Demand Elasticity The responsiveness of demand to changes in price E = (%ΔQ)/(%ΔP)=(ΔQ/ΔP)(P/Q) (ΔQ/ΔP) is the inverse of the slope of the demand curve,

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Presentation transcript:

Demand Elasticity The responsiveness of demand to changes in price E = (%ΔQ)/(%ΔP)=(ΔQ/ΔP)(P/Q) (ΔQ/ΔP) is the inverse of the slope of the demand curve, a negative constant (P/Q) is the ratio of price to quantity, always positive, but declines as price falls E < 0, but the positive |E| is often used AKA “Own-price elasticity of demand”

Watch the video Episode 16: Elasticity of Demand

Demand Elasticity & Revenue Total Revenue = P x Q = TR Marginal Revenue = ΔTR/ΔQ Change in TR divided by change in Q MR = P + (ΔP/ΔQ)Q = P[1 + (1/E)] MR = 0 when E=-1 (unitary elastic) MR > 0 when E < -1 (elastic) MR -1 (inelastic) Slope MR = 2 x (slope of demand curve)

Demand Elasticity & Revenue Total Revenue = P x Q = TR Marginal Revenue = ΔTR/ΔQ Change in TR divided by the change in Q change in total revenue for a change in quantity MR = P + (ΔP/ΔQ)Q = P[1+(1/E)] MR = 0 when E = -1 (unitary elastic) MR > 0 when E < -1 (elastic) MR -1 (inelastic) = P + [ 1 + (1/E)] Slope MR = 2 x (slope of demand curve) e slope of MR = 2 x (slope of the demand curve)

Watch the video Price Elasticity and Total Revenue

Calculating Demand Elasticity Arc elasticity – elasticity over an interval [ΔQ/(average Q)]/[ΔP/(average P)] Average elasticity between two points Linear or Nonlinear demand curve Point elasticity – elasticity at a point Price/[Price – (Price intercept)] Linear demand, or Line tangent to nonlinear demand Difficult to use in practice because the price intercept is not often known

Arc Elasticity Example P 1 = 30, Q 1 = 400; P 2 =20, Q 2 = 600 Arc E = = = =

Exercise: fill in the empty cells of table PriceQuantityTotal Revenue Marginal Revenue Arc elasticity 60 8n.a

Exercise: Answers PriceQuantityTotal Revenue Marginal Revenue Arc elasticity n.a /8 = /8 =

Point Elasticity Example P 0 = 100; P I = 300 P 0 is the price point on the demand curve P I is the intercept of the demand curve on the price axis Point E = = -1/2 = -0.5

Factors Affecting Elasticity Availability of Substitutes More/closer substitutes, more elastic Proportion of Buyer’s Budget Larger proportion, more elastic Time Period Longer time to adjust, more elastic

Other Elasticities Income Elasticity of Demand %ΔQ/%ΔM = (ΔQ/ΔM)(M/Q) Measures shift in demand as income changes Normal (+) or Inferior (-) goods Cross-Price Elasticity %ΔQ 1 /%ΔP 2 = (ΔQ 1 /ΔP 2 )(P 2 /Q 1 ) Measures shift in demand for change in price of a related good Substitute (+) or Complement (-)