Price Elasticity of Demand and Its Measurements
Peng Shen
October 13, 2021
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The Algebra of Supply and Demand
Recall from your high school mathematics knowledge, we can use algebraic
equations (or functions) to express the curves on a graph.
Therefore, we can use linear equations (or functions) of quantity
demanded (or quantity supplied) on price of the product (denote as P) to
describe the demand (or supply).
1 Demand equation (function): P = a + b · Q d
where b < 0 for most goods, and Q d is the quantity demanded.
2 Supply equation (function): P = c + d · Q s
where d > 0, and Qs is the quantity supplied.
3 Equilibrium condition: Q s = Q d = Q ∗ , and P = P ∗
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An example (from graph to equation) demand
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An example (from graph to equation) demand
Use the first 2 points in red: from the point (3, 2.5) to the point (4, 2)
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An example (from graph to equation) demand
Use the first 2 points in red: from the point (3, 2.5) to the point (4, 2)
P − 2.5 Qd − 3
=
2 − 2.5 4−3
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An example (from graph to equation) demand
Use the first 2 points in red: from the point (3, 2.5) to the point (4, 2)
P − 2.5 Qd − 3
=
2 − 2.5 4−3
Demand equation (function) is: P = − 12 Q d + 4
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An example (from graph to equation) supply
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An example (from graph to equation) supply
Use the first 2 points in red: from the point (6, 2) to the point (7, 2.5)
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An example (from graph to equation) supply
Use the first 2 points in red: from the point (6, 2) to the point (7, 2.5)
P −2 Qs − 6
=
2.5 − 2 7−6
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An example (from graph to equation) supply
Use the first 2 points in red: from the point (6, 2) to the point (7, 2.5)
P −2 Qs − 6
=
2.5 − 2 7−6
Supply equation (function) is: P = 12 Q s − 1
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An example (from graph to equation) equilibrium
Solve the system of two equations with Q s = Q d = Q ∗ , and P = P ∗ , so
1 1
P = Q − 1 , and P = − Q + 4 =⇒
2 2
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An example equilibrium (solve the equations)
Solve the above system of equations for the equilibrium quantity and price.
Equate the two functions and re-arrange items
1 1 1 1
Q−1 = − Q+4 =⇒ Q+ Q = 4+1
2 2 2 2
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An example equilibrium (solve the equations)
Solve the above system of equations for the equilibrium quantity and price.
Equate the two functions and re-arrange items
1 1 1 1
Q−1 = − Q+4 =⇒ Q+ Q = 4+1
2 2 2 2
So that the equilibrium quantity is Q ∗ = 5, plug this into supply function
(or demand function, whichever you like), we have (we use supply here)
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An example equilibrium (solve the equations)
Solve the above system of equations for the equilibrium quantity and price.
Equate the two functions and re-arrange items
1 1 1 1
Q−1 = − Q+4 =⇒ Q+ Q = 4+1
2 2 2 2
So that the equilibrium quantity is Q ∗ = 5, plug this into supply function
(or demand function, whichever you like), we have (we use supply here)
1
P∗ = ·5−1 =⇒ P ∗ = $1.5 , and Q ∗ = 5
2
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An Exercise
Solve for the equilibrium point for the following market:
Demand function: P = 16 − 2Q d
Supply function: P = 4 + 4Q s
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An Exercise
Solve for the equilibrium point for the following market:
Demand function: P = 16 − 2Q d
Supply function: P = 4 + 4Q s
16 − 2Q = 4 + 4Q =⇒ Q∗ = 2 =⇒
P ∗ = 16 − 2 · 2 = $12
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An Exercise
Solve for the equilibrium point for the following market:
Demand function: P = 16 − 2Q d
Supply function: P = 4 + 4Q s
16 − 2Q = 4 + 4Q =⇒ Q∗ = 2 =⇒
P ∗ = 16 − 2 · 2 = $12
So that the equilibrium point is (Q ∗ , P ∗ ) = (2, $12)
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Price elasticity of demand and supply
Recall that if the demand (resp. supply) curve is more “steep”, then the
consumers (resp. producers) will take more tax burden.
This is related to the responsiveness of the quantity demanded (resp.
supplied) to a change in price.
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Price elasticity of demand and supply
Recall that if the demand (resp. supply) curve is more “steep”, then the
consumers (resp. producers) will take more tax burden.
This is related to the responsiveness of the quantity demanded (resp.
supplied) to a change in price.
Price elasticity of demand (resp. supply): the responsiveness of the
quantity demanded (resp. supplied) to a change in price.
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Price elasticity of demand and supply
Recall that if the demand (resp. supply) curve is more “steep”, then the
consumers (resp. producers) will take more tax burden.
This is related to the responsiveness of the quantity demanded (resp.
supplied) to a change in price.
Price elasticity of demand (resp. supply): the responsiveness of the
quantity demanded (resp. supplied) to a change in price.
% change in quantity demanded (supplied)
Price elasticity of demand (supply ) = % change in price ,
∆Q d /Q d × 100%
εdp =
∆P/P × 100%
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Price elasticity of demand and supply
Recall that if the demand (resp. supply) curve is more “steep”, then the
consumers (resp. producers) will take more tax burden.
This is related to the responsiveness of the quantity demanded (resp.
supplied) to a change in price.
Price elasticity of demand (resp. supply): the responsiveness of the
quantity demanded (resp. supplied) to a change in price.
% change in quantity demanded (supplied)
Price elasticity of demand (supply ) = % change in price ,
∆Q d /Q d × 100% ∆Q d /Q d
εdp = = ,
∆P/P × 100% ∆P/P
Peng Shen Price Elasticity of Demand October 13, 2021 8 / 26
Price elasticity of demand and supply
Recall that if the demand (resp. supply) curve is more “steep”, then the
consumers (resp. producers) will take more tax burden.
This is related to the responsiveness of the quantity demanded (resp.
supplied) to a change in price.
Price elasticity of demand (resp. supply): the responsiveness of the
quantity demanded (resp. supplied) to a change in price.
% change in quantity demanded (supplied)
Price elasticity of demand (supply ) = % change in price ,
∆Q d /Q d × 100% ∆Q d /Q d ∆Q s /Q s
εdp = = , εsp =
∆P/P × 100% ∆P/P ∆P/P
Why do we use percentage change in quantity (resp. price) instead of
change in quantity (resp. price)?
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Why percentage change?
Here after, we will talk about the price elasticity of demand (i.e. εdp ) only
A → B.
If we use change in quantity over
change in price...
When the unit of price is
8−4
dollar: 16−18 = −2.
Figure 1: Demand curve of apple When the unit of price is cent:
8−4
1600−1800 = −0.02.
Price Quantity The value is sensitive to the unit of
A 18 4 measure. It is difficult to compare
B 16 8 the responsiveness.
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Midpoint formula
And, here after, we will use an “unconventional” method to calculate
percentage change, i.e., the midpoint formula.
(Q −Q ) d d
Percentage change in quantity: ∆Q d % = 2d d1 × 100%
Q +Q
2 1
2
(P2 −P1 )
Percentage change in price: ∆P% = P2 +P1
× 100%
2
Price elasticity of demand (midpoint formula):
∆Q d % (Q d − Q d ) (P2 − P1 ) ∆Q d ∆P
dp = = 2 d d 1 ÷ = ÷
∆P% Q2 +Q1 P2 +P1 Q2 + Q1d
d P2 + P1
2 2
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Why use midpoint?
Why do we use the midpoint?
Price Quantity
A 18 4
B 16 8
If we use the conventional way to
calculate percentage change...
Figure 2: Demand curve of apple 8−4 16−18
A → B: 4 ÷ 18 = −9.
4−8 18−16
B → A: 8 ÷ 16 = −4.
The two cases gives different values.
To ensure that we have only one value of the price elasticity of demand
between the same two points on a demand curve, we use the midpoint
formula.
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Apply the midpoint formula
Percentage change in quantity
demanded: (8−4) × 100% ≈ 66.67%
( 8+4
2 )
Percentage change in price:
(16−18)
Figure 3: Demand curve of apple × 100% ≈ −11.76%
( 16+18
2 )
Price Quantity
A 18 4 The price elasticity between point A
66.67%
B 16 8 and point B is −11.76% ≈ −5.67
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Apply the midpoint formula
There is no need to write the
percentage change in percent. It is
enough to write it in decimal.
And no need to calculate exactly
the midpoint, just use the sum. So
dp between point A and point B is
8 − 4 16 − 18 0.3333 Figure 4: Demand curve of apple
÷ ≈ ≈ −5.67
8 + 4 16 + 18 −0.0588
And further, we can rewrite the price elasticity as below
∆Q d ∆P ∆Q d P2 + P1
dp = d d
÷ = d d
×
Q2 + Q1 P2 + P1 Q2 + Q1 ∆P
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Connect Elasticity with Slope
For Demand Curve given by: P = a + b · Q d , we have Slope = b
∆Q d P2 + P1
dp = d d
×
Q2 + Q1 ∆P
P2 + P1 ∆Q d
dp = ×
Q2d + Q1d ∆P
Figure 5: Demand curve of apple
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Connect Elasticity with Slope
For Demand Curve given by: P = a + b · Q d , we have Slope = b
∆Q d P2 + P1
dp = d d
×
Q2 + Q1 ∆P
P2 + P1 ∆Q d
dp = ×
Q2d + Q1d ∆P
P2 + P1 1
dp = ×
Q2d + Q1d Slope
Figure 5: Demand curve of apple
P2 + P1 1
= d d
×
Q2 + Q1 b
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Compare elasticity
Price elasticity of demand is always negative.
Law of demand:
price ↓, quantity demanded ↑
price ↑, quantity demanded ↓
We compare elasticities by comparing their absolute value.
Although -3 is actually a smaller number than -2, we say that a price
elasticity of -3 is larger than a price elasticity of -2.
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Elastic, Unit elastic, and inelastic
The demand between point A and B is
Elastic: the percentage change in quantity demanded is greater than the
percentage change in price, so the elasticity is greater than -1 (e.g. -2).
Unit elastic: the percentage change in quantity demanded is equal to the
percentage change in price, so the elasticity is equal to -1.
Inelastic: the percentage change in quantity demanded is less than the
percentage change in price, so the elasticity is smaller than -1 (e.g. -0.5).
Figure 6: Here we drop the minus sign in front of the Price Elasticity of Demand
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Price elasticity along a demand curve
The price elasticity
between point A and point B is
−5.67.
between point C and point D is
Figure 7: Demand curve of apple −1.
Price Quantity between point E and point F is
A 18 4
−0.18.
B 16 8
C 11 18
D 9 22
E 4 32
F 2 36
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Price elasticity along a demand curve
The price elasticity
between point A and point B is
−5.67.
between point C and point D is
Figure 7: Demand curve of apple −1.
Price Quantity between point E and point F is
A 18 4
−0.18.
B 16 8
C 11 18
D 9 22 As we move down along the
E 4 32 demand curve, the demand changes
F 2 36 from being elastic to being inelastic.
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Elasticity of two demand curves
If two demand curves intersect, on the intervals close to the intersection,
the flatter demand curve is more elastic.
Price elasticity of D1 between A and B is -1.6.
Price elasticity of D2 between A and C is -0.3.
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Two extreme cases
Perfectly elastic: Perfectly inelastic:
price elasticity = 0
price elasticity = infinity
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Price elasticity of demand
Figure 8: Perfectly elastic Figure 9: Elastic Figure 10: Unit elastic
Figure 11: Inelastic Figure 12: Perfectly inelastic
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Total expenditure and total revenue
When price ↑, total expenditure can ↑, or ↓, or remain the same
the change in expenditure depends on elasticity
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Total expenditure and total revenue
When price ↑, total expenditure can ↑, or ↓, or remain the same
the change in expenditure depends on elasticity
Terminology: Total Expenditure = Total Revenue = P × Q
Total revenue: amount of money a firm receives from selling a good or
service, calculated by price times the number of units sold (P × Q).
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Price elasticity of demand and total expenditure
Effect of a price cut on total expenditure, or equivalently, total revenue
two parts of the effect: a. price per unit ↓, b. number of units sold ↑
Figure 13: Price elasticity: -0.46, total
expenditure (or revenue) decreases Figure 14: Price elasticity: -1.73, total
expenditure (or revenue) increases
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Price elasticity of demand and total expenditure
If demand is elastic (|| > 1), then changes in quantity demanded is
greater than changes in price; and if demand is inelastic (|| < 1), then
changes in quantity demanded is smaller than changes in price.
Figure 15: Elasticity, Price Change, and Expenditure
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Price elasticity of demand and total expenditure
Why are price elasticity and total expenditure (or total revenue) related?
Percentage change in quantity demanded
Price elasticity of demand =
Percentage change in price
If it is greater than -1, in a price cut, the quantity demanded goes up by a
higher percentage than price, raising the expenditure (or revenue).
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Price elasticity of demand and total expenditure
Why are price elasticity and total expenditure (or total revenue) related?
Percentage change in quantity demanded
Price elasticity of demand =
Percentage change in price
If it is greater than -1, in a price cut, the quantity demanded goes up by a
higher percentage than price, raising the expenditure (or revenue).
Effect of a price cut on expenditure depends on price elasticity of demand
if demand is elastic, expenditure (or revenue) increases
if demand is unit elastic, expenditure (or revenue) does not change
if demand is inelastic, expenditure (or revenue) decreases
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Total revenue
Previously we learned about perfectly competitive market. In a perfectly
competitive market, firms are price takers.
Here, let’s consider a firm that
chooses a price
sells each unit of product at almost no cost
Example: Amazon’s digital book
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Total revenue
Previously we learned about perfectly competitive market. In a perfectly
competitive market, firms are price takers.
Here, let’s consider a firm that
chooses a price
sells each unit of product at almost no cost
Example: Amazon’s digital book
The firm wants to maximize its profits (total revenue - total cost). Since
the total cost is zero, it is the same as maximizing the total revenue.
You will learn more about producer’s theory later.
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Price elasticity of demand and total revenue
On a straight line demand curve
shown in the left figure. As quantity
demanded increases, the elasticity
decreases (from > 1 to < 1).
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Price elasticity of demand and total revenue
On a straight line demand curve
shown in the left figure. As quantity
demanded increases, the elasticity
decreases (from > 1 to < 1).
Hence, as the quantity demanded
increases, the total revenue first
increases, then decreases.
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Price elasticity of demand and total revenue
On a straight line demand curve
shown in the left figure. As quantity
demanded increases, the elasticity
decreases (from > 1 to < 1).
Hence, as the quantity demanded
increases, the total revenue first
increases, then decreases.
The maximizing point is at which
the price elasticity of demand is
equal to 1 (unit elastic).
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