No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Three: Demand 76 PRICE ELASTICITY OF DEMAND Influenced by: 1. Time: As time passes after a price change, the demand curve becomes more elastic as people discover substitutes 2. Substitutes: The more substitutes are available, the more elastic the demand curve becomes. 3. % Income spent: The higher the % of income spent on a good, the more elastic the demand curve will be. ELASTICITY DEFINED We’ve seen how the price elasticity of demand is related to the slope of the demand curve, but it is NOT the slope. The slope of any line is very much dependent upon the scale given. For example, the same demand curve that looks very “inelastic” when the vertical price axis is in pennies may look very “elastic” if we changed the scale to be in hundreds of dollars. So to actually calculate elasticity, we need to be a bit more precise and avoid a measure that depends on our choice of measurement units. The formal definition is as follows: Price Elasticity of Demand equals the percentage change in quantity demanded divided by the percentage change in price; or: E D = % change in Q D % change in P With this definition, elasticity is calculated as a negative number (since price and quantity are inversely related), but it is common convention to drop the negative number in discussing elasticity of demand. Another reason (beyond the slope being affected by the units of measurement) for using the more formal definition is that the price elasticity of demand changes along a linear demand curve, as seen in Figure 3.8 . (It is beyond our scope to demonstrate the calculation of numbers for Figure 3.8 , but the interested reader can do a quick web search on “price elasticity of demand for linear demand curve” and find many examples of this calculation.) P ($) Q (#) E D > 1, Elastic E D = 1, Unit Elastic E D < 1, Inelastic D Figure 3.8, Change in Elasticity along linear demand curve. The midpoint of a linear demand curve is unit elastic. The demand curve is elastic above this point and is inelastic below it.