Price Elasticity of Demand Lecture 1

Demand Curves Show How Sensitive Consumers are to Price Changes Relatively inelastic 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. 4.  Q is not as great as theP. P Demand Quantity Demanded/unit time

Demand Curves Show How Sensitive Consumers are to Price Changes Relatively elastic 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. 4.  Q is greater than theP. P Demand Quantity Demanded/unit time

Elastic? or, Corn Here the slope relates that the Price Here the slope relates that the quantity demanded is very sensitive to price changes 1000 bu./month

Inelastic? Corn 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 ! Price 6 5 4 3 2 1 1 2 3 4 5 million bu/month

Calculating Elasticity Due to the problems with scaling depicted here, we rely on a mathematical determination of elasticity.

Price Elasticity of Demand (Ed) percentage change in quantity demanded ------------------------------------------------------ percentage change in price

Calculating Ed: Ed All 3 of these equations yield the same answer = %Qd / %P = (Qd / P) * P0 / Q0 = (1 / Slope) * P0 / Q0 All 3 of these equations yield the same answer

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”

Example: P0 = 8 P1 = 7 Q0 = 40 Q1 = 48 Step 1: Q = 48 - 40 = 8 Step 2: Use the formula for Ed.

Step 3: Ed = (Qd / P) * P0 / Q0 = (8 /-1) * (8/40) = - 1.6

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.

Since we know that an Ed = - 1 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?

Step 1: Ed = % Q / %  P Step 2: %Q = Ed * % P Step 3: % Q = - 1.6 * +20% = - 32%

What would a 20% increase in the quantity demanded result in ? Step 1: Ed = % Q / %  P Step 2: % P = 1 / Ed * % Q

Step 3: % P = (1 / - 1.6) * +20% = - 12.5%

If you have trouble with algebraic derivations of an equation then, REMEMBER: % P X Ed = % Q % Qd X (1 / Ed) = % P

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.

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).

Ed > 1  %Q > %P Ed< 1  %Q < %P. Ed= 1  %Q = %P.

1971 Estimates of Price Elasticity of Demand at Retail in the US Ed beef - .6438 pork -.4130 chicken -.7773 milk -.3455 sugar -.2419 bread -.1500 all foods -.2368 non foods -1.0179