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ECON 201 PRINCIPLES OF MICROECONOMICS. Chapter 4. Professor Carol Cui. Price Elasticity of Demand. Measures 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 Why need it?
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ECON 201 PRINCIPLES OF MICROECONOMICS Chapter 4 Professor Carol Cui
Price Elasticity of Demand • Measures 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 • Why need it? • To answer questions such as “If supply drops, will the price increases by a large amount? How big will the quantity drops?”
P1 P1 P2 P2 Q1 Q2 Q1 Q2 High Elasticity (flat) Low Elasticity (steep)
Sign of Price Elasticity of Demand • We only care the magnitude (i.e. absolute value) and ignore the minus sign because: • Price of a good and the quantity demanded always move in the opposite direction (recall Law of Demand) • Price elasticity is the only elasticity measure where we ignore the sign.
Elasticity vs. Slope • Elasticity and slope are not the same. • If a demand curve is a straight line, • its slope is constant, but • its price elasticity gets smaller as we move down the line.
Inelastic vs. Elastic Demand • Perfectly inelastic demand: η = 0 • Unit elastic demand: η = 1 • Inelastic demand: 0 < η < 1 • Perfectly elastic demand: η = ∞ • Elastic demand: η > 1
Perfectly Inelastic Demand • The quantity demanded remains constant regardless of the price level. • The good is a necessity and has few substitutes. • Examples: water, salt, insulin to diabetics
Perfectly Elastic Demand • The quantity demanded changes by an infinitely large percentage in response to a tiny price change. • The good has a perfect substitute.
Unit Elastic Demand • The percentage change in the quantity demanded equals to the percentage change in price.
Inelastic Demand • The percentage change in the quantity demanded is less thanthe percentage change in price. (Steeper slope) • Examples: food, gasoline.
Elastic Demand • The percentage change in the quantity demanded is more thanthe percentage change in price. (Flatter slope) • Examples: diamonds, taxi services.
Factors Affect the Elasticity of Demand • Closeness of Substitutes • The closer the substitutes for a good, the more elastic is the demand. • Proportion of Income Spent on Good • The greater the proportion of income spent on a good, the more elastic is the demand. • Time Elapsed Since Price Change • The longer the time elapsed, the more elastic is the demand.
