Lecture 03: Elasticity

MAcc Pre-entry Program (Economics)

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After studying this lecture, you will be able to:

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Define, calculate, and explain the factors that influence the price elasticity of demand

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Define, calculate, and explain the factors that influence the income elasticity of demand and the cross elasticity of demand

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Define, calculate, and explain the factors that influence the elasticity of supply

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calculate You know that when supply decreases, the equilibrium price rises and the equilibrium quantity decreases.

But does the price rise by a large amount and the quantity decrease by a little?

Or does the price barely rise and the quantity decrease by a large amount?

The answer depends on the responsiveness of the quantity demanded of a good to a change in its price.

Price Elasticity of Demand

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You might think about the responsiveness of the quantity demanded of a good to a change in its price in terms of the

slope of the demand curve.

If the demand curve is steep, the price rises by a lot; if the demand curve is almost flat, the price barely rises.

But the slope of a demand curve depends on the units in which we measure the price and the quantity. We can choose these units to make the demand curve steep or flat.

To measure responsiveness we need a measure that is independent of units of measurement.

Elasticity is such a measure.

Price Elasticity of Demand

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The price elasticity of demand is a units-free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buying plans remain the same.

Calculating Price Elasticity of Demand

The price elasticity of demand is calculated by using the formula:

Price Elasticity of Demand

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To calculate the price elasticity of demand: We express the change in price as a percentage of the average price—the average of the initial and new price, … and we express the change in the quantity demanded as a percentage of the average quantity demanded—the average of the initial and new quantity.

Price Elasticity of Demand

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Figure 4.1 calculates the price elasticity of demand for pizza.

Initially, the price of a pizza is $20.50 and the quantity demanded is 9 pizzas an hour.

Price Elasticity of Demand

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The price of a pizza falls to $19.50 and the quantity demanded increases to 11 pizzas an hour.

The price falls by $1 and the average price is $20.

The quantity demanded increases by 2 pizzas and the average quantity is 10 pizzas.

Price Elasticity of Demand