Price Elasticity of Demand

Price Elasticity of Demand

• Measures how responsive buyers are to price changes.
• Elastic demand occurs when consumers are sensitive to price changes, leading to a significant change in quantity demanded.
• Inelastic demand occurs when consumers are not sensitive to price changes, resulting in only a small change in quantity demanded.

Price Elasticity Coefficient

• Calculated as the percentage change in quantity demanded of a product divided by the percentage change in the price of the same product.

Midpoint Formula

• Used to ensure consistent results when calculating price elasticity.
• Ed = (Change in quantity / Sum of quantities/2) / (Change in price / Sum of prices/2)

Price Elasticity of Demand Formula

• Use percentages for a unit-free measure that allows comparison of elasticities across different products.
• Eliminate the minus sign to simplify the comparison of elasticities.

Interpretation of Elasticity of Demand

• Demand is elastic if Ed > 1.
• Demand is inelastic if Ed < 1.
• Demand is unit elastic if Ed = 1.
• Perfectly inelastic demand occurs when Ed = 0.
• Perfectly elastic demand occurs when Ed = ∞.

Extreme Cases

• Perfectly Inelastic Demand: Quantity demanded does not change regardless of price.
• Perfectly Elastic Demand: A small increase in price causes quantity demanded to drop to zero.

Total Revenue Test Overview

• Total Revenue = Price × Quantity.
• For elastic demand, price and total revenue move in opposite directions.
• For inelastic demand, price and total revenue move in the same direction.
• For unit elastic demand, total revenue does not change when price changes.

Total Revenue Test

• With Elastic Demand: Lowering the price leads to a net gain (blue area exceeds loss).
• With Inelastic Demand: Lowering the price results in a net loss (yellow loss exceeds gain).
• With Unit-Elastic Demand: Lowering the price leads to equal gain and loss.

Price Elasticity of Demand Summary

• Elastic Demand (Ed > 1): Quantity demanded changes by a larger percentage than price, total revenue decreases with a price increase.
• Unit Elastic Demand (Ed = 1): Quantity demanded changes by the same percentage as price, total revenue is unchanged.
• Inelastic Demand (Ed < 1): Quantity demanded changes by a smaller percentage than price, total revenue increases with a price increase.

Substitutability and Proportion of Income

• Substitutability: More substitutes available leads to more elastic demand.
• Proportion of income: A higher proportion of income spent on a good results in more elastic demand.

Luxury and Time

• Luxuries versus necessities: Luxury goods have more elastic demand.
• Time: More time available to adjust consumption leads to more elastic demand.

Applications of Price Elasticity of Demand

• Large crop yields: Can lead to lower total revenue due to inelastic demand.
• Excise taxes: Generate more total revenue with inelastic demand.
• Decriminalization of illegal drugs: May result in more total revenue due to inelastic demand.

Price Elasticity of Supply Overview

• Measures sellers' responsiveness to price changes.
• Elastic supply means producers are responsive to price changes.
• Inelastic supply means producers are not responsive to price changes.

Price Elasticity Of Supply Formula

• Es = (Percentage change in quantity supplied of product X) / (Percentage change in price of product X)

Price Elasticity of Supply

• Supply is elastic if Es > 1.
• Supply is unit elastic if Es = 1.
• Supply is inelastic if Es < 1.
• Perfectly inelastic supply occurs when Es = 0.

Price Elasticity of Supply and Time

• Time is a primary determinant of elasticity of supply.
• Time periods include immediate market period, short run, and long run.

Supply Time Periods

• Immediate Market Period: Supply is perfectly inelastic.
• Short Run: Supply is more elastic than in the immediate market period.
• Long Run: Supply is even more elastic than in the short run.

Applications of Elasticity of Supply

• Antiques: Inelastic supply.
• Reproductions: More elastic supply.
• Volatile gold prices: Inelastic supply.

Formula for Cross Elasticity of Demand

• Exy = (percentage change in quantity demanded of product X)/(percentage change in price of product Y)

Cross Elasticity of Demand

• Measures how the purchase of one good responds to a change in the price of another good.
• Substitute goods have a positive cross elasticity.
• Complementary goods have a negative cross elasticity.
• Independent goods have a cross elasticity of zero or near-zero.

Applications of Cross Elasticity of Demand

• It can determine if a company should change a price.
• Also determine if the government should allow a merger between companies.

Formula for Income Elasticity of Demand

• Ei= (percentage change in quantity demanded)/(percentage change in income)

Income Elasticity of Demand

• Measures how buyers respond to changes in their income.
• Normal goods have a positive income elasticity.
• Inferior goods have a negative income elasticity.

Income Elasticity Insights

• Goods with high income elasticities are most affected by a recession.
• Goods with low or negative income elasticity are less affected by a recession.

Explore price elasticity of demand, which measures buyer responsiveness to price changes. Elastic demand indicates consumer sensitivity, causing significant quantity demanded changes. Inelastic demand shows insensitivity, resulting in minor changes. Learn about the price elasticity coefficient, midpoint formula, and demand interpretation.