Price elasticity of demand is the responsiveness of consumers to a change in the price of a product. If consumers are responsive to price changes, then the demand is elastic. If consumers are not responsive, then the demand is inelastic.
Important Notes:
-
Using percentages allows for any use of units (e.g. change in price can be measured in dollars or cents)
-
Negative signs are ignored
Elastic
- when Ed > 1 (change in demand exceeds change in price)
Inelastic
- when Ed < 1 (change in price exceeds change in demand)
Graphical Analysis
Rationale:
-
At lower quantities, additional units give large relative increases (e.g. there is a 100% increase from 1 to 2)
-
Total
Revenue
- Total revenue increases when demand is elastic
- Total revenue is at a max when Ed = 1
- Total
revenue decreases when demand is inelastic
Determinants
of Price Elasticity of demand
-
Substitutability - the more substitutes, the more elastic the demand
-
Proportion of Income - the higher the price relative to your budget, the more elastic the demand for the product (e.g. diamond rings have a very elastic demand because they are so expensive)
-
Luxuries vs. Necessities - necessities are inelastic; luxuries are elastic
-
Time - over time, product demand is more elastic because people can find more substitutes
The
main determinant of supply elasticity is time:
-
The market period is a short amount of time where supply is perfectly inelastic (vertical)
is a short amount of time where supply is perfectly inelastic (vertical)
-
-
In the long run, everything can be adjusted, and firms are most elastic.
Other
types of elasticity:
- Substitutes
have a positive Exy
- Complements
have a negative Exy
- Independent
goods have a Exy of 0
- Normal
goods have a positive Ei
- Inferior goods have a negative Ei
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