Microeconomics

Demand Elasticity

Table of Contents

Introduction3

Demand Elasticity & key concepts3

Calculation of Elasticities3

Arc Elasticity4

Point Elasticity7

Elasticity and a Linear Demand curve8

Elasticity of Demand for nonlinear Demand curves10

Price Elasticity of Demand and Price Discrimination12

Factors Influencing Price Elasticity of Demand13

Conclusion14

References15

Demand Elasticity

Introduction

Economic lore depicts Alfred Marshall leaping in 1881 from the low roof of the Oliva Hotel while on vacation in Palermo, Italy; Marshall, the legend continues, ran through the town's streets shouting, “Eureka, I've found it!” The legend has his excitement stemming from his discovery of a simple formalization for the concept of elasticity (Keynes, 1963). 1 Marshall was not the first to incorporate something like elasticity in his economic analysis. He was familiar with the work of mathematical economists Augustin Cournot and Johann von Thünen, both of whom developed theories of firm behavior earlier in the nineteenth century and arguably hinted at elasticity. The classical economist John Stuart Mill also discussed the impact of changes in price on quantity consumed and on the impact of tariffs on output and prices; Fleming Jenkin had alluded to the elasticity concept in 1870 (Ekelund & Hebert, 1990).

Demand Elasticity & key concepts

The most important question that comes to your mind is that how to measure elasticity. There are in two methods used that are used to measure elasticity, which includes point and arc method.

Calculation of Elasticities

Microeconomic theory develops the demand for a product or service primarily as a function of its own price, the prices of related goods and services, and income:

where p is own price, pr is price of related good(s), and M is income.

  The definition of an elasticity is the percentage change in the dependent variable divided by the percentage change in the independent or causal variable. Thus, the price elasticity of demand is calculated as percentage change in quantity demanded divided by percentage change in price, holding all other independent variables constant:

Arc Elasticity

This formula for elasticity between two distinct points on the demand curve raises the question as to what is the base Q and base P: the price/quantity combination before or after the change? To avoid ambiguity and to give the same percentage changes whether price is rising or falling, the average of the prices and the average of the two quantities are frequently used. This yields the computational formula for price elasticity of demand:

A (relatively) simple computational formula for the price elasticity when moving from one point on the demand curve to a second point on the demand curve is then the (change in quantity divided by change in price) multiplied by the sum of prices divided by sum of quantities. This yields an arc elasticity of demand, measured for a given movement along the curve.

Consider the demand schedule in Table B.

Table B Demand Schedule

Price

Quantity

$9

0

$8

1

$7

2

$6

3

$5

4

$4

5

$3

6

$2

7

$1

8

$0

9

The arc elasticity for a change in price from $8, with Q = 1, to $7 with Q = 2, is

Were price expressed in cents rather than dollars, the elasticity coefficient would be

Whether price is measured in dollars or cents, the percentage change in price is the same because units ...