3.5 Price Elasticity of Demand
Notes
Price elasticity of demand measures how strongly quantity demanded responds to a price change.
- Formula (use the absolute value): $\displaystyle E_d = \frac{\% \text{ change in quantity demanded}}{\% \text{ change in price}}$
- Percent change $\displaystyle = \frac{\text{new} - \text{original}}{\text{original}} \times 100\%$. (Some textbooks use the midpoint method instead; the idea is the same.)
- $E_d > 1$: elastic (buyers are very responsive). $E_d < 1$: inelastic (buyers respond little). $E_d = 1$: unit elastic.
- Demand tends to be elastic when there are many substitutes, the good is a luxury, it takes a large share of the budget, or buyers have time to adjust.
- Demand tends to be inelastic for necessities with few substitutes, such as medicine, salt or gasoline in the short run.
- Worked example: movie tickets rise from $10 to $12, a $20\%$ increase. Tickets sold fall from 500 to 350, a $30\%$ decrease. $\displaystyle E_d = \frac{30\%}{20\%} = 1.5$, so demand is elastic.
Practice
The price of gasoline rises by $10\%$ and the quantity demanded falls by $2\%$. The price elasticity of demand is:
$\displaystyle \frac{2\%}{10\%} = 0.2$, which is less than 1.
A store cuts the price of headphones from $80 to $60, and weekly sales rise from 200 to 300 pairs. What is the price elasticity of demand?
Price falls $\displaystyle \frac{20}{80} = 25\%$; quantity rises $\displaystyle \frac{100}{200} = 50\%$; $\displaystyle \frac{50\%}{25\%} = 2$.
Demand for which good is most likely to be inelastic?
Insulin is a necessity with no close substitutes, so buyers keep buying when the price rises.
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