Elasticity of Demand AG BM 102

Introduction Key issue: how responsive is the consumption of a product to a change in its price? The demand curve provides a quantitative answer But the answer depends on units of measurement Elasticity does not depend on units of measurement!

Definition: The own price elasticity of demand - the percentage change in the quantity demanded in response to a one percent change in the price of the product

An Example - Beef Price/lb. Quantity lb./cap. $5.00 50 $3.75 75 $4.75 55 $3.50 80 $4.50 60 $3.25 85 $4.25 65 $3.00 90 $4.00 70 $2.75 95

Calculating the Equation for the Demand Curve Take any two points, such as $4.00 and 70 lb, and $3.00 and 90 lb. The equation for a straight line is Q = a + b P In that equation a and b are constants that together define a specific line. You did this with x and y in algebra

Check to see if points are on the line Q = 150 – 20P P = 4, Q = 150 - 20 (4) = 70 P = 5, Q = 150 - 20 (5) = 50

Formula for Demand Elasticity Note: ε is the Greek letter epsilon

Elasticity at P=$4.00 and Q=70 lbs.

Interpreting elasticity Inelastic Elastic Unitary elastic

Inelastic demand means that the quantity change is proportionately less than the price change Demand is not especially price responsive – an example, the demand for milk

Elastic demand means that the quantity change is proportionately more than the price change. Demand is particularly price responsive – an example, the demand for lobster

Another view of the formula Point elasticity

Note The units cancel out, so elasticity is not dependent on the units used in the data For straight-line demand curves, the value of the elasticity changes as you move along the line The closer you are to the vertical axis the more elastic is demand The closer to the horizontal axis the more inelastic is demand

Elasticity at P=$5.00 and Q=50 lbs.

Some demand issues Is the demand for all food elastic or inelastic? Is the demand for all meat elastic or inelastic? Is the demand for beef elastic or inelastic? Is the demand for prime rib elastic or inelastic?

Concluding comments Elasticity allows us to talk about demand without worrying about the units of measurement It makes discussion of demand curves easier Makes analysis of changes in demand easier