Elasticity

Last Time…

Demand, supply, and market equilibrium.

• Demand/supply reveals the relationship between quantity demanded/supplied and the
market price.
• Ceteris paribus, the higher the price of a good, the smaller is the quantity demanded (the
law of demand), and the larger is the quantity supplied (the law of supply).
• Market equilibrium is achieved when the price equalizes quantity demanded and
quantity supplied.
A quantitative question: how sensitive does quantity demanded/supplied react
to price changes?
• If the price of rice goes up by 20%, we might still consume rice as much as before; but if
the price of whiskey goes up by 20%, people might consume much less than before.
Price Elasticity of Demand

We know that when supply decreases, the equilibrium price rises and the
equilibrium quantity decreases (law of demand).
• 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

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.
Price Elasticity of Demand
Price
(HKD per gallon)
The figure on the right shows Amy’s
demand for purified water per week.
• When the price of purified water is 36
HKD per gallon, Amy consumes 10 36
gallon purified water per week.
• When the price of purified water is 20
HKD per gallon, Amy consumes 18 20
gallon purified water per week.
What is the slope of the demand curve?
What does the slope mean?
10 18 Quantity
(gallon per week)
Price Elasticity of Demand
Price
(HKD per bottle)
The figure on the right shows Amy’s
demand for apple juice per week.
• When the price is 20 HKD per bottle,
Amy consumes 5 bottles per week.
• When the price is 14 HKD per bottle,
Amy consumes 8 bottles per week. 20

What is the slope of the demand curve? 14

What does the slope mean?
• Which demand is more responsive to
price changes?
5 8 Quantity
(bottle per week)
Price Elasticity of Demand

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 (unit-free).
Elasticity is such a measure.
Price Elasticity of Demand

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:

% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑

% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
Price Elasticity of Demand

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

The figure 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

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 quantity
demanded increases by 2 pizzas an
hour.
Price Elasticity of Demand

The average price is $20 and the

average quantity demanded is 10
pizzas an hour.
Price Elasticity of Demand

The % change in quantity demanded,

Δ%𝑄, is calculated as
Δ𝑄
× 100%, which is
𝑄𝑎𝑣𝑒
2
× 100% = 20%
10
The % change in price, Δ%𝑃, is
Δ𝑃
calculated as × 100%, which is
𝑃𝑎𝑣𝑒
−$1
× 100% = −5%
$20
Price Elasticity of Demand

The price elasticity of demand is

%ΔQ 20%
= = −4
%ΔP −5%
Price Elasticity of Demand

Average Price and Quantity

By using the average price and average quantity, we get the same elasticity
value regardless of whether the price rises or falls.

Percentages and Proportions

The ratio of two proportionate changes is the same as the ratio of two
percentage changes.
∆𝑄 ∆𝑃
%∆𝑄/%∆𝑃 = /
𝑄 𝑃
Price Elasticity of Demand

A Units-Free Measure
Elasticity is a ratio of percentages, so a change in the units of measurement
of price or quantity leaves the elasticity value the same.

Minus Sign and Elasticity

The formula yields a negative value, because price and quantity move in
opposite directions.
But it is the magnitude, or absolute value, that reveals how responsive the
quantity change has been to a price change.
Price Elasticity of Demand

Inelastic and Elastic Demand

Demand can be inelastic, unit elastic, or elastic, and range from zero to infinity.
If the quantity demanded doesn’t change when the price changes, the price
elasticity of demand is zero and the good has a perfectly inelastic demand.
Price Elasticity of Demand

Figure (a) illustrates the case of a

good that has a perfectly inelastic
demand.
The demand curve is vertical.
Price Elasticity of Demand

If the percentage change in the

quantity demanded equals the
percentage change in price, …
the price elasticity of demand equals 1
and the good has unit elastic demand.
Figure (b) illustrates this case—a
demand curve with ever declining
slope.
Price Elasticity of Demand

If the percentage change in the quantity demanded is smaller than the percentage
change in price,
• the price elasticity of demand is less than 1 and the good has inelastic demand.
If the percentage change in the quantity demanded is greater than the percentage
change in price,
• the price elasticity of demand is greater than 1 and the good has elastic demand.
Price Elasticity of Demand

If the percentage change in the

quantity demanded is infinitely large
when the price barely changes, …
the price elasticity of demand is
infinite and the good has a perfectly
elastic demand.
Figure (c) illustrates the case of
perfectly elastic demand—a
horizontal demand curve.
Price Elasticity of Demand

The Factors That Influence the Elasticity of Demand

The elasticity of demand for a good depends on:
1. The closeness of substitutes
2. The proportion of income spent on the good
3. The time elapsed since a price change
Price Elasticity of Demand

Closeness of Substitutes
The closer the substitutes for a good or service, the more elastic is the demand.
Necessities, such as food or housing, generally have inelastic demand.
Luxuries, such as exotic vacations, generally have elastic demand.
Price Elasticity of Demand

An example of inelastic demand

Daraprim is used mainly to treat
toxoplasmosis, a parasite infection that can
cause serious or even life-threatening
problems for people with compromised
immune systems, like AIDS patients and
certain cancer patients.
Price Elasticity of Demand

An example of inelastic demand

In 2015, Daraprim was acquired by
Turing Pharmaceuticals. The price of
the drug was raised from $13.5 to
$750 per pill overnight.
The price hike soon drew attention
and criticism from newspapers,
healthcare professionals, and even
presidential candidates such as
Hillary Clinton, Bernie Sanders, and
Donald Trump.
Price Elasticity of Demand

An example of inelastic demand

Martin Shkreli, former CEO of Turing
Pharmaceuticals, was charged with security
fraud and sentenced to seven years in prison
and $7.4 million fines.
The U.S. FDA approved generic form of
Daraprim in 2020 in order to reduce the its
price.
Price Elasticity of Demand

An example of elastic demand

During March 2017, 2,939 Tesla vehicles were
registered in Hong Kong.
In April 2017, not a single newly purchased Tesla
model was registered.
What happened?
Price Elasticity of Demand

An example of elastic demand

The Hong Kong government used to provide tax
breaks to buyers of electric cars…
Then the tax break was slashed in April 2017.
As a result, the cost of a basic Model S has risen
from less than 570,000 HKD to around 988,000 HKD.
Can we infer the price elasticity from the data?
Price Elasticity of Demand

Proportion of Income Spent on the Good

The greater the proportion of income consumers spend on a good, the larger
is the elasticity of demand for that good.

Time Elapsed Since Price Change

The more time consumers have to adjust to a price change, or the longer that
a good can be stored without losing its value, the more elastic is the demand
for that good.
Price Elasticity of Demand

Price Elasticities in the Real-World

The real-world price elasticities of demand in the
table range from 1.52 for metals, the item with
the most elastic demand in the table, to 0.05 for
oil, the item with the most inelastic demand in
the table. The demand for food is also inelastic.
• Oil and food, which have poor substitutes and inelas-
tic demand, might be classified as necessities.
Furniture and motor vehicles, which have good
substitutes and elastic demand, might be classified as
luxuries.
Price Elasticity of Demand

Price Elasticities in the Real-World

The price elasticity of demand for food in the
United States is estimated to be 0.12, which is an
average over all types of food.
• The demand for grapes and the demand for beef are
elastic – these food items have many good substitutes.
• The demand for oranges is unit elastic.
• The demand for the Florida winter tomatoes is more
elastic (less inelastic) than the demand for tomatoes
because it have closer substitutes than tomatoes in
general.
• Carrots and cabbage, on which we spend a very
small proportion of income, have an almost zero
elastic demand.
Price Elasticity of Demand

Elasticity Along a Linear Demand Curve

The figure shows how the elasticity of
demand changes along a linear demand
curve.
At the mid-point of the demand curve,
demand is unit elastic.
Price Elasticity of Demand

At prices above the mid-point of the

demand curve, demand is elastic.
At prices below the mid-point of the
demand curve, demand is inelastic.
Price Elasticity of Demand

For example, if the price falls from $25 to

$15, the quantity demanded increases
from 0 to 20 pizzas an hour.
The average price is $20 and the average
quantity is 10 pizzas.
The price elasticity of demand is (20/10)
divided by (10/20), which equals 4.
Price Elasticity of Demand

If the price falls from $10 to $0, the

quantity demanded increases from 30 to 50
pizzas.
The average price is $5 and the average
quantity is 40 pizzas.
The price elasticity is (20/40) divided by
(10/5), which equals 1/4.
Price Elasticity of Demand

If the price falls from $15 to $10, the

quantity demanded increases from 20
to 30 pizzas an hour.
The average price is $12.50 and the
average quantity is 25 pizzas.
The price elasticity is (10/25) divided
by (5/12.5), which equals 1.
Case: Peanut Butter

Peanut Butter Prices Rise 30 to 40 Percent

Scott Karns, president and CEO of Karns Foods, said “People are still going to
need it for their family. It’s still an extremely economical item.” Patty Nolan, who
is on a fixed income, said “I love peanut butter so I’m using a little less so I don’t
go through it.”
Source: The Patriot News, November 2, 2011
The Questions
• Does the news clip imply that the
demand for peanut butter is elastic or
inelastic?
• If the data are two points on the
demand curve for peanut butter, what
is the price elasticity of demand?