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4.4: Calculating Elasticity

  • Page ID
    210836
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    A lot of classroom topics in economics are purely conceptual. They are useful to know but direct applications to a real-life situation are either impossible or impractical. For example, nearly every principles-level microeconomics covers consumer utility. It is generally assumed that that the consumption of any good or service must give the user some level of utility (i.e., satisfaction). But how does one quantify either the level or change in utility? If you eat an Oreo cookie, can you measure your satisfaction? Or can you compare levels of satisfaction between the third and fourth cookie?

    Unlike ordinal concepts, like utility, many types of elasticity can be accurately measured. Let’s take price elasticity of demand as an example.

    The equation for price elasticity is very simple:

    \[|E|=\dfrac{\% \text { change in price }}{\% \text { change in quantity demanded }} \nonumber \]

    So, if you know the starting price, ending price, starting quantity, and ending quantity then you can calculate the value of E (i.e., price elasticity).

    The value of E represents the percentage change in quantity demanded given a 1% change in price.

    If the value of E is -2.3%, we first turn the negative into a positive value (this process is called taking the absolute value and is represented by the vertical brackets around E, │E│). The 2.3% represents the change in quantity demanded resulting from a 1% change in price.

    A graph of a bar graphDescription automatically generated

    When the value of price elasticity is greater than 1 (as depicted in the graphic above), we say that this good is price elastic. In other words, consumers are sensitive to a change in price.

    On the other hand, when the value of price elasticity is less than one (as depicted in the graphic below), we say that this good in price inelastic (consumers are insensitive to price changes).

    A diagram of a bar graphDescription automatically generated

    Notice how in each case the price was changed by the same amount (1%). Whatever the value of E, it is always in relation to a 1% change in price.

    A table with text and numbersDescription automatically generated with medium confidence

    News Alert

    Mr. Lundgren, Macy’s CEO, tried to create a new kind of national department store that would no longer compete head-to-head with lower-priced competitors like J. C. Penney and Kohl’s. But the changes amounted to “too much, too fast,” Mr. Lundgren acknowledged in an interview. It turns out that men, in particular, are creatures of shopping habit. They want to go to the local department store and find the Dockers where they have always been.

    Mr. Lundgren said that abruptly curtailing discounts like coupons was Macy’s biggest misstep, contributing to four consecutive months of falling store sales this spring. Macy’s stock has dropped more than 40 percent since it bought the May stores. Mr. Lundgren said his plan “will take longer than we had planned or expected,” adding that “the strategy is crystal clear, and I know we are on the right track.”

    NYTs, September 29, 2007

    Based on the information in this news article, which of the following best describes the value of price elasticity of demand for the average Macy’s customer?

    1. \(|E|<1\)
    2. \(|E|=1\)
    3. \(|E|>1\)
    4. \(|E|<0\)

    This page titled 4.4: Calculating Elasticity is shared under a not declared license and was authored, remixed, and/or curated by Martin Medeiros.

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