Chapter 4
Demand
Elasticity
Managerial Economics: Economic
Tools for Today’s Decision Makers,
4/e By Paul Keat and Philip Young
Demand Elasticity
• The Economic Concept of Elasticity
• The Price Elasticity of Demand
• The Cross-Elasticity of Demand
• Income Elasticity
• Other Elasticity Measures
• Elasticity of Supply
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
The Economic Concept of Elasticity
Elasticity: The sensitivity of one
variable to another or, more precisely,
the percentage change in one variable
relative to a percentage change in
another.
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
The Price Elasticity of Demand
Price elasticity of demand: The
percentage change in quantity
demanded caused by a 1 percent
change in price.
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The Price Elasticity of Demand
Arc elasticity: Elasticity which is
measured over a discrete interval of a
demand (or a supply) curve.
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The Price Elasticity of Demand
Point elasticity: Elasticity measured at
a given point of a demand (or a supply)
curve.
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The Price Elasticity of Demand
The point elasticity of a linear demand
function can be expressed as:
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The Price Elasticity of Demand
Elasticity
differs along
a linear
demand
curve.
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
The Price Elasticity of Demand
Categories of Elasticity
1. Relative elasticity of demand
EP > 1
2. Relative inelasticity of demand
EP < 1
3. Unitary elasticity of demand
EP = 1
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The Price Elasticity of Demand
Limiting cases
1. Perfect elasticity
EP = ∞
2. Perfect inelasticity
EP = 0
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
The Price Elasticity of Demand
Determinants of Elasticity
• Ease of substitution
• Proportion of total expenditures
• Durability of product
• Possibility of postponing purchase
• Possibility of repair
• Used product market
• Length of time period
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
The Price Elasticity of Demand
A long-run demand
curve will be more
elastic than a short-run
curve.
As the time period
lengthens consumers
find way to adjust to
the price change
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
The Price Elasticity of Demand
Derived demand: The demand for products
or factors that are not directly consumed,
but go into the production of a final product.
The demand for such a product or factor
exists because there is demand for the final
product.
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
The Price Elasticity of Demand
The derived demand curve will be more
inelastic:
1. the more essential is the component in
question.
2. the more inelastic is the demand curve for
the final product.
3. the smaller is the fraction of total cost going
to this component.
4. the more inelastic is the supply curve of
cooperating factors.
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
The Price Elasticity of Demand
There is a relationship between the price elasticity
of demand and revenue received.
• If price decreases and, in percentage terms,
quantity rises more than price dropped, then total
revenue will increase.
• If price decreases and, in percentage terms,
quantity rises less than price dropped, then total
revenue will decrease.
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
The Price Elasticity of Demand
As price decreases
• revenue rises when
demand is elastic
• falls when it is
inelastic
• reaches it peak
when elasticity of
demand equals 1.
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
The Price Elasticity of Demand
Marginal Revenue: The change in
total revenue resulting from changing
quantity by one unit.
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The Price Elasticity of Demand
For a straight-line
demand curve the
marginal revenue
curve is twice as
steep as the
demand.
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The Price Elasticity of Demand
At the point where
marginal revenue
crosses the X-axis,
the demand curve is
unitary elastic and
total revenue
reaches a
maximum.
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
The Cross-Elasticity of Demand
Cross-elasticity of demand: The
percentage change in quantity
consumed of one product as a result of
a 1 percent change in the price of a
related product.
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
The Cross-Elasticity of Demand
Arc Elasticity
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The Cross-Elasticity of Demand
Point Elasticity
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The Cross-Elasticity of Demand
The sign of cross-elasticity for
substitutes is positive.
The sign of cross-elasticity for
complements is negative.
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
Income Elasticity
Income Elasticity of Demand: The
percentage change in quantity
demanded caused by a 1 percent
change in income.
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Income Elasticity
Arc Elasticity
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Income Elasticity
Point Elasticity
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Income Elasticity
Categories of income elasticity
• Superior goods
EY > 1
• Normal goods
0 > EY > 1
• Inferior goods
EY < 1
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
Income Elasticity
Categories of
Income Elasticity
• Superior goods
• Normal goods
• Inferior goods
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
Other Elasticity Measures
Elasticity is encountered every time a
change in some variable affects
quantities.
• Advertising expenditure
• Interest rates
• Population size
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
