Demand Elasticity: Managerial Economics: Economic Tools For Today's Decision Makers, 4/e by Paul Keat and Philip Young

Chapter 4
Demand
Elasticity
Managerial Economics:
Economic Tools for Today’s
Decision Makers, 4/e By Paul
Keat and Philip Young
Lecturer: KEM REAT Viseth, PhD (Economics) 1

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
Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young
2
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.
percent change in A
Coefficient of Elasticity 
percent change in B
3
The Price Elasticity of Demand
Price elasticity of demand: The
percentage change in quantity
demanded caused by a 1 percent
change in price.
%D Quantity
Ep =
%D Price
4
Arc elasticity: Elasticity which is
measured over a discrete interval of a
demand (or a supply) curve.
Q2  Q1 P2  P1
Ep  
(Q1  Q2 ) / 2 ( P1  P2 ) / 2
5
Point elasticity: Elasticity measured at
a given point of a demand (or a supply)
curve.
dQ P1
εP = x
dP Q1
6
The point elasticity of a linear demand
function can be expressed as:
D Q P1
εP = x
D P Q1
7
Elasticity
differs along
a linear
demand
curve.
8
Categories of Elasticity
1. Relative elasticity of demand
EP > 1
2. Relative inelasticity of demand EP < 1
3. Unitary elasticity of demand
EP = 1
9
Limiting cases
1. Perfect elasticity
EP = ∞
2. Perfect inelasticity
EP = 0
10
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
11
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
12
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.
13
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.
14
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.
15
As price decreases
• revenue rises when
demand is elastic
• falls when it is
inelastic
• reaches it peak
when elasticity of
demand equals 1.
16
Marginal Revenue: The change in
total revenue resulting from changing
quantity by one unit.
D Total Revenue
MR =
D Quantity
17
For a straight-line
demand curve the
marginal revenue
curve is twice as
steep as the
demand.
18
At the point where
marginal revenue
crosses the X-axis,
the demand curve is
unitary elastic and
total revenue
reaches a
maximum.
19
The Cross-Elasticity of Demand
Cross-elasticity of demand: The
consumed of one product as a result of
a 1 percent change in the price of a
related product.
%D Quantity of goodA
Ex =
%D Price of good B
20
Arc Elasticity
Q2 A  Q1 A P2 B  P1B
Ex  
(Q1 A  Q2 A ) / 2 ( P1B  P2 B ) / 2
21
Point Elasticity
dQA PB
εx = x
dPB QA
22
The sign of cross-elasticity for

substitutes is positive.
The sign of cross-elasticity for

complements is negative.
23
Income Elasticity
Income Elasticity of Demand: The
demanded caused by a 1 percent
change in income.
%D Quantity
EY =
%D Income
24
Income Elasticity
Arc Elasticity
Q2  Q1 Y2  Y1
EY  
(Q1  Q2 ) / 2 (Y1  Y2 ) / 2
25
Income Elasticity
Point Elasticity
dQ Y
εY = x
dY Q
26
Income Elasticity
Categories of income elasticity
• Superior goods
EY > 1
• Normal goods
0 > EY > 1
• Inferior goods
EY < 1
27
Income Elasticity
Categories of
Income Elasticity
• Superior goods
• Normal goods
• Inferior goods
28
Other Elasticity Measures
Elasticity is encountered every time a
change in some variable affects
quantities.
• Advertising expenditure
• Interest rates
• Population size
29
Elasticity of Supply
Price Elasticity of Supply: The
percentage change in quantity supplied
as a result of a 1 percent change in
price
%D Quantity supplied
ES =
%D Price
30
Arc elasticity
Q2  Q1 P2  P1
Es  
(Q1  Q2 ) / 2 ( P1  P2 ) / 2
31
Point elasticity
dQ P1
S  
dP Q1
32
If the supply curve slopes upward and

to the right, the coefficient of supply
elasticity is a positive number.
33
When the supply curve is more elastic, the
effect of a change in demand will be greater
on quantity than on the price of the product.
With a supply curve of low elasticity, a

change in demand will have a greater effect
on price than on quantity.
34

Demand Elasticity: Managerial Economics: Economic Tools For Today's Decision Makers, 4/e by Paul Keat and Philip Young

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Demand Elasticity: Managerial Economics: Economic Tools For Today's Decision Makers, 4/e by Paul Keat and Philip Young

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Chapter 4

Lecturer: KEM REAT Viseth, PhD (Economics) 1

Elasticity: The sensitivity of one

As the time period

The demand for such a product or factor

1. the more essential is the component in question.

• If price decreases and, in percentage terms,

• If price decreases and, in percentage terms,

The sign of cross-elasticity for

The sign of cross-elasticity for

If the supply curve slopes upward and

With a supply curve of low elasticity, a

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