ECON 1B03 Study Guide - Final Guide: Ice Cream Cone, Arc Elasticity, Demand Curve
16 Sep 2016
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Chapter : Elasticity
Elasticity
- measure of how much buyers and sellers respond to changes in market conditions
- measures how responsive Qd or Qs is to changes in price, income, or price of related
goods
- allows us to quantify changes in quantity demanded and supplied when dealing with
price change
Elasticity of Demand
- price elasticity of demand, Ep: measures how much the quantity demanded of a
good responds to a change in the price of that good
- Ep = percentage change in Qd/percentage change in P
= % r in Qd / % r in P
% r in Qd = (new-old)/old x 100% → percentage change formula for quantity
demanded
- coefficient of elasticity: the number we get from our calculation Ep=1.5
- size of coefficient will tell us how elastic the good is – how responsive demand is to a
change in price
Types of Demand
Inelastic Demand
- quantity demanded does not respond strongly to price changes
- the % change in Qd < % change in P
- Ep < 1
- Demand curve = fairly steep because a large change in Q corresponds to
a small change in P
- )f the price of required textbook of increases, the demand doesn’t
change; required textbook demand is inelastic
- Inelastic goods tend to be necessities, things we buy no matter what the price like
food, textbooks, utilities, etc.
Elastic Demand
- quantity demanded responds strongly to changes in price
- the % change in Qd > % change in P
- Ep > 1
- Demand curve = fairly flat
- Price change is smaller than change in quantity demanded
- prices increase by 10%, quantity demanded falls by 40%
- most manufacturers, eg. Coffee (can switch to tea)
Perfectly Inelastic Demand
- quantity demanded does not respond to price changes at all
- Ep = 0
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- Demand curve = vertical
- Buy the same amount regardless of price increase
- Complete necessities like heart medication, buy the same amount no matter what
the price
- Slope is undefined
Perfectly Elastic Demand
- quantity demanded changes infinitely with any change in price
- Ep >= infinity
- Demand curve = horizontal
- at any P above P*, demand is 0;
- at any P below P*, demand is infinite
- eg. Wheat is wheat no matter who is selling it; if seller 1 tries to
increase price above P*, there will be 0 demand because they will
find a seller selling at P* or below P*
- this works only for goods that are completely homogeneous
Unit Elastic
- quantity demanded changes by the same percentage as the price
- Ep = 1
- Demand curve = non-linaer
- Change in P and change in Q are the same, both change by the same amount
- Good doesn’t exist that is characterized as unit elastic
- Just a divider between elastic and inelastic
Recap
- Ep = 1, demand unit elastic
- Ep >1, demand elastic
- Ep <1, demand inelastic
- eg. Food: inelastic (no substitute, necessity for life); Green grapes: elastic
Calculating Elasticity
Method 1
- Ep = % r in Qd
- % r in P
- Example 1: The price of milk increases by 2% and Qd decreases by .5%
Ep = -.5/2 = -.25
- milk is inelastic because coefficient of Ep is < 1
Method 2: Midpoint Formula
- measures arc elasticity → one variable with respect to another between two given
points on a line, pts A and B
- each point has two sets of values: A (P1, Q1), B (P2, Q2), and plug them into
equation
- the midpoint formula takes the average of those two
- going from point A to B, it gives you one value, but point B to A gives you another
coefficient… this formula takes the average of those two points so direction of A to B
or B to A doesn’t matter
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- Ep = (Q2-Q1) / ([Q2+Q1]/2)
(P2-P1)/ ( [P2+P1] /2)
- We use it when we are giving two prices and their corresponding Qd values.
- Pt A → P = 4, Q = 120; Pt B → P = 6, Q = 80
- Example 2: The price of an ice cream cone increases from $2.00 to $2.20 and the
amount you buy falls from 10 to 8 cones, then your elasticity of demand would be
calculated as:
Ep = (8-10) / ((8+10)/2)
(2.20-2)/((2.20+2)/2)
= -2/9
0.20/2.10
= -2.32 → Therefore, inelastic since Ep<1
Method 3: Point Elasticity
- Measures the impact of a marginal (small, incremental) change in price on quantity
demanded
- Ep = (dQ/dP)*(P/Q)
- What is the change in Q with respect to the change in P
- dQ/dP is the slope of a linear demand curve when demanded in form Q =f(P)
Example 3: Demand is given by the equation Qd = 200 – 3P. What is the point
elasticity of demand when price is $15?
Qd = 200-3(15) – 155
Ep = -3 (15/155) → -3 is differentiated; always the # in front of P = slope
= -0.29 → Therefore, inelastic
When we calculate price elasticity of demand, we drop the negative sign:
- because we have a negative relationship between P and Q and the negative sign just
indicates the negative relationship
- Example 1: Ep = 0.25, Ep < 1, demand for milk is inelastic
- Example 2: Ep = 2.32, Ep > 1, demand for ice cream is elastic
- Example 3: Ep = 0.29, Ep > 1, demand is inelastic
- The greater the sensitivity, the more responsiveness from that good
Determinants of Ep
- close substitutes: goods with close substitutes have more elastic demand
o will stop buying the expensive one and buy cheap substitute
- necessity vs. luxury: luxury goods have more elastic demand
o don’t change demand for necessities so inelastic, but luxury objects are more
elastic because we don’t necessarily need to continue buying
- definition of market: the more narrowly defined the market, the more elastic
demand of good is
o the more broad the market, the more inelastic the good (food)
o the more narrowly defined the market, the more elastic (broccoli)
- time period: goods tend to have more elastic demand over longer time horizon
o tend to be more elastic over the long run vs short run
o demand might change slightly in short run but not by much
o demand is more inelastic in short run
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ECON 1B03 Full Course Notes
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Document Summary
Measure of how much buyers and sellers respond to changes in market conditions. Measures how responsive qd or qs is to changes in price, income, or price of related goods allows us to quantify changes in quantity demanded and supplied when dealing with price change. Price elasticity of demand, ep: measures how much the quantity demanded of a good responds to a change in the price of that good. Ep = percentage change in qd/percentage change in p. = % r in qd / % r in p. Inelastic demand the % change in qd < % change in p. Quantity demanded does not respond strongly to price changes. Demand curve = fairly steep because a large change in q corresponds to a small change in p. )f the price of required textbook of increases, the demand doesn"t change; required textbook demand is inelastic.
