Elasticity of demand

 The responsiveness of quantity

demanded to changes in price or other
factors (income, etc
 Responsiveness to price = referred to as
price elasticity of demand.
 Technically defined as the RATIO %
change in quantity demanded to the 1%
change in the price.
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 Elasticity of demand
E = (ΔQ/Q1)/(ΔP/P1) = (Q2—Q1)/Q1 x P1/ (P2—P1)
Where E = elasticity of demand (responsiveness to price
changes)
ΔQ = Change in utilisation
ΔP = Change in price
Q2 = Utilisation at time2 (e.g. after reduction in
fees)
Q1 = Utilisation at time1 (e.g. before reduction
in fees)
P2 = Price at time2 (e.g. reduced level of fees)
P2 = Price at time1 (e.g. initial or baseline fees)
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 Elasticity of demand
 Suppose that the user fee for OPD
services was reduced across the board
from (a flat rate of) 2000= per patient
to 1000= per patient.

 Suppose also that, as a consequence,

utilization rose from 20,000 per year to
60,000 per year.
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 Elasticity of demand
 The proportionate (%) increase in
utilization is (60,000- 20,000)/20,000 = 2
(200%).... (1)

 The proportionate (%) reduction in price

is (1000 – 2,000)/1,000 = -1 (-
100%)............. (2)
 The price elasticity of demand is thus (1)/
(2) = 200%/-100% = - 2.
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 Elasticity of demand

 The figure 2 means that for every 1%

reduction in price, the utilization
increases by 2%.
 The negative sign simply means that
the changes took place in opposite
directions; in this case prices were
reduced, while utilization increased.

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 Elasticity of demand

 If the elasticity figure bears a positive

sign, it means the direction of change is
the same
 In practice the variation is usually along
a curve.

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 Elasticity of demand

 A more meaningful index is the

average elasticity of demand, (in
which case the denominators are
average figures, and formula
becomes thus

ΔQ/ΔP x (P2 + P1)/(Q2 + Q1).

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 Calculating Elasticities
Point Elasticity: Arc or Average Elasticity:

Q1 - Q0 / Q0 Q1 - Q0 / Q1 + Q0
Ed = - ---------------- Ed = - -----------------------
P1 - P0 / P1 P1 - P0 / P1 + P0

When calculating the price elasticity of demand from

points on a demand curve or demand schedule, the arc
or average elasticity should always be used.
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 Interpreting Elasticity
 If Ed > 1, demand is elastic or the
percent change in Qd > percent price
change.
 If Ed = 1, demand is unitary elastic or
the percent change in Qd = percent
price change.
 If Ed < 1, demand is inelastic or the
percent change in Qd < percent price
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 Elasticity of demand
 Assume an
increase in price.

 D1 = least elastic
demand

 D2 = more elastic
demand

 D3 = even more
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 Extreme Values for Price
Elasticity
 Ed = , Perfectly  Ed = 0, Perfectly
Elastic Demand Inelastic Demand
 The demand curve is  The demand curve is
horizontal. vertical.
P P

Q/t Q/t
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 Elasticity of demand

 Assume an
increase in price.
What would the
shape look like

For an addictive
substance?
Substance with a
large price
elasticity?
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 Importance of elasticities

 Has implications for policy-

 e.g. taxing cigarettes, beer, airtime &
healthcare effectively increases their
prices.
 The effect on quantity consumed depends
on the price elasticity.

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 Importance of elasticities

 Heavy smokers may not respond to

prices at all because they are completely
hooked.

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 Key policy questions to
consider
 If prices fall, to what extent will this
achieve an increase in utilisation?
 Who will the reduction favour the more;
the young or the old, women, men

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