Differentiation 288

Practice Problem
2 Given the demand function
P = 100 Q
calculate the price elasticity of demand when the price is
(a) 10 (b) 50 (c) 90
Is the demand inelastic, unit elastic or elastic at these prices?
Example
Given the demand function
P = 50 2Q
nd the elasticity when the price is 30. Is demand inelastic, unit elastic or elastic at this price?
Solution
To nd dQ/dP we need to differentiate Q with respect to P. However, we are actually given a formula for P
in terms of Q, so we need to transpose
P = 50 2Q
for Q. Adding 2Q to both sides gives
P + 2Q = 50
and if we subtract P then
2Q = 50 P
Finally, dividing through by 2 gives
Q = 25
1
/2P
Hence
=
1
/2
We are given that P = 30 so, at this price, demand is
Q = 25
1
/2(30) = 10
These values can now be substituted into
E =
to get
E = = 1.5
Moreover, since 1.5 > 1, demand is elastic at this price.
D
F
1
2
A
C
30
10
dQ
dP
P
Q
dQ
dP
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It is quite common in economics to be given the demand function in the form
P = f (Q)
where P is a function of Q. In order to evaluate elasticity it is necessary to nd
which assumes that Q is actually given as a function of P. Consequently, we may have to trans-
pose the demand equation and nd an expression for Q in terms of P before we perform the
differentiation. This was the approach taken in the previous example. Unfortunately, if f (Q) is
a complicated expression, it may be difcult, if not impossible, to carry out the initial re-
arrangement to extract Q. An alternative approach is based on the fact that
=
A proof of this can be obtained via the chain rule, although we omit the details. This result
shows that we can nd dQ/dP by just differentiating the original demand function to get dP/dQ
and reciprocating.
1
dP/dQ
dQ
dP
dQ
dP
4.5 Elasticity 289
Example
Given the demand function
P = Q
2
4Q + 96
nd the price elasticity of demand when P = 51. If this price rises by 2%, calculate the corresponding
percentage change in demand.
Solution
We are given that P = 51, so to nd the corresponding demand we need to solve the quadratic equation
Q
2
4Q + 96 = 51
that is,
Q
2
4Q + 45 = 0
To do this we use the standard formula
discussed in Section 2.1, which gives
Q =
=
=
The two solutions are 9 and 5. As usual, the negative value can be ignored, since it does not make sense to
have a negative quantity, so Q = 5.
4 14
2
4 196
2

( ) (( ) ( )( ))
( )
4 4 4 1 45
2 1
2
b b ac
a
( )
2
4
2

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To nd the value of E we also need to calculate
from the demand equation, P = Q
2
4Q + 96. It is not at all easy to transpose this for Q. Indeed, we would
have to use the formula for solving a quadratic, as above, replacing the number 51 by the letter P.
Unfortunately this expression involves square roots and the subsequent differentiation is quite messy. (You
might like to have a go at this yourself !) However, it is easy to differentiate the given expression with respect
to Q to get
= 2Q 4
and so
= =
Finally, putting Q = 5 gives
=
The price elasticity of demand is given by
E =
and if we substitute P = 51, Q = 5 and dQ/dP = 1/14 we get
E = = 0.73
To discover the effect on Q due to a 2% rise in P we return to the original denition
E =
We know that E = 0.73 and that the percentage change in price is 2, so
0.73 =
which shows that demand changes by
0.73 2 = 1.46%
A 2% rise in price therefore leads to a fall in demand of 1.46%.
percentage change in demand
2
percentage change in demand
percentage change in price
D
F
1
14
A
C
51
5
dQ
dP
P
Q
1
14
dQ
dP
1
2Q 4
1
dP/dQ
dQ
dP
dP
dQ
dQ
dP
Differentiation 290
Practice Problem
3 Given the demand equation
P = Q
2
10Q + 150
find the price elasticity of demand when Q = 4. Estimate the percentage change in price needed to
increase demand by 10%.
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The price elasticity of supply is dened in an analogous way to that of demand. We dene
E =
This time, however, there is no need to ddle the sign. An increase in price leads to an increase
in supply, so E is automatically positive. In symbols,
E =
If (Q
1
, P
1
) and (Q
2
, P
2
) denote two points on the supply curve then arc elasticity is obtained, as
before, by setting
P = P
2
P
1
Q = Q
2
Q
1
P =
1
/2(P
1
+ P
2
)
Q =
1
/2(Q
1
+ Q
2
)
The corresponding formula for point elasticity is
E =
dQ
dP
P
Q
Q
P
P
Q
percentage change in supply
percentage change in price
4.5 Elasticity 291
Example
Given the supply function
P = 10 + Q
nd the price elasticity of supply
(a) averaged along an arc between Q = 100 and Q = 105
(b) at the point Q = 100
Solution
(a) We are given that
Q
1
= 100, Q
2
= 105
so that
P
1
= 10 + 100 = 20 and P
2
= 10 + 105 = 20.247
Hence
P = 20.247 20 = 0.247, Q = 105 100 = 5
P = (20 + 20.247) = 20.123, Q = (100 + 105) = 102.5
The formula for arc elasticity gives
E = = = 3.97
5
0.247
20.123
102.5
Q
P
P
Q
1
2
1
2

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(b) To evaluate the elasticity at the point Q = 100, we need to nd the derivative, . The supply equation
P = 10 + Q
1/ 2
differentiates to give
= Q
1/ 2
=
so that
= 2 Q
At the point Q = 100, we get
= 2 100 = 20
The formula for point elasticity gives
E = = 20 = 4
Notice that, as expected, the answers to parts (a) and (b) are nearly the same.
20
100
dQ
dP
P
Q
dQ
dP
dQ
dP
1
2 Q
1
2
dP
dQ
dQ
dP
Differentiation 292
Advice
The concept of elasticity can be applied to more general functions and we consider some
of these in the next chapter. For the moment we investigate the theoretical properties of
demand elasticity. The following material is more difficult to understand than the fore-
going, so you may prefer just to concentrate on the conclusions and skip the intermediate
derivations.
Practice Problem
4 If the supply equation is
Q = 150 + 5P + 0.1P
2
calculate the price elasticity of supply
(a) averaged along an arc between P = 9 and P = 11
(b) at the point P = 10
We begin by analysing the relationship between elasticity and marginal revenue. Marginal
revenue, MR, is given by
MR =
d(TR)
dQ
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Now TR is equal to the product PQ, so we can apply the product rule to differentiate it. If
u = P and v = Q
then
= and = = 1
By the product rule
MR = u + v
= P + Q
= P 1 +
Now
= E
so
=
This can be substituted into the expression for MR to get
MR = P 1
The connection between marginal revenue and demand elasticity is now complete, and this
formula can be used to justify the intuitive argument that we gave at the beginning of this
section concerning revenue and elasticity. Observe that if E < 1 then 1/E > 1, so MR is negative
for any value of P. It follows that the revenue function is decreasing in regions where demand
is inelastic, because MR determines the slope of the revenue curve. Similarly, if E > 1 then
1/E < 1, so MR is positive for any price, P, and the revenue curve is uphill. In other words,
the revenue function is increasing in regions where demand is elastic. Finally, if E = 1 then
MR is 0, and so the slope of the revenue curve is horizontal at points where demand is unit
elastic.
Throughout this section we have taken specic functions and evaluated the elasticity at
particular points. It is more instructive to consider general functions and to deduce general
expressions for elasticity. Consider the standard linear downward-sloping demand function
P = aQ + b
when a < 0 and b > 0. As noted in Section 4.3, this typies the demand function faced by a
monopolist. To transpose this equation for Q, we subtract b from both sides to get
aQ = P b
and then divide through by a to get
Q = (P b)
1
a
D
F
1
E
A
C
1
E
dP
dQ
Q
P
dQ
dP
P
Q
D
F
dP
dQ
Q
P
A
C
dP
dQ
du
dQ
dv
dQ
dQ
dQ
dv
dQ
dP
dQ
du
dQ
4.5 Elasticity 293
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Hence
=
The formula for elasticity of demand is
E =
so replacing Q by (1/a)(P b) and dQ/dP by 1/a gives
E =
=
=
Notice that this formula involves P and b but not a. Elasticity is therefore independent of the
slope of linear demand curves. In particular, this shows that, corresponding to any price P, the
elasticities of the two demand functions sketched in Figure 4.20 are identical. This is perhaps a
rather surprising result. We might have expected demand to be more elastic at point A than at
point B, since A is on the steeper curve. However, the mathematics shows that this is not the
case. (Can you explain, in economic terms, why this is so?)
Another interesting feature of the result
E =
is the fact that b occurs in the denominator of this fraction, so that corresponding to any price,
P, the larger the value of the intercept, b, the smaller the elasticity. In Figure 4.21, elasticity at
C is smaller than that at D because C lies on the curve with the larger intercept.
The dependence of E on P is also worthy of note. It shows that elasticity varies along a
linear demand curve. This is illustrated in Figure 4.22. At the left-hand end, P = b, so
P
b P
P
b P
P
P b
1
a
P
(1/a)(P b)
dQ
dP
P
Q
1
a
dQ
dP
Differentiation 294
Figure 4.20
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E = = =
At the right-hand end, P = 0, so
E = = = 0
As you move down the demand curve, the elasticity decreases from to 0, taking all pos-
sible values. Demand is unit elastic when E = 1 and the price at which this occurs can be found
by solving
= 1 for P
P
b P
0
b
0
b 0
b
0
b
b b
4.5 Elasticity 295
Figure 4.21
Figure 4.22
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P = b P (multiply both sides by b P)
2P = b (add P to both sides)
P = (divide both sides by 2)
The corresponding quantity can be found by substituting P = b/2 into the transposed demand
equation to get
Q = b =
Demand is unit elastic exactly halfway along the demand curve. To the left of this point E > 1
and demand is elastic, whereas to the right E < 1 and demand is inelastic.
In our discussion of general demand functions, we have concentrated on those which are
represented by straight lines since these are commonly used in simple economic models. There
are other possibilities and Practice Problem 11 investigates a class of functions that have con-
stant elasticity.
b
2a
D
F
b
2
A
C
1
a
b
2
Differentiation 296
Practice Problems
5 Given the demand function
P = 500 4Q
2
calculate the price elasticity of demand averaged along an arc joining Q = 8 and Q = 10.
6 Find the price elasticity of demand at the point Q = 9 for the demand function
P = 500 4Q
2
and compare your answer with that of Practice Problem 5.
7 Find the price elasticity of demand at P = 6 for each of the following demand functions:
(a) P = 30 2Q
(b) P = 30 12Q
(c) P = (100 2Q)
Arc elasticity Elasticity measured between two points on a curve.
Elastic demand Where the percentage change in demand is more than the corresponding
percentage change in price: E > 1.
Inelastic demand Where the percentage change in demand is less than the corresponding
percentage change in price: E < 1.
Price elasticity of demand A measure of the responsiveness of the change in demand due
to a change in price: (percentage change in demand) (percentage change in price).
Price elasticity of supply A measure of the responsiveness of the change in supply due to
a change in price: (percentage change in supply) (percentage change in price).
Unit elastic demand Where the percentage change in demand is the same as the percent-
age change in price: E = 1.
Key Terms
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8 If the demand equation is
Q + 4P = 60
find a general expression for the price elasticity of demand in terms of P. For what value of P is
demand unit elastic?
9 Consider the supply equation
Q = 4 + 0.1P
2
(a) Write down an expression for dQ/dP.
(b) Show that the supply equation can be rearranged as
P = (10Q 40)
Differentiate this to find an expression for dP/dQ.
(c) Use your answers to parts (a) and (b) to verify that
=
(d) Calculate the elasticity of supply at the point Q = 14.
10 If the supply equation is
Q = 7 + 0.1P + 0.004P
2
find the price elasticity of supply if the current price is 80.
(a) Is supply elastic, inelastic or unit elastic at this price?
(b) Estimate the percentage change in supply if the price rises by 5%.
11 Show that the price elasticity of demand is constant for the demand functions
P =
where A and n are positive constants.
12 Find a general expression for the point elasticity of supply for the function,
Q = aP + b (a > 0)
Deduce that the supply function is
(a) unit elastic when b = 0
(b) inelastic when b > 0
Give a brief geometrical interpretation of these results.
A
Q
n
1
dP/dQ
dQ
dP
4.5 Elasticity 297
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