Download Price elasticity of demand

Microeconomics in Modules
and
Economics in Modules
Third Edition
Krugman/Wells
Module 8
Income Effects, Substitution Effects,
and Elasticity
What You Will Learn
1
2
3
4
How the income and substitution effects
explain the law of demand
The definition of elasticity, a measure of
responsiveness to changes in prices or
incomes
The importance of the price elasticity of
demand, which measures the
responsiveness of the quantity demanded
to changes in price
How to calculate the price elasticity of
demand
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Explaining the Law of Demand
• The substitution effect of a change in the
price of a good is the change in the quantity
consumed of that good as the consumer
substitutes the good that has become relatively
cheaper for the good that has become
relatively more expensive.
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Explaining the Law of Demand
• The income effect of a change in the price of
a good is the change in the quantity consumed
resulting from a change in the consumer’s
purchasing power as a result of the change in
the price of the good.
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Economics in Action
Giffen Goods
• Some observers claimed that Ireland’s demand curve for
potatoes sloped upward, not downward.
• Suppose an inferior good—people demand less of it when
their income rises—absorbs a large share of people’s budgets.
• Suppose the price of the good, say potatoes, increases. This
would, other things equal, cause people to substitute other
goods for potatoes.
• But other things are not equal: given the higher price of
potatoes, people are poorer. This increases the demand for
potatoes because potatoes are an inferior good.
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Defining and Measuring Elasticity
• Economists use the concept of elasticity to measure the
responsiveness of one variable to changes in another.
• The price elasticity of demand is the ratio of the percent
change in the quantity demanded to the percent change in
the price as we move along the demand curve (dropping
the minus sign).
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The Price Elasticity of Demand
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Demand for Vaccinations
Price of vaccination
$21
20
When price rises to $21 per
vaccination, world demand
falls to 9.9 million
vaccinations (point B).
B
A
D
0
9.9 10.0
Quantity of vaccinations (millions)
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Calculating the Price Elasticity
of Demand
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Using the Midpoint Method
• The midpoint method is a technique for calculating the
percent change.
• In this approach, we calculate changes in a variable
compared with the average, or midpoint, of the starting
and final values.
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Using the Midpoint Method
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Using the Midpoint Method
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Economics in Action
Estimating Elasticities
Good
Price elasticity
Inelastic demand
Eggs
Beef
Stationery
Gasoline
0.1
0.4
0.5
0.5
Price elasticity
of demand < 1
1.2
2.3
2.4
4.1
Price elasticity
of demand > 1
Elastic demand
Housing
Restaurant meals
Airline travel
Foreign travel
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Summary
1. Elasticity is a general measure of responsiveness
that can be used to answer such questions.
2. The price elasticity of demand—the percent
change in the quantity demanded divided by the
percent change in the price (dropping the minus
sign)—is a measure of the responsiveness of the
quantity demanded to changes in the price.
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