Introduction to Elasticity

Read this chapter to learn about the concept of elasticity. Be sure to read all the sections in this chapter (Sections 5.1-5.4) following the introduction.

5.1 Price Elasticity of Demand and Price Elasticity of Supply

By the end of this section, you will be able to:

Calculate the price elasticity of demand
Calculate the price elasticity of supply

Both the demand and supply curve show the relationship between price and the number of units demanded or supplied. Price elasticity is the ratio between the percentage change in the quantity demanded (Qd) or supplied (Qs) and the corresponding percent change in price. The price elasticity of demand is the percentage change in the quantity demanded of a good or service divided by the percentage change in the price. The price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in price.

Elasticities can be usefully divided into three broad categories: elastic, inelastic, and unitary. An elastic demand or elastic supply is one in which the elasticity is greater than one, indicating a high responsiveness to changes in price. Elasticities that are less than one indicate low responsiveness to price changes and correspond to inelastic demand or inelastic supply. Unitary elasticities indicate proportional responsiveness of either demand or supply, as summarized in Table 5.1.

If . . .

Then . . .

And It Is Called . . .

$\text { % change in quantity > % change in price }$

$\dfrac{\text { % change in quantity }}{\text { % change in price }}>1$

Elastic

$\text { % change in quantity = % change in price }$

$\dfrac{\text { % change in quantity }}{\text {% change in price }}=1$

Unitary

$\text { % change in quantity < % change in price }$

$\dfrac{\text { % change in quantity }}{\text {% change in price }} < 1$

Inelastic

Table5.1 Elastic, Inelastic, and Unitary: Three Cases of Elasticity

To calculate elasticity, instead of using simple percentage changes in quantity and price, economists use the average percent change in both quantity and price. This is called the Midpoint Method for Elasticity, and is represented in the following equations:

$\begin{aligned} \% \text { change in quantity } &=\frac{\mathrm{Q}_{2}-\mathrm{Q}_{1}}{\left(\mathrm{Q}_{2}+\mathrm{Q}_{1}\right) / 2} \times 100 \\ \% \text { change in price } &=\frac{\mathrm{P}_{2} \mathrm{P}_{1}}{\left(\mathrm{P}_{2}+\mathrm{P}_{1}\right) / 2} \times 100 \end{aligned}$

The advantage of the is Midpoint Method is that one obtains the same elasticity between two price points whether there is a price increase or decrease. This is because the formula uses the same base for both cases.