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