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lec 6

lec 6 - 3.a Elasticity of Demand Even though we assume that...

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3.a. Elasticity of Demand Even though we assume that all market demand curves have negative slopes (implying that at a lower price a greater quantity will be purchased), the degree of responsiveness varies widely from one commodity to another. Elasticities measure the magnitude of the responsiveness of any variable (such as quantity demanded and quantity supplied) to a change in particular determinats. For a reduction in the price of cigarettes may lead to an infinitesimal increase in purchase while a reduction in airplane fares may produce a veritable explosion in air travel. The law of demand tells us to expect some increase in quantity demanded, but not how much. The price elasticity of demand is a measure of how sensitive quantity demanded is to a change in a product’s price. It can be defined as the percentage change in quantity demanded divided by the percentage change in price. The ratio will always be negative for any downward sloping demand curve. E d = percent change in quantity demanded Percent change in price For example, if a 10 percent price increase brings about a 20 percent reduction in quantity demanded, the price elasticity of demand is –20 percent/+ 10 percent, or –2.0. Economists usually drop the minus sign on the understanding that price and quantity demanded always move in different direction and simply refer to the elasticity as being, in this case, 2.0. Price elasticity of demand provides a quantitative measure of the price responsiveness of quantity demanded along a demand curve. The higher the numerical value of the elasticity, the larger the effect of a price change on quantity. If the elasticity is only .2, then a 10 percent price increase will reduce quantity demanded by just 2 percent (2 percent/10 percent = .2). Alternatively, if the elasticity is 4.0, a 10 percent rise will reduce quantity demanded by 40 percent (40 percent/10 percent = 4.0). Elasticity of Demand and Total Revenue One simple way to think of elasticity of demand is to relate it to total revenue. For example, suppose a relatively small decline in price is associated with a relatively large increase in the quantity demanded. The total revenue from sales rises, and the demand is said to be elastic. This relationship is shown below.

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lec 6 - 3.a Elasticity of Demand Even though we assume that...

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