Economics » Elasticity » Price Elasticity of Demand and Price Elasticity of Supply

Key Concepts and Summary

Key Concepts and Summary

Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a change in its price. It is computed as the percentage change in quantity demanded (or supplied) divided by the percentage change in price. Elasticity can be described as elastic (or very responsive), unit elastic, or inelastic (not very responsive). Elastic demand or supply curves indicate that quantity demanded or supplied respond to price changes in a greater than proportional manner. An inelastic demand or supply curve is one where a given percentage change in price will cause a smaller percentage change in quantity demanded or supplied. A unitary elasticity means that a given percentage change in price leads to an equal percentage change in quantity demanded or supplied.

Glossary

elastic demand

when the elasticity of demand is greater than one, indicating a high responsiveness of quantity demanded or supplied to changes in price

elastic supply

when the elasticity of either supply is greater than one, indicating a high responsiveness of quantity demanded or supplied to changes in price

elasticity

an economics concept that measures responsiveness of one variable to changes in another variable

inelastic demand

when the elasticity of demand is less than one, indicating that a 1 percent increase in price paid by the consumer leads to less than a 1 percent change in purchases (and vice versa); this indicates a low responsiveness by consumers to price changes

inelastic supply

when the elasticity of supply is less than one, indicating that a 1 percent increase in price paid to the firm will result in a less than 1 percent increase in production by the firm; this indicates a low responsiveness of the firm to price increases (and vice versa if prices drop)

price elasticity

the relationship between the percent change in price resulting in a corresponding percentage change in the quantity demanded or supplied

price elasticity of demand

percentage change in the quantity demanded of a good or service divided the percentage change in price

price elasticity of supply

percentage change in the quantity supplied divided by the percentage change in price

unitary elasticity

when the calculated elasticity is equal to one indicating that a change in the price of the good or service results in a proportional change in the quantity demanded or supplied

Review Questions

  1. What is the formula for calculating elasticity?
  2. What is the price elasticity of demand? Can you explain it in your own words?
  3. What is the price elasticity of supply? Can you explain it in your own words?

Problems

  1. The equation for a demand curve is P = 48 – 3Q. What is the elasticity in moving from a quantity of 5 to a quantity of 6?
  2. The equation for a demand curve is P = 2/Q. What is the elasticity of demand as price falls from 5 to 4? What is the elasticity of demand as the price falls from 9 to 8? Would you expect these answers to be the same?
  3. The equation for a supply curve is 4P = Q. What is the elasticity of supply as price rises from 3 to 4? What is the elasticity of supply as the price rises from 7 to 8? Would you expect these answers to be the same?
  4. The equation for a supply curve is P = 3Q – 8. What is the elasticity in moving from a price of 4 to a price of 7?

Critical Thinking Questions

  1. Transatlantic air travel in business class has an estimated elasticity of demand of 0.40 less than transatlantic air travel in economy class, with an estimated price elasticity of 0.62. Why do you think this is the case?
  2. What is the relationship between price elasticity and position on the demand curve? For example, as you move up the demand curve to higher prices and lower quantities, what happens to the measured elasticity? How would you explain that?

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