Measures of Elasticity:

 

Price Elasticity of Demand is a measure of sensitivity or responsiveness to prices changes.  Price elasticity is primarily determined by the availability and costs of perceived substitutes.  In addition, elasticity is affected by price of the good relative to one’s total budget.  Finally, elasticity is a function of time.  The demand for a good or service becomes more elastic as the time horizon increases…it takes time to identify and acquire substitutes.  The concept of price elasticity demand is possibly best seen as:

 

%  chg in qty / % chg price = ED

 

 

Price elasticity can be calculated two ways:

 

(1) PRICE ELASTICITY OF DEMAND (point APPROACH)

 

 

 

 

 

q2 - q1                           p2 - p1

-----------------         /       ---------------    =      Ed

q1                                    p1

                                   

                                               

 

Another common formula for point elasticity

 

                   Chg q / q            p      chg q

        Ed  =  ------------     =      -- X  --------

                   Chg p / p            q      chg p

 

 

Calculation may be easier as the ratio of price to quantity multiplied by the slope of the demand function.

 

 

 

(2) PRICE ELASTICITY OF DEMAND (ARC APPROACH)

 

 

q2 - q1                           p2 - p1

-----------------         /       ---------------    =      ed

q1 + q2                          p2 + p1

            ------                               -------

                2                                     2

 

 

 

Cross elasticity of demand = eab =

 

% Chg qty of good A   /  % chg price of good B

 

 

EAB < 0, Then A & B are complements

 

 

EAB  > 0, Then A & B are substitutes

 

 

 

 

income elasticity = % chg qty / % chg Y = EY

 

        Normal Good:  EY > 0

 

        Inferior Good: EY  < 0