EY < 0
Income Elasticity
• Income elasticity examples

• Short-run income elasticity for food expenditure is about 0.5 and the
elasticity of restaurant meals 1.6.
• The short-run income elasticity for jewelry and watches appeared to be 1.0,
long run is 1.6.
• For gasoline the short-run income elasticity is between 0.35 and 0.55, long
run between 1.1 and 1.3.
Other Demand Elasticity
• Elasticity is encountered every time a change in some variable affects

demand such as:
• advertising expenditures
• interest rates
• population size
Elasticity of Supply
• Price elasticity of supply: the percentage change in quantity

supplied as a result of a 1 percent change in price
% Quantity Supplied
ES 
% Price
The coefficient of supply elasticity is a normally a positive number
Elasticity of Supply
• When the supply curve is more elastic, the effect of a

change in demand will be greater on quantity than on the
price of the product
• When the supply curve is less elastic, a change in demand

will have a greater effect on price than on quantity
Global Application
There are substantial differences in elasticities around the world.

Summary
• Elasticity is defined as the sensitivity of one variable to another.

• Price elasticity of demand is the percentage change in the quantity
demanded of a product caused by a percentage change in its own price.
• When demand is elastic, revenue rises as quantity demanded increases;
revenue reaches its peak at the point of unitary elasticity and descends
as quantity rises on the demand curve’s inelastic sector.
• Cross-price elasticity, the relationship between the demand for one
product and the price of another.
• Income elasticity, measures the sensitivity of demand for a product to
changes in the income of the population.

LN04 Keat020827 07 Me LN04

Uploaded by

Copyright:

Available Formats

LN04 Keat020827 07 Me LN04

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

LN04 Keat020827 07 Me LN04

Uploaded by

Copyright:

Available Formats

Demand

• The economic concept of elasticity

• Define and measure elasticity

• Apply the concepts of price elasticity, cross-elasticity, and income

• Understand the determinants of elasticity

• Show how elasticity affects revenue

• Elasticity: the percentage change in one variable relative to a

• Price elasticity of demand: the percentage change in quantity

• Point elasticity: elasticity measured at a given point of a demand (or

• When demand is nonlinear, the calculation of ΔQ/ΔP is

Ed= dQ/dP * P1/Q1

• The derivative of Q with respect to P (i.e., dQ/dP) is simply

• such a curve has a nonlinear equation:

• where –b is the elasticity coefficient

• Relative elasticity of demand: Ep > 1

• Factors affecting demand elasticity

• The derived demand curve will be more inelastic:

• The relationship between price and revenue depends on elasticity

The lower chart shows the effect of

• coffee: short run -0.2, long run -0.33

• Cross-price elasticity of demand: the percentage change in quantity

• Arc cross-elasticity-relates the percentage change in quantity to the

• The sign of cross-elasticity for substitutes is positive

• The sign of cross-elasticity for complements is negative.

• Two products are considered good substitutes or complements when the

• Cross-price elasticity of demand examples:

• used in fiscal policy because the Finance Minister

• Income elasticity of demand: the percentage change in quantity

• Income elasticity examples

• Elasticity is encountered every time a change in some variable affects

• Price elasticity of supply: the percentage change in quantity

• When the supply curve is more elastic, the effect of a

• When the supply curve is less elastic, a change in demand

There are substantial differences in elasticities around the world.

• Elasticity is defined as the sensitivity of one variable to another.

You might also like