ECON1101 - Price Elasticity

Price Elasticity is a measure of how a quantity demanded of a good responds to a change in price of said good.

## Calculating Elasticity

It's just the percentage change in quantity/percentage change in price.

(1)
\begin{align} \frac {\frac {∆Q}{Q}} {\frac {∆P}{P}} \end{align}

Midpoint Method:

(2)
\begin{align} \frac {\frac {∆Q}{Q_{mid}}} {\frac {∆P}{P_{mid}}} \end{align}

(where the midpoint is the middle of the original P/Q and the new P/Q)

## Elasticity vs Inelasticity

A smoother (less steeper) slope is more price elastic, as with the same ∆P, it creates a bigger ∆Q

If price elasticity > 1, we call it elastic demand
If price elasticity == 1, we call it unit elastic demand
If price elasticity < 1, we call it inelastic demand

## Determiners of Price Elasticity

• Substitution possibilities
• i.e. if there is no substitute, demand will stay pretty much the same regardless of price change
• Budget share
• i.e. if a holiday is just the leftover budget money, the likelihood of it being spent depends drastically on the price
• Time
• i.e. if a purchase will save you time, it is more likely to be made

## Determiners of Supply Elasticity:

• Flexibility of inputs (how much choice do they have over what they use)
• Mobility of inputs
• Ability to produce substitute inputs
• Time (needed to manufacture things)

## Perfect Elasticity/Inelasticity

Perfectly Elastic Demand

• Horizontal graph
• You can sell as many of your product as you like at that price

Perfectly Inelastic Supply:

• Vertical Graph
• You can sell your product for as much as you like, the quantity demand will not change.
• examples are vaccinations and medicines, essential items

## Importance of Curve Position

Elasticity is not a constant thing over a graph, it changes depending on the point
(e.g. a change in price for a very small quantity demand may be a 50% quantity demand increase over a 10% price reduction, whereas a change in price for a very large quantity may be the opposite).
Demand is more elastic in the top half.

## Marginal Revenue

If you decrease the price to attract new customers, you decrease the profit from all customers.

Hence there is a point where you’re losing money by decreasing the price.

### Elastic Demand

Increasing the price (P↑) leads to a decrease in revenue (R↓)
Decreasing the price (P↓) leads to an increase in revenue (R↑)

### Inelastic Demand

Increasing the price (P↑) leads to an increase in revenue (R↑)
Decreasing the price (P↓) leads to a decrease in revenue (R↓)

## Cross Price Elasticity

The percentage by which quantity demand of a good changes in response to a 1 percent change in the price of the second good.
When cross price elasticity is positive, the 2 goods are substitutes (i.e. essentially equivalent).
When cross price elasticity is negative, the 2 goods are compliments (i.e. they are related but not equivalent).

## Income Elasticity of Demand

Percentage change in quantity demand in response to a 1% change in income.
Normal goods have a positive income elasticity of demand, whereas inferior goods have a negative one.

page revision: 6, last edited: 22 Aug 2011 03:37