Unit 5: Elasticity – Microeconomics Study Notes

Unit 5: Elasticity

Introduction to Elasticity

Elasticity is a fundamental concept in microeconomics that measures how responsive consumers and producers are to changes in various economic factors, such as price, income, or the price of related goods. Understanding elasticity helps economists and businesses predict changes in demand and supply, and make informed decisions about pricing and production.

• Definition: Elasticity quantifies the percentage change in one variable in response to a percentage change in another variable.

• General Formula:

$\text{Elasticity} = \frac{\%\ \text{Change in Quantity Demanded (or Supplied)}}{\%\ \text{Change in Factor Examined}}$

• Elasticity is measured in percentages, making it independent of the units used for quantity and price.

• Elasticity applies to both linear and non-linear demand and supply curves.

Lesson 5.1: Price Elasticity of Demand

The Price Elasticity of Demand measures how sensitive the quantity demanded of a good is to changes in its price. This concept is crucial for understanding consumer behavior and for setting optimal prices.

• Formula:

$\text{Price Elasticity of Demand} = \frac{\%\ \text{Change in Quantity Demanded}}{\%\ \text{Change in Price}}$

• Elasticity is not the slope of the demand curve, but rather a measure of the curve's responsiveness.

• As price changes, the quantity demanded will change; the magnitude depends on how responsive consumers are.

Calculating Elasticity: The Midpoint Formula

To accurately calculate elasticity between two points on a demand curve, economists use the midpoint formula:

$\text{Price Elasticity of Demand} = \frac{\frac{Q_2 - Q_1}{(Q_1 + Q_2)/2}}{\frac{P_2 - P_1}{(P_1 + P_2)/2}}$

• This formula uses the average of the initial and final quantities and prices to determine elasticity between two points.

Interpreting Price Elasticity of Demand

The value of price elasticity of demand is always negative due to the inverse relationship between price and quantity demanded. However, economists often refer to the absolute value for interpretation.

• Inelastic Demand: $0 < |E_d| < 1$ — The percentage change in quantity demanded is less than the percentage change in price.

• Unit Elastic Demand: $|E_d| = 1$ — The percentage change in quantity demanded equals the percentage change in price.

• Elastic Demand: $|E_d| > 1$ — The percentage change in quantity demanded is greater than the percentage change in price.

Graphical Representation

Demand curves can have both elastic and inelastic regions, separated by a point of unit elasticity. The responsiveness of consumers to price changes is illustrated by the steepness or flatness of the demand curve:

• A flatter demand curve indicates more elastic demand.

• A steeper demand curve indicates more inelastic demand.

Example: If the price of a product decreases from $P_1$ to $P_2$, and the quantity demanded increases from $Q_1$ to $Q_2$, the elasticity can be calculated using the midpoint formula above.

Summary Table: Types of Price Elasticity of Demand

Elasticity Value	Type	Description
$0 < |E_d| < 1$	Inelastic	Quantity demanded changes less than price
$|E_d| = 1$	Unit Elastic	Quantity demanded changes exactly as price
$|E_d| > 1$	Elastic	Quantity demanded changes more than price

Additional info: The notes also reference graphical illustrations showing how the slope of the demand curve affects elasticity, and how elasticity varies along the curve. These are standard concepts in introductory microeconomics.