EC1101E W3 Chapter 5 Elasticities

What are the 2 problems with Slope?

1) The slope of a demand curve depends on the arbitrary units of measurement. 2) The slope of the demand curve doesn't tell us anything about the SIGNIFICANCE of a change in price or quantity - whether it is a relatively small or a relatively large change.

Define elasticity

Elasticity measures the sensitivity of one market variable to another.

HOW to calculate price elasticity of demand?

Formula = (% change in quantity demanded) / (% change in price) HOW to calculate % change in both quantity demanded and price? Use the MIDPOINT FORMULA

NOTE: Elasticity and Straight-Line Demand Curves

NOTE: Elasticity is the ratio of PERCENTAGE changes. What remains constant on a linear demand curve is the ratio of absolute or unit change. (At different parts of the demand curve, we will see different elasticities.) Elasticity of demand varies along a straight-line demand curve. More specifically, demand becomes less elastic as we move downward and rightward.

Categorizing Demand

PERFECTLY INELASTIC DEMAND - A price elasticity of demand equal to 0. (Curve = vertical line) A change in price does not lead to change in quantity demanded. INELASTIC DEMAND - A price elasticity of demand between 0 and 1. (Curve = steep) Quantity changes by a small percentage than price. ELASTIC DEMAND - A price elasticity of demand greater than 1. (Curve = less steep) Quantity changes by a larger percentage than price changes. PERFECTLY ELASTIC DEMAND - A price elasticity of demand approaching infinity. (Curve = horizontal line) As long as the price stays at one particular value, any quantity might be demanded. BUT, the tiniest change in price results in 0 quantity demanded. UNIT ELASTIC DEMAND - A price elasticity of demand equal to 1. Quantity demanded changes according to the percentage change in price. The demand is neither elastic nor inelastic.

Define price elasticity of demand

Price elasticity of demand measures the SENSITIVITY of QUANTITY DEMANDED to the price of the good itself.

HOW to measure price elasticity of demand?

Slope / steepness of the demand curve - The flatter the demand curve, the greater will be the decrease in quantity demanded along the curve. The flatter the demand curve --> the greater the sensitivity of quantity demanded to price. (small change in price leads to big change of quantity demanded). HOWEVER, this is only partially correct.

The Elasticity Approach

The price elasticity of demand for a good is the percentage change in quantity demanded divided by the percentage change in price. (Technically, we should follow the +ve / -ve sign but the normal convention is to drop the sign and look at the absolute number). The price elasticity of demand tells us the percentage change in quantity demanded for EACH 1% CHANGE in price. The greater the elasticity value, the more sensitive quantity demanded is to price. THEREFORE, the greater the elasticity value, the more sensitive quantity demanded is to price. NOTE: When we calculate price elasticity off demand, we imagine that ONLY PRICE is changing, ceteris paribus. --> We measure elasticity along an unchanging demand curve.

What is the midpoint formula?

When determining elasticities, calculate the % change in a variable using the midpoint formuila: the change in the variable divided by the average of the old and new values. This is because the change in the variable could have been an increase or decrease. For instance, use (old price - new price) or (old quantity demanded - new quantity demanded) The +ve / -ve sign doesn't matter.