Chapter 6: Elasticity and Demand
Chapter 6:
ELASTICITY AND DEMAND
Essential Concepts
1. The price elasticity of demand (E) measures the responsiveness or sensitivity of consumers to
changes in the price of a good by taking the ratio of the percentage change in quantity demanded to
2. Demand is elastic when
E>1
, demand is inelastic when
E<1
, and demand is unitary elastic when
E=1
. [Note: The symbol “| |” denotes the absolute value.]
3. Using price elasticity, the percentage change in quantity demanded (%Qd) can be predicted for a
given percentage change in price (%P) as
4. The effect of a change in price on total revenue (TR = PQ) is determined by the price elasticity of
demand. When demand is elastic (inelastic), the quantity (price) effect dominates. Total revenue
always moves in the same direction as the variable (P or Q) having the dominant effect. When
5. Several factors affect the elasticity of demand for a good: (1) the better and more numerous the
substitutes for a good, the more elastic is the demand for the good, (2) the greater the percentage of
6. When calculating the value of E, computing percentage changes can be avoided by using a simpler
formula for computing elasticity which can be obtained through the following algebraic operations:
Chapter 6: Elasticity and Demand
7. Price elasticity can be measured either (1) over an interval (or arc) along demand, or (2) at a specific
point on the demand curve. In either case, E still measures the sensitivity of consumers to changes in
8. When calculating the price elasticity of demand over an interval of demand, use the arc or interval
elasticity formula:
E=DQ
DP×Average P
Average Q
9. When calculating the price elasticity of demand at a point on demand, multiply the slope of demand
(Q/P), computed at the point of measure, times the ratio P/Q, computed using the values of P and
Q at the point of measure. The method of measuring the point elasticity depends on whether demand
is linear or curvilinear.
Point Elasticity when Demand is Linear
10. In general, the price elasticity of demand varies along a demand curve. For linear demand curves,
11. Marginal revenue (MR) is the change in total revenue per unit change in output:
MR =DTR
DQ
13. For any demand curve (linear or curvilinear), when demand is elastic (|E| > 1), MR is positive. When
demand is inelastic (|E| < 1), MR is negative. When demand is unitary elastic (|E| = 1), MR is zero.
14. For all demand and marginal revenue curves, the relation between marginal revenue, price, and
elasticity can be expressed as
15. Income elasticity (EM) measures the responsiveness of quantity demanded to changes in income,
holding the price of the good and all other demand determinants constant.
16. Cross-price elasticity (EXY ) measures the responsiveness of quantity demanded of good X to changes
in the price of related good Y, holding the price of good X and all other demand determinants for good
X constant.
17. To calculate interval measures of income and cross-price elasticities, the following formulas can be
employed:
elasticities can be calculated as
Answers to Applied Problems
1. The analyst believes demand is inelastic because he believes an increase in price will increase total
revenue. The publisher believes demand is elastic because he believes an increase in price will
decrease total revenue.
2. a. True; price and quantity are inversely related.
b. False; |%ΔQ| is less than |%ΔP|.
3. a. more elastic
b. more elastic
4. E = – 1 at Aztec because changes in the price of advertising have no effect on total advertising ex–
penditures. Quantity of ads demanded = $2,000,000/Pad or Q = 2,000,000P – 1.
5. The WSJ reported that cigarette companies hiked cigarette prices by 76 cents per pack to an average
retail price of $2.71 in 2000—a 37% increase. The price increase was “successful” because demand
6. Sales of whisky will fall; %ΔQ/20% = – 0.2, so %ΔQ = – 4%, and sales fall by 4%.
7. a. and b. P = $25 per month and Q = 50 lockers per month
8. a. No. At P = $15, E = 15/(15 – 20) = – 3. Since |E| > 1, an increase in price will decrease TR, and,
9. E = – 8%/5% = – 1.6, demand is elastic. During 1991, average household income fell due to a
10. a.
–1.432 =115,040 –12,790
66 –233 ´149.50
63,915
Answers to Mathematical Exercises
1. a. P = P(Q) = 40 – 2Q
b. TR = R(Q) = (40 – 2Q)Q = 40Q – 2Q2
2. a.
E=dQ
dP
P
Q=–36P–2´P
36P–1= –1