a units-free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buyers' plans remain the same
Price elasticity of demand = % change in quantity demanded / % change in price ... use absolute value so ignore the minus sign
% change in quantity demanded = (Orginal quant. - New quant.) / average of old and new quant.
% change in price = (Orginal price - New Price) / average of old and new price
Elasticity is a units-free measure because
the % change in each variable is independent of the units in which the variable is measured. The ratio of the 2 %s is a # without units.
Perfectly inelastic demand
Quantity demanded is constant regardless of the price changes. The price elasticity of demand is 0.
ex of good: low price elasticity of demand = insulin.
Unit elastic demand
if the % change in the quantity demanded equals the % change in price, then price elasticity = 1 and the good is said to have a unit elastic demand.
% change in the quantity demanded is less than the percentage change in price (price elasticity is between 0 and 1)
perfect elastic demand
if the quantity demanded changes by an infinitely large % in response to a tiny price change, then the price elasticity of demand is infinity
ex: soft drink machine located side by side
if % change in quantity demanded exceeds % change in price, the price elasticity of demand is greater than 1 and the good is said to have an elastic demand.
The change in total revenue depends on the elasticity of demand in the following ways:
- If demand is elastic: 1% price cut increases quantity sold by more than 1% & total rev. increase
- If demand is inelastic: 1% price cut increases quantity sold by less than 1% & total rev. decrease
- If demand is unit elastic: 1% price cut increases quantity sold by 1% & total rev. doesn't change
total revenue test
is a method of estimating the price elasticity of demand by observing the change in total rev. that results from a change in the price, when all other influences on the quantitiy sold remain same
- price cut ^ total rev. demand = elastic
- price cut decrease total rev. demand = inelastic
- price cut leave total rev. unchange, demand = unit elastic
magnitude of the elasticity of demand depends on
- the closness of substitutes
- the proportion of income spent on the good = higher % of income a good cost the more elastic the demand
- the time elapsed since a price change = the more time that has passed the more elastic the demand
Cross Elasticity of Demand
Measures the influence of a change in price of a subsitute or complement.
Measure of the responsiveness of the demand for a good to a change in the rpice of a substitute or complement, other things remainig same
- cross elasticity of demand = % change in quantity demanded / % change in price of a substitute or complement
- positive for a substitute and negative for a complement
- the larger the cross elasticity of demand the greater the change in demand and the larger the shift in the demand curve
- if two items are not related then the cross elasticity is 0.
Income Elasticity of Demand
Responsiveness of the demand for a good or service to a change in income, other things remaining the same.
- income elasticity of demand = % change in quantity demanded / % change in income
- Greater than 1 (normal good, income elastic) = as income ^, % of income spent on good ^
- Positive and less than 1 ( normal good, income inelastic) = as income ^, % of income spent on good decreases
- Negative (inferior good) = as income ^, % of income spent on good decreases
Elasticity of Supply
Measures the responsiveness of the quantity supplied to a change in the price of a good when all the other influences on selling plans remain the same
- Elasticity of supply = % change in quantity supplied / % change in price
- No matter how steep the supply curve is , if it is linear and pases through the origin, supply is unit elastic
Magnitude of the elasticity of supply depends on
- Resource substitution possibilities = when good is produced in many countires or can be obtained easily then it is highly elastic.
- Time frame for the supply decision > momentary supply (response of quantitiy supplied immediately following price change)
> long-run supply (response of quantitiy supplied to a change in price after all the technologically possible ways of adjusting supply have been exploited)
> short-run supply (the quantity supplied responds to a price change when only some of the technologically possible adjustments to production have been made) producers can control quantitiy supplied quickly