Unit 3 Module 4 Elasticity
The price elasticity of demand measures the responsiveness of quantity demanded to changes in price;
it is calculated by dividing the percentage change in quantity demanded by the percentage change in price.
Demand is price inelastic if the absolute value of the price elasticity of demand is less than 1;
it is unit price elastic if the absolute value is equal to 1; and it is price elastic if the absolute value is greater than 1.
Elasticity Demand = Change in quantity/(starting point quantity+ ending point quantity)/2 all divided by change in price/( starting point price/ending point price)/2
Always use absolute value (change negative numbers to positive)
The cross price elasticity of demand measures the way demand for one good or service responds to changes in the price of another. It is the percentage change in the quantity demanded of one good or service at a specific price divided by the percentage change in the price of another good or service, all other things unchanged.
Cross price elasticity is positive for substitutes, negative for complements, and zero for goods or services whose demands are unrelated.
Be careful not to confuse elasticity with slope. The slope of a line is the change in the value of the variable on the vertical axis divided by the change in the value of the variable on the horizontal axis between two points.
Elasticity is the ratio of the percentage changes. The slope of a demand curve, for example, is the ratio of the change in price to the change in quantity between two points on the curve. The price elasticity of demand is the ratio of the percentage change in quantity to the percentage change in price. As you will see, when computing elasticity at different points on a linear demand curve, the slope is constant—that is, it does not change—but the value for elasticity will change.
The income elasticity of demand reflects the responsiveness of demand to changes in income. It is the percentage change in quantity demanded at a specific price divided by the percentage change in income, ceteris paribus.
Income elasticity is positive for normal goods and negative for inferior goods.
On a linear demand curve, the price elasticity of demand varies depending on the interval over which you are measuring it.
For any linear demand curve, the absolute value of the price elasticity of demand will fall as you move down and to the right along the curve.
The price elasticity of supply measures the responsiveness of quantity supplied to changes in price. It is the percentage change in quantity supplied divided by the percentage change in price. It is usually positive.
Supply is price inelastic if the price elasticity of supply is less than 1; it is unit price elastic if the price elasticity of supply is equal to 1; and it is price elastic if the price elasticity of supply is greater than 1. A vertical supply curve is said to be perfectly inelastic. A horizontal supply curve is said to be perfectly elastic.
You measure the percentage change between two points as the change in the variable divided by the average value of the variable between the two points. Thus, the percentage change in quantity between points A and B in Figure 4.1 is computed relative to the average of the quantity values at points A and B: (60,000 + 40,000)/2 = 50,000. The percentage change in quantity, then, is 20,000/50,000, or 40%. Likewise, the percentage change in price between points A and B is based on the average of the two prices: ($0.80 + $0.70)/2 = $0.75, and so there is a percentage change of 0.10/0.75, or 13.33%. The price elasticity of demand between points A and B is thus 40%/(13.33%) = 3.00. (Remember, we only consider the absolute value, or the positive value, of the elasticity of demand.)
This measure of elasticity, which is based on percentage changes relative to the average value of each variable between two points, is called "arc elasticity". The arc elasticity method (also called the midpoint method) has the advantage that it yields the same elasticity whether you go from point A to point B or from point B to point A. It is the method you shall use to compute elasticity.
The problem in assessing the impact of a price change on total revenue of a good or service is that a change in price always changes the quantity demanded in the opposite direction. An increase in price reduces the quantity demanded, and a reduction in price increases the quantity demanded.
To determine how a price change will affect total revenue, economists place price elasticities of demand in three categories. If the price elasticity of demand is greater than 1, demand is termed price elastic. If it is equal to 1, demand is unit price elastic. And if it is less than 1, demand is price inelastic.
The price elasticity of supply is greater when the length of time under consideration is longer because over time producers have more options for adjusting to the change in price.
When applied to labor supply, the price elasticity of supply is usually positive but can be negative. If higher wages induce people to work more, the labor supply curve is upward sloping and the price elasticity of supply is positive. In some very high-paying professions, the labor supply curve may have a negative slope, which leads to a negative price elasticity of supply.
Notice that with income elasticity of demand and cross price elasticity of demand you are primarily concerned with whether the measured value of these elasticities is positive or negative. In the case of income elasticity of demand, this tells you whether the good or service is normal or inferior. In the case of cross price elasticity of demand it tells you whether two goods are substitutes or complements.
With price elasticity of demand you were concerned with whether the measured absolute value of this elasticity was greater than, less than, or equal to 1 because this gave you information about what happens to total revenue as price changes. The terms elastic and inelastic apply to price elasticity of demand. They are not used to describe income elasticity of demand or cross price elasticity of demand.