Elasticity of Demand

Flashcards covering elasticity, its calculations, and relationship to total revenue.

Elasticity

A measure of the sensitivity of one variable to another.

X-elasticity of Y

Measures how much Y responds to a change in X. Formally, % change in Y / % change in X

Price elasticity of demand

% change in quantity demanded / % change in price

Income elasticity of demand

Measures the responsiveness of quantity demanded to changes in income.

Cross-price elasticity of demand

Measures the responsiveness of the quantity demanded of one good to a change in the price of another good.

εd at a point (Q, P)

dQ/dP * P/Q (derivative of Q in terms of P, multiplied by P/Q)

|εd| > 1

Elastic

|εd| < 1

Inelastic

|εd| = 1

Unit elastic

Perfectly elastic

|εd| = +∞

Perfectly inelastic

|εd| = 0

Total Revenue (TR)

P x Q

|εd| < 1 (Inelastic demand)

Price effect > Quantity effect, so TR ↑ as P ↑

|εd| > 1 (Elastic demand)

Quantity effect > price effect, so TR ↓ as P ↑

|εd| = 1 (Unit elastic demand)

TR does not change as P ↑

εd between two points (Q1, P1) and (Q2, P2)

((Q2 - Q1) / (Q1 + Q2) / 2) / ((P2 - P1) / (P1 + P2) / 2)