ELASTICITYlecture

# ELASTICITYlecture - Elasticity Formulas Conceptually,...

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Elasticity Formulas Conceptually, elasticity is a measure of responsiveness. Algebraically, it is the ratio of two percentage changes. When you think elasticity, you should think “responsiveness”. When we write “% X” - this means the percentage change in X Elasticity of Demand – (the own price elasticity of demand) – this measures the response of quantity demanded to a change in this good’s own price. It can also be interpreted as follows. If the elasticity of demand is –2, then a 1% increase in price will lead to a 2% decrease in quantity demanded. Likewise, if the elasticity of demand is –4, a 1% decrease in price will lead to a 4% increase in quantity demanded. E D = % Q d / % P By the 1 st Law of Demand, this must be negative. If % P > 0, then % Q d < 0 E D < 0 If % P < 0, then % Q d > 0 E D < 0 To keep things from being less confusing, we will often talk about the absolute value of the elasticity of demand (remove the negative sign). | E D | > 0. There will be three relevant ranges of the elasticity of demand. - < E D < -1, elastic Alternatively, 1 < | E D | < , elastic E D = -1, unit elastic | E D | = 1, unit elastic -1 < E D < 0, inelastic 0 < | E D | < 1, inelastic Also, E D = - , perfectly elastic | E D | = , perfectly elastic E D = 0, perfect inelastic | E D | = 0, perfectly inelastic Suppose there is a 20% increase in price that leads to a 40% reduction in quantity demanded. In this case, % P = 20%, % Q d = -40% E D = % Q d / % P = - 40% / 20% = -2 This would be an elastic demand curve (|E D | =2). Suppose a 60% increase in price leads to a 10% reduction in quantity demanded. In this case, % P = 60%, % Q d = -10% E D = % Q d / % P = - 10% / 60% = - 0.16This would be an inelastic demand curve (|E D | =0.16). Below, I have sketched a relatively elastic, inelastic and unit elastic curve. I am cheating a bit. Along any linear demand curve is the whole range of elasticities. Elasticities are not the same thing as the slope of the demand curve!

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Relatively elastic Relatively inelastic Unit elastic P 0 P 0 P 0 P 1 P 1 P 1 D D D Q 0 Q 1 Q 0 Q 1 Q 0 Q 1 Notice that for the relatively elastic curve, we see a large change in quantity demanded for a given % change in price. That is, demand is very responsive or elastic. If you’d rather, the % Q d is larger in magnitude than the % P. However, for the relatively inelastic curve, we see only a modest change in quantity demanded for the given % change in price. We would say that this demand curve is unresponsive, or inelastic. If you’d rather, the % Q d is smaller in magnitude than the % P. What happens to the total expenditures (spending) on a good as the price changes? We can use the elasticity concept to determine what happens to total expenditures (total spending) as we
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## ELASTICITYlecture - Elasticity Formulas Conceptually,...

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