1. Or the Price Elasticity of Demand

2. Price Elasticity of Demand
Law of Demand = there is an inverse or negative relationship between price and quantity demanded P Qd P Qd

3. Price Elasticity of Demand
Price Elasticity measures the effect on Quantity Demanded due to changes in Price
In other words, we want to know how big a change in Qd will occur if we change the Price.

4. Price Elasticity of Demand
Price Elasticity of Demand measures the sensitivity of consumers to a price change
Large changes in qty. demanded due to price changes = ELASTIC demand
Small or no changes in qty. demanded due to price changes = INELASTIC demand

5. Computing Elasticity of Demand
Ed = % in Qd
% in P
Ignore the “minus” sign!!!!
= “change”

6. Midpoint Formula
This is an alternative method if you have a hard time with percentages: Ed = ∆ Qd ÷ [(Q1+Q2)/2] ∆P ÷ [(P1+P2)/2]

7. Computing Elasticity of Demand
Elastic Demand
% ∆ in price is smaller than % ∆ in Qd, demand is ELASTIC OR
If Ed > 1, then demand is ELASTIC
Inelastic Demand
% ∆ in price is larger than % ∆ in Qd, demand is INELASTIC
If Ed < 1, then demand is INELASTIC

8. Computing Elasticity of Demand
What if % ∆ in price EXACTLY equals % ∆ in Qd?
Or, in other words…
Ed = 1?
You have “UNIT ELASTICITY”

9. Typical Demand Curves Elastic Product
Normally, a shallower or less steep demand curve D D

10. Typical Demand Curves Inelastic Product Normally, a steep demand curve

11. Typical Demand Curves Unit elastic Product
Normally, a rounded demand curve D D

12. Typical Demand Curves Perfectly Elastic Product
A horizontal demand curve D D

13. Typical Demand Curves Perfectly Inelastic Product
A vertical demand curve D D

14. TR = P x Q The Total Revenue Test
Another way of determining elasticity is the Total Revenue Test
TR = P x Q

15. Total Revenue Test
Elastic Demand:
Ed is elastic if:
P = TR Or

16. Total Revenue Test
Inelastic Demand:
Ed is inelastic if:
P = TR Or

17. P = no change in TR Or P = no change in TR
Total Revenue Test
Unit elasticity of Demand:
Ed is unit elastic if:
P = no change in TR Or
P = no change in TR

18. Determinants of Price Elasticity of Demand
Substitutability
If # of substitutes is large, then Ed is greater
Proportion of Income
If price increase in relation to consumer incomes, then Ed is greater
Luxuries vs. Necessities
Luxury items have greater Ed
Necessity items have a lower Ed
Time
The longer the time period involved, the more elastic a product demand becomes

19. Elasticity of a Linear Demand Curve
Areas of greater Elasticity P D
Areas of greater Inelasticity D Q

20. Other Demand Elasticities
Income Elasticity of Demand
Measures the change in quantity demanded as consumer incomes change
Cross-Price Elasticity of Demand
Measures how the quantity demanded of one good responds to the change in price of another good

21. Computing Income Elasticity of Demand
Elasticity of Income Demand =
IEd = % in Qd
% in Income
Normal goods and IEd = as income increases, Qd increases, thus a positive income elasticity of demand
Inferior goods and IEd = as income increases, Qd decreases, thus a negative income elasticity of demand

22. Computing Cross-Price Elasticity of Demand
CPEd = % in Qd of Good 1
% in Price of Good 2
Substitute goods and CPEd = as the price of Good 2 increases, Qd of Good 1 increases, thus a positive CPEd
Complementary goods and CPEd = as the price of Good 2 increases, Qd of Good 1 decreases, thus a negative CPEd

23. Another Explanation: