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Elasticity of Demand
Part II
Elastic
D1
Chapter 5
Inelastic
D1
Variety of Demand Curves
• Perfectly Inelastic
D1
– Quantity demanded does not respond to price changes
– Ed = 0
• Perfectly Elastic
D1
– Quantity demanded changes infinitely with price change
– Ed = ∞
Unit Elastic Demand
Elasticity = 1
Price
• Unit Elastic
– Quantity demanded changes by the same percentage as price
– Ed = 1
%∆ Qty D
-------------- = 1
. %∆ P
$5
4
Demand
1. A 22%
increase
in price . . .
0
80
100
Quantity
2. . . . leads to a 22% decrease in quantity demanded.
Perfectly Elastic
Perfectly Inelastic
Elasticity = Infinity
Elasticity = 0
Price
Price
Demand
1. At any price
above $4, quantity
demanded is zero.
%∆ Qty D
-------------- = 0
. %∆ P
$5
4
$4
%∆ Qty D
-------------- = ∞
. %∆ P
Demand
An ↑ Price…
2. At exactly $4,
consumers will
buy any quantity.
0
Quantity
100
0
3. At a price below $4,
quantity demanded is infinite.
. . . . leaves quantity demanded unchanged.
Unit Elastic Demand
Elasticity = 1
Price
%∆ Qty D
-------------- = 1
. %∆ P
$5
4
Demand
1. A 22%
increase
in price . . .
0
80
100
Quantity
2. . . . leads to a 22% decrease in quantity demanded.
Quantity
Slope versus Elasticity
• Price elasticity of demand is closely related to slope of a
demand curve---but it is not the same!
• The Slope of a linear demand curve is constant
• Elasticity changes at each point on line
• All linear demand curves have elastic, unit elastic & inelastic
points on the line
Calculating Elasticity
(simple method)
Price
$220
Prices rises from
$200
to
$220
B
$200
A
D1
0
% ∆ Qty D
Ed = -------------- .
%∆P
8
10
Quantity
(8(10
–
10)
8)
 100
20%
10

2
(2.20  2.00)
 100 10%
2.00
Ed > 1 => demand is Price Elastic
Problems with
Simple Elasticity Calculation
• The simple % method leads to different results based on
the direction of the quantity change
#2) Qty Rises 8 → 10
#1) Qty Falls 10 → 8
(10  8)
(8(10
– 10)
 8)
 100
20%
10

2
(2.20  2.00)
 100 10%
2.00
8
( 2 .00  2 .20 )
2 .20
Price
$220
B
$200
A
D1
0
 100
8
10
Quantity
 100

25%
9%
 2.7
Mid-Point Method
• The mid-point method achieves the same elasticity calculation
regardless of direction of price change
– Use the mid-point formula for all test calculations:
%∆ in Qty
=
--------------% ∆ in Price =
Price
$220
B
$200
A
D1
0
8
10
Quantity
∆ Q/[(Q1 + Q2)/2]
------------------------∆ P/[(P1 + P2)/2]
2 .
(10+8)/2
22%
------------------ = ----- = 2.3
.2 .
9.5%
(2.2+2)/2
Elasticity of Demand Practice Test
Stock Market 2014
Macro Stories
Micro Stories
2013 Data
Stock Market = +29.6% p.e. ratio = 20
GDP = +2.1%
Unemployment = 7.0%
Labor Participation = 30 year low
Debt = 17.3 Trillion
10yr bond = 3.0% Fed Funds = 0.0%
Europe = still in recession
China = facing inflation
Fed = New chairperson, taper of QE