Elasticity in Economics
Managerial Economics & Business Strategy Chapter 3
Quantitative Demand Analysis
Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008
The Elasticity Concept
• How responsive is variable “G” to a change in variable “S”
EG , S
% ΔG = % ΔS
If EG,S > 0, then S and G are directly related. If EG,S < 0, then S and G are inversely related. If EG,S = 0, then S and G are unrelated.
Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008
The Elasticity Concept Using Calculus
• An alternative way to measure the elasticity of a function G = f(S) is
EG , S
dG S = dS G
If EG,S > 0, then S and G are directly related. If EG,S < 0, then S and G are inversely related. If EG,S = 0, then S and G are unrelated.
Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008
Own Price Elasticity of Demand
EQX , PX %ΔQX = %ΔPX d • Negative according to the “law of demand.”
Elastic:
EQX , PX > 1
Inelastic: EQX , PX < 1 Unitary:
EQX , PX = 1
Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008
Perfectly Elastic & Inelastic Demand
Price Price D D
Quantity
Perfectly Elastic ( EQ X ,PX = −∞)
Quantity
Perfectly Inelastic ( EQX , PX = 0)
Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008
Own-Price Elasticity and Total Revenue
• Elastic
Increase (a decrease) in price leads to a decrease (an increase) in total revenue.
• Inelastic
Increase (a decrease) in price leads to an increase (a decrease) in total revenue.
• Unitary
Total revenue is maximized at the point where demand is unitary elastic.
Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008
Elasticity, Total Revenue and Linear Demand
P 100 TR
0
10
20
30
Quantitative Demand Analysis
Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008
The Elasticity Concept
• How responsive is variable “G” to a change in variable “S”
EG , S
% ΔG = % ΔS
If EG,S > 0, then S and G are directly related. If EG,S < 0, then S and G are inversely related. If EG,S = 0, then S and G are unrelated.
Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008
The Elasticity Concept Using Calculus
• An alternative way to measure the elasticity of a function G = f(S) is
EG , S
dG S = dS G
If EG,S > 0, then S and G are directly related. If EG,S < 0, then S and G are inversely related. If EG,S = 0, then S and G are unrelated.
Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008
Own Price Elasticity of Demand
EQX , PX %ΔQX = %ΔPX d • Negative according to the “law of demand.”
Elastic:
EQX , PX > 1
Inelastic: EQX , PX < 1 Unitary:
EQX , PX = 1
Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008
Perfectly Elastic & Inelastic Demand
Price Price D D
Quantity
Perfectly Elastic ( EQ X ,PX = −∞)
Quantity
Perfectly Inelastic ( EQX , PX = 0)
Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008
Own-Price Elasticity and Total Revenue
• Elastic
Increase (a decrease) in price leads to a decrease (an increase) in total revenue.
• Inelastic
Increase (a decrease) in price leads to an increase (a decrease) in total revenue.
• Unitary
Total revenue is maximized at the point where demand is unitary elastic.
Michael R. Baye, Managerial Economics and Business Strategy, 6e. ©The McGraw-Hill Companies, Inc., 2008
Elasticity, Total Revenue and Linear Demand
P 100 TR
0
10
20
30