Elasticity Perfectly elastic demand Perfectly inelastic demand Unit elastic demand

The price elasticity of demand compares the percent change in quantity demanded to the percent change in price.
To calculate PED we first calculate percent change in quantity demanded and the corresponding percent change in price as we move along the demand curve.

1. Elasticity

2. Elasticity defined The price elasticity of demand compares the percent change in quantity demanded to the percent change in price. To calculate PED we first calculate percent change in quantity demanded and the corresponding percent change in price as we move along the demand curve.

3. % change in QD= Change in QD/initial QD *100 % change in price= change in price/initial P *100 Suppose when price rises from $20 to $21 , the quantity demanded falls from 10 million to 9.9 million vaccinations. Therefore change in Qd is O.1 m vaccinations.

4. So the percent change in QD: -0.1 m vaccinations/10m vaccinations*100 =-1% Percent change in Price: $1/20*100=5% PED= % change in QD/% change in P = 1%/5%=0.2

5. The law of demand says that demand curve are downward sloping, so price and quantity demanded always move in the opposite directions. This means that the PED is a negative number. However, it is inconvenient to repeatedly write a minus sign. So when economists talk about PED, they usually drop the minus sign and report the absolute value of price elasticity of demand. So we drop the minus sign here.

6. The larger the PED, the more responsive the QD is to price. When PED is large---when consumers change their QD by a large percentage compared with the percentage change in price---economists say that demand is highly elastic. As for example a price elasticity of 0.2 indicates a small response of QD to price. That is QD will fall by a relatively small amount when price rises. That is what economists call inelastic demand.

7. An Alternative Way to Calculate PED Here we discuss a technical issue that arises when we calculate percent changes in variables and how economists deal with it. Consider the following data for some good: Price Quantity demanded Situaion A $0.90 1100 Situation B $1.10 900

8. From the above data, if we calculate PED going from situation A (initial price) to situation B (to a rise in price), we get PED=.818 But if we calculate PED going from situation B ( initial price) to situation A (a fall in price) we get PED=1.22 So we get two different PED for the same data.

9. To avoid this difficulty economists use an alternative way to calculate PED known as Mid-point method. The mid-point method replaces the usual definition of the percent change in a variable say X , with a slightly different definition: % change in X= change in X/average value of X *100

10. Using the previous data the PED according to mid-point method will be: % change in QD=-200/(900+1100)*100=-20% & % change in P=$.20/($.90+$1.10)*100=20% So PED= 20%/20%=1 dropping the minus sign. The important point is that we get the sam e result whether we go up the demand curve for situation A to situation B or down from situation B to situation A.

11. Categories of elasticitiy Perfectly elastic demand Perfectly inelastic demand Unit elastic demand Relatively elastic or elastic demand Relatively inelastic demand

12. Elasticity & Total Revenue Why does it matter whether demand is unit elastic, inelastic or elastic? Because this classification predicts how changes in the price of the good will affect TR earned by producers from the sale of that good. In many real-life situations it is crucial to know how price changes affect TR .

13. Except in the case of a good with perfectly elastic or perfectly inelastic demand, when a seller raises the price of the good, two countervailing effects are present: A price effect: after a price increase each unit sold sells at a higher price which tends to raise revenue A quantity effect: After a price increase, fewer units are sold, which tends to lower revenue.

14. The PED tells us what happens to TR when price changes: its size determines which effect is stronger: If the demand for good is unit-elastic an increase in price does not change TR . In this case QE and PE exactly offset each other. If the demand for a good is inelastic, a higher price increases TR. In this case PE is stronger than QE. If the demand for a good is elastic, an increase in price reduces TR. In this case QE is stronger than PE

15. Factors determining PED Whether close substitutes are available Whether the good is a necessity or a luxury Share of income spent on the good Time

16. Other demand elasticities Cross-price elasticity of demand Income elasticity of demand Supply elasticity of demand

17. Cross Price Elasticity Ecr = % change in quantity demanded of good A/ % change in the price of good B. Ecr = ∆Q A /∆P B *

18. Applications of S, D and Elasticity Can good news for farming be bad news for farmers? What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties? We answer such questions in three steps: First, we examine whether the S or D curve shifts. Second, we consider which direction curve shifts. Third, we use the S-and-D diagram to see how the market equilibrium changes.

19. $3 $2 100 110 S1 S2 Demand

20. In this case the discovery of new hybrid shifts the supply curve to the right. The demand curve remains the same. Because consumers’ desire to buy new wheat products at any given price is not affected by the introduction of a new hybrid. Figure 8 shows an example of such a change. When the S curve shifts from S1 to S2, the quantity of wheat sold increases from 100 to 110 and the price of wheat falls from $3 to $2.

21. Does this discovery make farmers better off? To answer this question consider what happens to total revenue (TR) received by farmers. Farmers’ TR is PQ and the discovery affects the farmers in two conflicting ways: 1.The hybrid allows farmers to produce more wheat (Q rises). 2. But now each bushel of wheat sells for less $ (P falls)

22. Whether TR rises or falls depends on elasticity of demand. In practice, the demand for basic foodstuffs such as wheat is usually inelastic because these items are relatively inexpensive and have few good substitutes. When the D curve is inelastic, a decrease in P causes TR to fall. As shown in the figure, the price of wheat falls substantially, whereas the quantity of wheat sold rises only slightly. TR falls from $300 to $220. The discovery of hybrid lowers the TR that farmers receive for the sale of their crops.

23. If farmers are made worse off by the discovery of this new hybrid, why do they adopt it? The answer is that in a competitive market like wheat, since each farmer is only a small part of the market for wheat, he or she takes the price of wheat as given. For any given price of wheat, it is better to use new hybrid to produce and sell more wheat. Yet when all famers do this, the supply of wheat increases, the price falls and farmers are worse off.

24. Although this example may at first seem hypothetical, it helps to explain a major change in the US economy over the past century. 200 years ago, most Americans lived on farms. Knowledge about farm methods was sufficiently primitive that most Americans had to be farmers to produce enough food to feed the nation’s population.

25. Yet over time, advances in farm technology increased the amount of food that each farmers could produce. This increase in food supply, together with inelastic demand, caused farm revenues to fall, which in turn encouraged people to leave farming.

26. When analyzing the effects of farm technology or farm policy, it is important to keep in mind what is good for farmers is not necessarily good for society as a whole. Improvement in farm technology can be bad for farmers but it is surely good for consumers who pay less for food. Similarly a policy aimed at reducing the supply of farm products may raise the incomes of farmers by raising prices, but it does so at the expense of consumers.