Elasticity4McGraw-Hill/IrwinCopyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Elasticity of DemandMeasures buyers responsiveness to price changesElastic demandSensitive to price changesLarge change in quantityInelastic demandInsensitive to price changesSmall change in quantityLO1

Price Elasticity of Demand FormulaFormula for price elasticity of demand

Ed = LO1Percentage Change in QuantityDemanded of Product XPercentage Change in Priceof Product X

Price Elasticity of Demand FormulaUse the midpoint formulaEnsures consistent results

Change in quantity Change in price Sum of quantities / 2 Sum of prices / 2LO1Ed =

Price Elasticity of Demand FormulaUse percentagesUnit free measureCompare responsiveness across productsEliminate the minus signEasier to compare elasticitiesLO1

Interpretation of Elasticity of Demand Ed > 1 demand is elastic Ed = 1 demand is unit elastic Ed < 1 demand is inelastic Extreme cases Perfectly inelastic Perfectly elasticLO1

Extreme CasesLO1D1P

Perfectly inelastic demandPerfectly inelastic demand(Ed = 0)0

Extreme CasesLO1

Perfectly elastic demandPD2Perfectly elasticdemand(Ed = )0

Total Revenue TestTotal Revenue = Price x QuantityInelastic demandP and TR move in the same directionElastic demandP and TR move in opposite directionsLO2

Summary of Price Elasticity of DemandLO2

Price Elasticity of Demand: A SummaryAbsolute Value of Elasticity CoefficientDemand IsDescriptionImpact on Total Revenue of a:Price IncreasePrice DecreaseGreater than 1(Ed > 1)Elastic or relatively elasticQd changes by a larger percentage than does priceTotal revenue decreasesTotal revenue increasesEqual to 1(Ed = 1)Unit or unitary elasticQd changes by the same percentage as does priceTotal revenue is unchangedTotal revenue is unchangedLess than 1(Ed < 1)Inelastic or relatively inelasticQd changes by a smaller percentage than does priceTotal revenue increasesTotal revenue decreases

Determinants of Elasticity of DemandSubstitutabilityMore substitutes, demand is more elasticProportion of IncomeHigher proportion of income, demand is more elasticLuxuries vs. NecessitiesLuxury goods, demand is more elasticTimeMore time available, demand is more elasticLO1

Price Elasticity of SupplyMeasures sellers responsiveness to price changesElastic supply, producers are responsive to price changesInelastic supply, producers are not responsive to price changes

LO3

Price Elasticity of SupplyFormula to compute elasticityEs > 1 supply is elasticEs < 1 supply is inelastic

LO3

Cross Elasticity of DemandMeasures responsiveness of sales to change in the price of another goodSubstitutes positive signComplements negative signIndependent goods - zeroLO4

Percentage change in quantity demanded of product XEx,y = Percentage change in price of product Y

Income Elasticity of DemandMeasures responsiveness of buyers to changes in income Normal goods positive signInferior goods negative signLO4

Percentage change in quantity demandedEi = Percentage change in income

Ex,y and EiLO4

Cross and Income Elasticities of DemandValue of CoefficientDescriptionType of Good(s)Cross elasticity: Positive (Ewz > 0)

Negative (Exy < 0)Quantity demanded of W changes in same direction as change in price of Z

Quantity demanded of X changes in opposite direction from change in price of YSubstitutes

ComplementsIncome elasticity: Positive (Ei >0)

Negative (Ei