Microeconomics - Price Elasticity

Now that you have completed the basics, let us move onto the various learning outcomes on Microeconomics you should look to know for your upcoming exam.

Price Elasticity
In general, the elasticity of a particular variable is the percentage change in quantity demanded or supplied, divided by the percentage change in the variable of concern. This ratio is often called the elasticity coefficient.

Price elasticity is defined as the percentage change in quantity demanded divided by the percentage change in price.

The price elasticity of demand can be expressed as:

Formula 3.1

Example: Price Elasticity
Where Ep is the price elasticity coefficient, %ΔQ represents the percentage in quantity, and %ΔP represents the percentage in price. If the price of gasoline goes up by 50%, and the quantity demanded decreases by 20%, the price elasticity of gasoline would be:

Ep = %Δ Quantity = -20% = -0.4
%Δ Price +50%

Typically, the negative sign is ignored and we would say that the price elasticity of gasoline is 0.4.

To calculate elasticity we must first have data for quantities purchased at different prices. Suppose that the price of a good goes from P0 to P1, and that we have data for the change in quantity demanded, which goes from Q0 to Q1. The calculation is typically made by dividing the actual change by the average(or midpoint) of the beginning and ending values. Suppose that the quantity demanded of a good goes from 10 to 14. The percentage change in quantity demanded could be expressed as:

(Q0 - Q1) = 4 = 0.333
0.5(Q0 + Q1) 0.5(24)

That number would be multiplied by 100 to get the percentage change, which in this case would be 33.3%.

Similarly, the percentage change in price can be expressed as:

(P0 - P1) x 100
0.5(P0 + P1)

Look Out!
Sometimes the denominator used for these percentage change calculations is simply the original value (P0 and Q0). Because the CFA text uses the midpoint method, unless the exam has instructions to the contrary, it would be safer to use the midpoint method.

The full elasticity calculation can be simplified by canceling out the 0.5 (one-half) and 100. The more simplified expression can be stated as:

Suppose, to continue the example given above, that the change in quantity demanded for the good (10 to 14) was in response to a price decrease from $8 to $7. In that case, the elasticity would be expressed as:

(10 - 14) / (10 + 14) = -4 / 24 = -1/6 = -15 = -2.5
(8 - 7) / (8 + 7) 1 / 15 1/15 6

Alternatively, the elasticity could have been calculated as: -4 divided by half of 24, which is equal to -0.333, over 1 divided by half of 15, which equals 0.1333.

So the elasticity would be -0.333 over 0.133 = - 2.5, the same answer as above.

The following definitions apply to calculations of price elasticity:

1) If Ep > 1, Demand is elastic. The percentage change in price will produce a greater percentage in quantity demanded. If the price goes up, then total revenues will go down. If the price goes down, then total revenues willincrease.

2) If Ep < 1, Demand is inelastic. The percentage change in price will produce a lower percentage in quantity demanded. If the price goes up, then total revenues will go up. If the price goes down, then total revenues will decrease. Put simply, these changes will be less drastic than if demand is elastic.

3) If Ep = 1, Demand has unitary elasticity. A percentage in price will produce the exact same percentage change in quantity. Therefore, changes in price will no have effect on total revenues.
If demand is elastic for a product, then a small change in price will cause a large change in quantity demanded. If the demand for a product is inelastic, even a large change in price might cause little change in quantity demanded.

Elasticity of Demand
Related Articles
  1. Financial Advisors

    Tips on Passing the CFA Level I on Your First Attempt

    Obtain valuable tips and helpful study instructions that can help you pass the Level 1 Chartered Financial Analyst exam on your first attempt.
  2. Financial Advisors

    Putting Your CFA Level I on Your Resume

    Learn techniques for emphasizing your CFA Level I status in the Skills and Certifications or Professional Development section of your resume.
  3. Professionals

    Investment Analyst: Career Path and Qualifications

    Learn how to prepare for a career as an investment analyst, and read more about how many professionals in the field progress during their careers.
  4. Professionals

    CAIA Vs. CFA: How Are They Different?

    Find out how the CAIA and CFA designations differ, including which professionals should seek either title based on their career ambitions.
  5. Professionals

    Equity Investments: CFA Level II Tutorial

    Chapter 1: Equity Valuation: Its Applications and Processes Chapter 2: Return Concepts for Equity Valuation Chapter 3: Industry Analysis With Porter's 5 Forces
  6. Professionals

    What To Expect On The CFA Level III Exam

    The Chartered Financial Analyst Level III exam, which is only offered in June, is the last in the series of three tests that CFA candidates must pass.
  7. Professionals

    What To Expect On The CFA Level I Exam

    Becoming a chartered financial analyst requires the passing of three grueling exams covering an array of topics.
  8. Options & Futures

    The Alphabet Soup of Financial Certifications

    We decode the meaning of the many letters that can follow the names of financial professionals.
  9. Professionals

    How to Ace the CFA Level I Exam

    Prepare to ace the CFA Level 1 exam by studying systematically.
  10. Personal Finance

    How To Choose A Financial Advisor

    Many advisors display similar skillsets that can make distinguishing between them difficult. The following guidelines can help you better understand their qualifications and services.
  1. Personal Financial Advisor

    Professionals who help individuals manage their finances by providing ...
  2. CFA Institute

    Formerly known as the Association for Investment Management and ...
  3. Security Analyst

    A financial professional who studies various industries and companies, ...
  4. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly ...
  1. What are the differences between a Chartered Financial Analyst (CFA) and a Certified ...

    The differences between a Chartered Financial Analyst (CFA) and a Certified Financial Planner (CFP) are many, but comes down ... Read Full Answer >>
  2. How do I become a Chartered Financial Analyst (CFA)?

    According to the CFA Institute, a person who holds a CFA charter is not a chartered financial analyst. The CFA Institute ... Read Full Answer >>
  3. What types of positions might a Chartered Financial Analyst (CFA) hold?

    The types of positions that a Chartered Financial Analyst (CFA) is likely to hold include any position that deals with large ... Read Full Answer >>
  4. Who benefits the most from prepaid expenses?

    Prepaid expenses benefit both businesses and individuals. Prepaid expenses are the types of expenses that are bought or paid ... Read Full Answer >>
  5. If I am looking to get an Investment Banking job. What education do employers prefer? ...

    If you are looking specifically for an investment banking position, an MBA may be marginally preferable over the CFA. The ... Read Full Answer >>
  6. Can I still pass the CFA Level I if I do poorly in the ethics section?

    You may still pass the Chartered Financial Analysis (CFA) Level I even if you fare poorly in the ethics section, but don't ... Read Full Answer >>
Hot Definitions
  1. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  2. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  3. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  4. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  5. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  6. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
Trading Center