PRICE ELASTICITY OF DEMAND AND SUPPLY

A. PRICE ELASTICITY OF DEMAND AND SUPPLY

Some purchases, like those for vacation travel, are luxuries that are very sensitive to price changes

PRICE ELASTICITY OF DEMAND.

The price elasticity of demand (sometimes simply called price elasticity) measures how much the quantity demanded of a good changes when its price changes. The precise definition of price elasticity is the percentage change in quantity demanded divided by the percentage change in price.

The ability to adjust consumption patterns implies that demand elasticities are generally higher in the long run than in the short run.

The price elasticity of demand for individual goods are determined by the economic characteris- tics of demand. Price elasticity tend to be higher when the goods are luxuries, when substitutes are available, and when consumers have more time to adjust their behavior. By contrast, elasticities are lower for necessities, for goods with few substitutes, and for the short run.

Calculationg Elasticities.

o When a 1 percent change in price calls forth more than a 1 percent change in quantity demanded, the good has price-elastic demand.

o When a 1 percent change in price produces less than a 1 percent change in quantity demanded, the good has price-inelastic demand.

o One important special case is unit-elastic demand, which occurs when the percentage change in quan- tity is exactly the same as the percentage change in price.

The price elastic ity of demand is evidently ED = 40/20 = 2

The price elasticity is greater than 1,

1. Recall that we drop the minus signs from the numbers, thereby treating all percentage changes as positive.

2. Note that the definition of elasticity uses percent- age changes in price and demand rather than absolute changes

3. Note the use of averaging to calculate percentage changes in price and quantity. The formula for a percentage change is ΔP/P. The value of ΔP in Table 4-1 is clearly 20

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