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Module 7: Elasticity of Demand

Overview
An important aspect of demand is how sensitive quantity demanded is to price changes.
Anyone who has studied economics knows the law of demand: a higher price will lead to a lower
quantity demanded. We can specify whether demand is elastic, inelastic, or unitary, depending
on the value of elasticity.

Objectives
At the end of this module, you are expected to
• To explain how economists measure the sensitivity of quantity demanded to price
changes.
• To identify what makes the demand for a good more or less sensitive to changes in its
price.

Elasticity

Economists use the elasticity of demand to measure how strongly consumers respond to
a change in price. When consumers are very sensitive to the price, such that they respond to a
price increase with a relatively large decrease in quantity demanded, demand is elastic. When
consumers are not so sensitive to the price, so that a price increase leads to a relatively small
decrease in quantity demanded, demand is inelastic. When consumers respond to a price increase
by decreasing the quantity demanded by the same percentage, demand is unitary. As it raises its
prices, Hershey would prefer to face inelastic demand, so that its higher prices will cause only a
relatively small decrease in the quantity sold.

When prices change, why does the quantity demanded change by a lot for some goods and
by just a little for other goods? Or to put it another way, why is demand for some goods elastic
and for other goods inelastic? Economists have identified five factors that make the demand for a
good more or less sensitive to price changes.

Table 7.1. Elastic, Inelastic, and Unitary: Three Cases of Elasticity

If… Then… And it is called…
% change in quantity > % change in price % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 Elastic
>1
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
% change in quantity = % change in price % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 Unitary
=1
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
% change in quantity < % change in price % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 Inelastic
<1
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒

By calculating the value of elasticity, economists can categorize the demand for goods
according to how sensitive consumers are to price changes. Remember that the elasticity of
demand is equal to the percentage change in the quantity demanded divided by the percentage
change in the price. So the larger the elasticity, the greater the percentage change in quantity
demanded relative to the percentage change in price and the stronger the response to a price
change.

Elastic Demand

If the elasticity of demand for a good is greater than 1.0, meaning that the quantity
demanded changes by a larger percentage than the price, then demand is elastic. When demand
is elastic, consumers are particularly responsive to a change in price. One of the reasons why

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demand can be elastic is that there are many substitutes for the good. So when the price changes
by a small percentage, the quantity demanded changes by a large percentage.

Inelastic Demand

If elasticity is less than 1.0, meaning that the quantity demanded changes by a smaller
percentage than the price, demand is inelastic. When demand is inelastic, price changes have
relatively little effect on the quantity demanded. Goods that are hard to do without, like medicine
and heating oil, often have inelastic demand. The price can change a lot for these goods, but the
quantity demanded will change very little. An extreme case occurs if the elasticity is 0. In this case,
a change in the price has no effect on the quantity demanded— the percentage change in quantity
demanded is 0.

Unitary Demand

The quantity demanded could change by the same percentage as the price. In that case,
the elasticity would be equal to 1.0, and demand would be unitary. Demand that is unit-elastic is
an “in- between” case, in which demand is neither elastic (with an elasticity greater than 1.0) nor
inelastic (with an elasticity less than 1.0).

Table 7.2. Determinants of the Elasticity of Demand

Table 7.3. Summary of the Elasticity of Demand

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Calculating Price Elasticity of Demand

To calculate elasticity, instead of using simple percentage changes in quantity and price,
economists use the average percent change in both quantity and price. This is called the Midpoint
Method for Elasticity, and is represented in the following equations:

𝑄2 – 𝑄1
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = 𝑥 100
(𝑄2 + 𝑄1)/2

𝑃2 – 𝑃1
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 = 𝑥 100
(𝑃2 + 𝑃1)/2

Let’s calculate the elasticity between points A and B and between points G and H shown
in Figure 7.2.

Figure 7.2. Calculating the Price Elasticity of Demand - The price elasticity of demand is calculated
as the percentage change in quantity divided by the percentage change in price.

First, apply the formula to calculate the elasticity as price decreases from ₱70 at point B
to ₱60 at point A:

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6.9%
Therefore, the elasticity of demand between these two points is which is 0.45, an
−15.4%
amount smaller than one, showing that the demand is inelastic in this interval. Price elasticities
of demand are always negative since price and quantity demanded always move in opposite
directions (on the demand curve). By convention, we always talk about elasticities as positive
numbers. So mathematically, we take the absolute value of the result. We will ignore this detail
from now on, while remembering to interpret elasticities as positive numbers.

This means that, along the demand curve between point B and A, if the price changes by
1%, the quantity demanded will change by 0.45%. A change in the price will result in a smaller
percentage change in the quantity demanded. For example, a 10% increase in the price will result
in only a 4.5% decrease in quantity demanded. A 10% decrease in the price will result in only a
4.5% increase in the quantity demanded. Price elasticities of demand are negative numbers
indicating that the demand curve is downward sloping, but are read as absolute values.

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Check this out!

Here are some video clips that you may view for easy understanding of the concept and
calculation of Elasticity of Demand:

https://www.youtube.com/watch?v=HHcblIxiAAk

https://www.youtube.com/watch?v=lrGiZ7aTlQo

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References:

Books:

Greenlaw, S. & Taylor, T. (2014) Principles of Microeconomics. Houston, Texas, USA: Rice University
Krueger, A.B. & Anderson, D.A. (2014) Explorations in Economics. New York, USA: BFW Worth
Publishers

Electronic:

https://www.youtube.com/watch?v=HHcblIxiAAk
https://www.youtube.com/watch?v=lrGiZ7aTlQo

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