Econ103 – Macroeconomic Principles  Fall 2010 – Prof: Werner Baer
Reading1p.1
Reading 1
PRICE ELASTICITY OF DEMAND
Price elasticity of demand is the percentage change in
quantity demanded caused by a percentage change in price.
Intuitively, it measures the sensitivity of consumer’s
demand to a change in price.
So, if price changes by 1%, elasticity tells us how much
the quantity demanded changes in percentage terms.
P
Q
E
d
Δ
Δ
=
%
%
Looking at Graph 1, the next equation tells us how to
calculate elasticity.
2
/
)
(
2
/
)
(
price
average
price
in
change
quantity
average
quantity
in
change
2
1
1
2
2
1
1
2
P
P
P
P
Q
Q
Q
Q
E
D
D
D
D
+

+

=
=
Graph 1
E
can take any value between 0 and infinity:
E<1: Inelastic demand
E = 1: Unit Elastic demand
E>1: Elastic demand
In the unit elastic case, if price increases, quantity
demanded decreases by the same %.
In the inelastic case, if price increases 1%, quantity
demanded decreases less than 1%. Example: goods that
people really need to buy, like medicines, or cheap goods
(like
a
50
cents
pen).
Remember:
price
elasticity
=
sensitivity to changes in price; so, if it is inelastic, people are
not sensitive to changes in price.
In the elastic demand case, if price increases 1%,
quantity demanded decreases more than 1%. Example: most
goods, especially if they are reasonably expensive and/or
luxurious items.
Special cases:
E = 0: Perfectly inelastic demand
E close to infinity: Perfectly elastic demand
In the first case, if E=0, a change in price has no effect
on the quantity demanded, i.e., the demand curve is vertical
(Graph 2). Some examples could be medicines, gasoline or
cigarettes, for many people.
Graph 2
In the second case, if E is close to infinity, quantity
demanded falls to zero if price increases, i.e., the demand
curve is horizontal (Graph 3). Examples are goods that have
perfect substitutes, like pizza from Dominos and pizza from
Papa Johns (as long as the pizzas are very similar).
Graph 3
PRICE ELASTICITY OF SUPPLY
Price elasticity of supply is the percentage change in
quantity supplied caused by a percentage change in price. It
is measuring the sensitivity of producer’s supply to a change
in price.
So, if price changes by 1%, elasticity tells us how much
the quantity supplied changes in percentage terms.
P
Q
E
S
Δ
Δ
=
%
%
2
/
)
(
2
/
)
(
2
1
1
2
2
1
1
2
P
P
P
P
Q
Q
Q
Q
S
S
S
S
+

+

=
The formula to calculate this elasticity is similar to the
one for elasticity of demand, but we use the quantity
supplied instead of quantity demanded.