63
4
ELASTICITY
K e y C o n c e p t s
Price Elasticity of Demand
♦
The
price elasticity of demand
is a unitsfree
measure of responsiveness of the quantity de
manded of a good to a change in its price when all
other influences on buyers’ plans remain the same.
The price elasticity of demand equals the magnitude of:
ave
ave
P
/
P
Q
/
Q
Δ
Δ
=
price)
in
change
e
(percentag
demanded)
quantity
in
change
e
(percentag
where “
ave
” stands for average.
♦
When the elasticity equals 0, the good has
perfectly
inelastic demand
and the demand curve is vertical.
♦
When the elasticity is less than 1 and greater than 0,
the good has
inelastic demand
.
♦
When the elasticity equals 1, the good has
unit
elastic demand
.
♦
When the elasticity is greater than 1 and less than
infinity, the good has
elastic demand
.
♦
When the elasticity equals infinity, the good has
perfectly elastic demand
and the demand curve is
horizontal.
Elasticity is
not
equal to the slope of the demand curve.
Moving along a linear demand curve the slope (
Δ
P/
Δ
Q
)
is constant but the elasticity falls in magnitude moving
downward along the curve.
Price elasticity and total revenue (
P
)
×
(
Q
):
When demand is
A price cut results in
Inelastic (elasticity < 1) a decrease in total revenue
Unit elastic
(elasticity = 1)
no change in total revenue
Elastic (elasticity > 1)
an increase in total revenue
The
total revenue test
estimates the price elasticity of
demand by noting how a change in price affects the
total revenue spent on the product.
A person’s expenditure on a good follows the same
rules. If the good has an elastic demand, a price cut
increases expenditure; if it has a unit elastic demand, a
price cut does not change expenditure; and, if it has an
inelastic demand, a price cut decreases expenditure.
The price elasticity of demand depends on three factors:
♦
Substitutability
— the more close substitutes there
are for the good, the larger is its price elasticity. Ne
cessities generally have few substitutes and so have a
small elasticity; luxuries generally have many substi
tutes and so have a large elasticity.
♦
Proportion of income spent on the good
— the greater
the proportion of income spent on a good, the lar
ger is its price elasticity of demand.
♦
Time elapsed since the price change
— the more time
that has passed since the price changed, the greater
is the price elasticity of demand.
More Elasticities of Demand
The
cross elasticity of demand
measures the respon
siveness of demand for a good to a change in the price
of a substitute or complement.
The cross elasticity of demand equals:
.
good)
related
a
of
price
the
in
change
e
(percentag
demanded)
quantity
the
in
change
e
(percentag
The sign of the cross elasticity of demand depends on
whether the goods are substitutes or complements.
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 Spring '10
 BAIYEEMBI
 Microeconomics, Price Elasticity, Supply And Demand, F Demand

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