Introduction to Elasticity


Elasticity is a numerical measure of the responsiveness of Qd or Qs to one of its determinants.

So basically, elasticity is about measuring the effect of one variable onto another variable.
For example, if a company specializes in developing applications for mobile devices. If this company decides to increase the price for their services then what would be the impact on demands.

Price Elasticity of Demand

Price Elasticity of Demand = (Percentage change in Qd) / (Percentage change in P)


Assume that price elasticity of demand = 20% / 10% = 2. See the figure below:

Note that along a D curve, P and Q are supposed to move in opposite directions, which would make price elasticity negative. However, for the sake of simplicity, the minus sign is ignored and consider that price elasticities as positive numbers.

Calculating Percentage Changes

Standard method of computing the percentage (%) change is given below:
(end value − start value) / (start value) × 100%

So, for example, assuming the company that develops apps, and wanting to increase the price (depicted in the figure below as moving from A to B).
The % change in P = ($350 − $250) /$250 = 40%


The problem with standard method is that it provides different answers depending on the starting point.
From A to B, P increases 40%, Q falls 25%, elasticity = 25/40 = 0.62
From B to A, P decreases 28%, Q increases 25%, elasticity = 25/28 = 0.89

That's the reason why another method is used and it's called midpoint method, which is represented by the following formula:
(end value − start value) / (midpoint) × 100%



Exercise on Calculating the Elasticity

Check your answers here: Solution to the Exercise on Calculating the Elasticity

What determines price elasticity?

We will consider a couple of examples help to understand the determines price elasticity, where each one compares two common goods.
In each example:

Example 1: Aspirin versus Jetski Rides

Example 2: Pizzas versus Food

Example 3: Health club (Gym) membership versus electrcity

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Date of last modification: 2019