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1.1ElasticityofDemand
Measures responsiveness of demand (or supply) to changes in an underlying factor (e.g. price, income, other prices). Own-Price elasticity of demand = % change in quantity demanded % change in price
1.1.1ElasticDemand
eP >1inmagnitude(<1) SupposeeP =1.5andyouarecurrently buying30lbs.ofbeef/yr.at$3/lb. Ifbeefpricesincreaseto$3.15perpound(a 5%increase),howmuchbeefdoyou consume?
1.1.1ElasticDemand
Answer:The%changeinbeefconsumption is7.5%(1.5x5%) Theamountofbeefconsumedfalls2.25 poundsto27.75
1.1.1ElasticDemand
Whathappenstoyourexpendituresonbeef? Theyfallfrom$90($3x30)to$87.40($3.15x 27.75)
1.1.1ElasticDemand
RULE: Elastic:P Revenue
1.1.1PerfectlyElasticDemand
Price D
Quantity
1.1.1InelasticDemand
eP <1inmagnitude(>1) SupposeeP =.5andyouarecurrentlybuying 1500gals.ofgasoline/yr.at$1/gal. Ifgasolinepricesincreaseto$1.05pergallon (a5%increase),howmuchgasolinedoyou consume?
1.1.1InelasticDemand
Answer:The%changeingasoline consumptionis2.5%(.5x5%) Theamountofgasolineconsumedfalls37.5 gallonsto1462.5gallons
1.1.1InelasticDemand
Whathappenstoyourexpenditureson gasoline? Theyrisefrom$1500($1x1500)to $1525.625($1.05x1462.5)
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1.1.1InelasticDemand
RULE: Inelastic:PRevene
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1.1.1PerfectlyInelasticDemand
Price D
Quantity
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1.1.2LINEARDEMAND
Asyoumovealongalineardemandcurve,the priceelasticityofdemandchanges.
Price elasticity of demand =
1.1.2LINEARDEMANDCURVE
Price
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eP = - Q=16 - 2P
eP = - 1
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eP = 0
Quantity
8 16
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1.1.2GroupStudy
Ifyourmarginalcostis0,whatpricewillyou setifyouarefacingademandQ=162P? Whatistheelasticityofdemandatthatprice?
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1.1.3Pointelasticity
Whenthedemandfunctionisknown,wecancalculate preciselytheelasticityateachpoint. Whenthedemandfunctionisnotknown,andweonly havetwopointsofthedemandcurve,therearetwo waystocalculateelasticity.
Pointelasticity:useoriginalP,Qwhencalculatingpercentage change Arcelasticity:useaverageP,Qwhencalculatingpercentage change
1.1.3PointElasticity
Ifpriceincreasesfrom$40to$50,quantity demandedfallsfrom30to20. Usingpointelasticitieswegetthata25% increaseinpriceleadstoa33.33%decreasein demand.Thepointelasticityis .3333/.25= 1.333
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1.1.3PointElasticity
Goingintheoppositedirection:Ifprice decreasesfrom$50to$40,quantity demandedrisesfrom20to30. Here,a20%decreaseinpriceleadstoa50% increaseindemand.Thepointelasticityof .50/.20=2.5
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1.1.3ArcElasticity
Whyarethesetwoanswersdifferent? Whilethereisnorightwaytodothis, conventionistousethearcelasticityof demandwheretheaveragepriceandquantity isused.
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1.1.3ArcElasticity
Forourexample,thiswouldworkthe followingway: the%changeinpriceis(10/45)=.2222 the%changeinquantityis(10/25)=.4 thearcelasticityis .4/.2222= 1.8
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