Demand elasticity
On occasion someone may be interested in knowing how responsive the demand for a
good is to its price, the price of another good, or consumer incomes.
This can present a problem
since we need to choose a unit in which to measure demand, and some ways of measuring that
responsiveness are sensitive to the unit chosen.
That is, the measurement may change if we
change units.
For example, suppose we are interested in measuring the responsiveness of the demand
for, say, eggs, to the price of eggs.
How would we measure the demand for eggs?
Well, we
could measure it by the individual egg, or by dozens of eggs, or by the gross (144 eggs). OK,
suppose that when the price of an egg is 8 cents, or 96 cents per dozen, the demand for eggs in a
particular market is 20,000 dozen per week.
And suppose that when the price of an egg is 6
cents, or 72 cents per dozen, demand is 22,000 dozen per week.
Well, we could measure the responsiveness of the demand for eggs to the price of eggs
this way: take the change in price and divide it into the change in the quantity demanded that
results from that price.
That number is the increase in the number of units demanded per 1 unit
decrease in price.
OK, let's apply that formula to the above situation, using the individual egg as
our unit.
In doing so we get
(22,000 X 12
– 20,000 X 12 )/(6 – 8) = – 24,000/2 = 12,000
Well, what if we measure demand in dozens of eggs?
Then we get
(22,000 – 20,000)/(72 – 96) =
– 2,000/24 = 83.3
Obviously, there is a big difference.
How can we get around the "units problem?"
Simple.
Instead of dividing one change
into the other (change in price into change in quantity demanded), we could divide
percentage
changes
.
When we do this, we get rid of the unit in which demand is measured.
In other words,
no matter what unit we use to measure demand, the number we come up with is the same.
Let's
see.
If demand rises from 20,000 X 12 eggs to 22,000 x 12 eggs when the price of an egg falls
from 8 to 6 cents, then there is a
(22,000 X 12 – 20,000 X 12)/(20,000 X 12) X 100 % =
10%
increase in the quantity demanded from a
(6 – 8)/8 X 100% = 25%
decrease in price.
So if we divide the percentage increase in demand by the percentage decrease
in price that caused it, we come up with 10%/25% = .4.