ELASTICITY
The law of demand states that price and quantity demanded are inversely related, ceteris paribus.
What we don't know is by what percentage quantity demanded changes as price changes.
Suppose price rises by 10%.
As a result, quantity demanded falls.
But by what percentage does
it fall?
The answer to this question lies in the notion of price elasticity of demand.
PRICE ELASTICITY OF DEMAND
A measure of the responsiveness of quantity demanded to changes in price.
E
d
=
% ∆ in Q
d
% ∆ in P
Note:
Since P and Q
d
are inversely related, one would expect E
d
to take a (-) sign. However, E
d
is
always shown as an absolute number - which mean it would always be shown as a positive
number.
MIDPOINT ELASTICITY FORMULA
∆ in Q
d
E
d
=
% ∆ in Q
d
=
(Q
d1 +
Q
d2
)/2
% ∆ in P
∆ in P
(P
1 +
P
2
)/2
Example:
Assume when P
1
= $10 →
Q
d1
= 100; Now assume that price rise from P
1
= $10 to P
2
= $12 and as
a result, Q
d
decrease from Q
d1
= 100 to Q
d2
= 50. Calculate the midpoint elasticity.
50
E
d
=
(100 + 50)/2
= 3.7
2
(10 + 12)/2
We use midpoint estimate to avoid having two values for E
d
, depending on whether the price
increases or decreases

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PERFECTLY ELASTIC AND PERFECTLY INELASTIC DEMAND
E
d
=
% ∆ in Q
d
→ Numerator
% ∆ in P
→ Denominator
→
The numerator can be greater than the denominator
→
The numerator can be less than the denominator
→
The numerator can be equal to the denominator
Elastic Demand

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