Overview
This lecture continues with an example calculating price elasticity of demand, comparing elastic and inelastic cases, and explaining the economic meaning of these results.
Example 2: Calculating Price Elasticity of Demand
- Initial price (P1) is $2.50 per gallon; quantity demanded (Q1) is 500 gallons.
- New price (P2) is $3.50 per gallon; quantity demanded (Q2) is 450 gallons.
- Calculate percentage change in quantity: (450 - 500) / ((450 + 500) / 2) × 100% = -10.5%.
- Calculate percentage change in price: (3.50 - 2.50) / ((3.50 + 2.50) / 2) × 100% = 33.3%.
- Elasticity of demand = (-10.5%) / (33.3%) = -0.315.
Interpretation of Elasticity Result
- Elasticity magnitude less than 1 (|−0.315| < 1) means the demand is inelastic.
- Inelastic demand: quantity demanded changes less (−10.5%) than the price increases (33.3%).
- Consumers are less responsive to price changes (e.g., gas vs. cereal).
Comparison to Previous Example
- Previous example (cereal) had a larger elasticity (>1), indicating elastic demand.
- For gas, demand is more rigid—price increases cause a proportionally smaller decrease in quantity.
Key Terms & Definitions
- Elasticity of Demand — Measures how much quantity demanded responds to a price change; calculated as % change in quantity / % change in price.
- Inelastic Demand — When elasticity is less than 1, meaning consumers are not very responsive to price changes.
- Magnitude — The absolute value of elasticity, ignoring the negative sign, used to assess elasticity strength.
- Midpoint Method — A way to calculate percentage changes using the average of starting and ending values.
Action Items / Next Steps
- Review the elasticity formula and practice with new examples.
- Prepare for part three or four of the lecture, which will build on these concepts.