Transcript Class Notes - Nc State University

Price Elasticity of Demand
Lecture 1
1
Demand Curves Show How Sensitive
Consumers are to Price Changes
Relatively inelastic
P
1. Quantity demanded is not affected very
much by price changes.
2. Therefore not very sensitive to price changes.
3. Not many substitutes, short period of time,
and small proportion of budget.
Demand
4.  Q is not as great as theP.
Quantity Demanded/unit time
2
Demand Curves Show How Sensitive
Consumers are to Price Changes
Relatively elastic
P
Demand
1. Quantity demanded is affected very
much by price changes.
2. Therefore very sensitive to price changes.
3. Many substitutes, long period
of time, and large proportion
of budget.
Quantity Demanded/unit time
4.  Q is greater than theP.
3
Elastic? or,
Corn
Price
Here the slope relates that the
quantity demanded is very
sensitive to price changes
6
5
4
3
2
1
0
0
100
200
300
400
500
1000 bu./month
4
Inelastic?
Price
6
BUT a change in the scale of
measure changes the graph
so as to make it look as
though the quantity demanded
is NOT very sensitive to
changes in price !
Corn
5
4
3
2
1
1
2
3
4
5
million bu/month
5
Calculating Elasticity
Due to the problems with scaling
depicted here, we rely on a
mathematical determination of
elasticity.
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Price Elasticity of Demand (Ed)
Ed =
percentage change in quantity demanded
-----------------------------------------------------percentage change in price
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Calculating Ed:
Ed
All 3 of these equations
yield the same answer
= %Qd / %P
= (Qd / P) * P0 / Q0
= (1 / Slope) * P0 / Q0
8
Interpreting an Elasticity
Estimate
If Ed were to = - .75, what does it tell us?
“For every 1% change in price, Qd will
change .75% in the opposite direction”
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Example:
P0 = 8
Q0 = 40
P1 = 7
Q1 = 48
Step 1: Q = 48 - 40 = 8
P = 7 - 8 = -1
Step 2: Use the formula for Ed.
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Step 3:
Ed = (Qd / P) * P0 / Q0
= (8 /-1) * (8/40) = - 1.6
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Step 4:
This means that for every 1 % change in
price that there is a 1.6 % change in
quantity demanded in the opposite
direction.
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Since we know that an Ed = - 1.6 means
that a 1 % change in price results in a
1.6% change in quantity demanded in
the opposite direction,
What would a 20% increase in price
result in?
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Step 1: Ed =
% Q / %  P
Step 2: %Q = Ed * % P
Step 3: % Q = - 1.6 * +20% = - 32%
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What would a 20% increase in the
quantity demanded result in ?
Step 1: Ed = % Q / %  P
Step 2: % P = 1 / Ed * % Q
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Step 3:
% P = (1 / - 1.6) * +20% = - 12.5%
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If you have trouble with algebraic
derivations of an equation then,
REMEMBER:
% P X Ed = % Q
% Qd X (1 / Ed) = % P
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We now know how to mathematically
determine Ed, what does it tell us
about elasticity ?
Economist usually drop the negative
sign of the elasticity of demand for
they know that P Q.
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Ed > 1  elastic demand (very responsive
to price changes).
Ed< 1  inelastic demand (not very
sensitive to prices).
Ed = 1  unitary elastic (ratio of %s = 1).
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Ed > 1  %Q > %P
Ed< 1  %Q < %P.
Ed= 1  %Q = %P.
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1971 Estimates of Price Elasticity
of Demand at Retail in the US
beef
pork
chicken
milk
sugar
bread
all foods
non foods
Ed
- .6438
-.4130
-.7773
-.3455
-.2419
-.1500
-.2368
-1.0179
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