1. Elasticity and Its Applications
Elasticity: a measure of the responsiveness of quantity
demanded or quantity supplied to one of its determinants
e.g.:
Price elasticity of demand: a measure of the responsiveness
of quantity demanded of a good to its price
· One of the most important applications:
Example: You own a museum and you want to increase your
revenue (P x Q), should you raise or lower the entrance fee?
To answer this question, we need to know the responsiveness
of quantity demanded of museum visiting to its price
change, i.e., we need to know the price elasticity of demand
for museum.

2. This chapter:
· Elasticity of demand
· Elasticity of supply
· How and where to apply the concept of elasticity
The elasticity of demand
· The price elasticity of demand: how sensitive is the
quantity demanded of a good to its price change?
-- What determine the price elasticity of demand?
· Necessities versus Luxuries
· Availability of close substitute
· Definition of the market
· Time horizon

3. Examples:
For each of the following pairs of goods, circle the one
that you expect to have a more elastic demand.
1). Automobile v.s. Honda Civic
2). Gasoline in New York City v.s. Gasoline in Arizona
3). Cosmetics v.s. Salt
4). Dentists v.s. Economists
Computing the price elasticity of demand
price elasticity of demand = (% Δ in QD) / (% Δ in P)
= (percentage change in quantity demanded) /
(percentage change in price)

4. e.g. when price ↑ from $2 to $3, QD ↓ from 100 to 50
-- Why not simple use ΔQD /ΔP?
1. Unit: percentage change is unit free
2. Size of the changes in relative term.
Case 1: P ↑ from $100 to $101
QD ↓ from 2 to 1
Case 2: P ↑ from $1 to $2
QD ↓ from 100 to 99

5. ΔQD / ΔP (ΔQD / ΔP) x (P / QD)
Case 1 -1 -67
Case 2 -1 -0.015

6. -- The elasticity of demand along a linear demand curve
Point A: (P, Q) = ($6, 1)
Point B: (P, Q) = ($4, 2)
Point C: (P, Q) = ($2, 3)
ΔQD / ΔP = -1/2 for all points.
Ed (A) = -3
Ed (B) = -1
Ed (C) = -1/3

7. -- Total Revenue and the Price Elasticity of Demand
-- The Variety of demand curves
Roughly speaking, a flatter demand curve is more elastic than
a steep demand curve.
· The income elasticity of demand
: a measure of the responsiveness of the quantity demanded
of a good to a change in consumers’ income
income elasticity of demand = (% Δ in QD) / (% Δ in Y)
= (percentage change in quantity demanded) / (percentage
change in income)

8. e.g.:
Let price = $10
When income = $10,000, QD = 20
When income = $20,000, QD = 30
Income elasticity of demand = 0.6
* “Sign” matters here: Normal goods versus Inferior
goods

9. · The cross-price elasticity of demand
: a measure of the responsiveness of the quantity
demanded of a good to a change in the price of another
good
cross-price elasticity of demand
= (% Δ in QDGood A) / (% Δ in PGood B)
e.g.:
Let price of apples unchanged.
When price of orange = $2, QDApples = 20
When price of orange = $4, QDApples = 30
Cross-price elasticity of demand = 0.6
* “Sign” matters here: Substitutes versus Complements

10. The elasticity of Supply
The price elasticity of supply: how sensitive is the quantity
supplied of a good to its price change?
-- price elasticity of supply = (% Δ in QS) / (% Δ in P)
= (percentage change in quantity supplied) / (percentage
change in price)
-- What determines the price elasticity of supply?
· The property of the goods
- flexible: manufacturing goods
- inflexible: lands with good views, good athletes
· the time horizon: the longer, the larger
-- The variety of supply curves

11. Applications
1. Can good news for farming be bad news for farmers?
- new hybrid of wheat
- supply of wheat increases
- P ↓ and Q ↑
- if price elasticity of demand
is small (P x Q) ↓
- bad news for farmers!
What should farmers have learned from this?
- cut production together supply ↓ P ↑and Q ↓
(P x Q) ↑
- problem: hard to monitor

12. 2. Does drug interdiction increase or decrease drug-
related crime?