1. 20
CHAPTER
Elasticity of
Demand & Supply

3. I WOULD LIKE TO TALK TO YOU
TODAY ABOUT TWO PRODUCTS.

4. Source: American Diabetes Association

6. Now you say to
yourselves again,
what do bicycles
and insulin have in
common?

7. Insulin Bicycles
$100
$300
$3
$200
$2
$100
$1
20 M 100 200 500

10. Insulin Bicycles
Cannot be Can be
delayed delayed

12. Insulin Bicycles
Few substitutes Many Substitutes
Cannot be delayed Can be delayed

14. Insulin Bicycles
Few substitutes Many Substitutes
Cannot be delayed Can be delayed
Inexpensive expensive

15. Insulin Bicycles
$100
$300
$3
$200
$2
$100
$1
20 M 100 200 500
4. The total receipts test: Price X Quantity = Revenue
P X Q = Revenue P X Q = Revenue
$3 X 20 m = $ 60,000,000 $300 X 100 =$ 30,000
$2 X 20 m =$ 40,000,000 $200 X 200 =$ 40,000
$1 X 20 m =$ 20,000,000 $100 X 500 =$ 50,000

16. POP IS ELASTIC!

17. INELASTICITY OF MILK

18. ELASTIC OR INELASTIC
(TOTAL RECEIPTS TEST)
$2
$1
Inelastic Elastic
20 30 40 50
Total Receipts Test Total Receipts Test
20 x $2 = $40.00 20 x $2 = $40
30 x $1 = $30.00 50 x $1 = $50

19. Elastic Demand
1. Substitutes(butter)
2. Luxury (mink coat)
3. Expensive (car)
4. Has durability (refrigerator)
Inelastic Demand
1. No substitutes (milk)
2. Necessity (insulin)
3. Inexpensive (safety pin)
4. No durability (pencil)

20. Elastic Demand For Cassette Tapes
“TR” Test
$2.50x100,000=$250,000
D $1.50x600,000=$900,000
+$650,000
-$1
.

21. ELASTIC DEMAND FOR CASSETTE TAPES
Total Receipts Test
$2.50=$250,000 “TR” Test
$1.50=$900,000 $2.50x100,000=$250,000
+ $650,000
D $1.50x600,000=$900,000
+$650,000
-$1

22. D
“TR” Test
$2 = $30 bil.
$1 = $20 bil.
-$10 bil.
-$1
+25% QD

23. ELASTIC OR INELASTIC DEMAND
Elastic or Inelastic Demand
Elastic
Inelastic

24. ESTIMATING THE ELASTICITY OF DEMAND
3 KEY QUESTIONS:
1. SUBS? 2. NECESSITY? 3. EXPENSIVE?

25. PRICE ELASTICITY OF DEMAND
Think About It...
THE LAW OF DEMAND SAYS...
Consumers will buy more
when prices go down and less
when prices go up
HOW MUCH MORE OR LESS?
DOES IT MATTER?
to whom?
Price Elasticity Provides an Answer

26. PRICE ELASTICITY OF DEMAND
Measures Responsiveness to
Price Changes
P The percentage change in quantity
The percentage change in price
.01
P2 .02
P1
D Elasticity is .5
Q2 Q1 Q

27. PRICE ELASTICITY OF DEMAND
Commonly Expressed as…
P The percentage change in quantity
The percentage change in price
%Q d
P2 % P
P1
D Elasticity is .5
Q2 Q1 Q

28. PRICE ELASTICITY OF DEMAND
The Price-Elasticity Coefficient and Formula
Percentage change in quantity
demanded of product X
Ed Percentage change in price
= of product X
Or equivalently…
change in quantity demanded of X
Ed Original quantity demanded of X
=
 Change in price of X
Original price of X
Elimination of the Minus Sign

29. PRICE ELASTICITY OF DEMAND
Interpretations of Ed
Elastic Demand
.04
Ed =2
= .02
Inelastic Demand
.01
Ed = .5
= .02
Unit Elasticity
.02
Ed =1
= .02

30. PRICE ELASTICITY OF DEMAND
Extreme Cases
Perfectly Inelastic Demand
P D1
Ed = 0
0 Q
Perfectly Elastic Demand
P
D2
Ed = 
0 Q

31. PRICE ELASTICITY OF DEMAND
Refinement –
The Midpoint Formula
Change in Change in

quantity price
Ed =
Sum of Sum of
Quantities/2 prices/2

32. PRICE ELASTICITY & TOTAL REVENUE
When prices are So is total revenue
low,
P TR
D
Q Quantity Demanded

33. PRICE ELASTICITY & TOTAL REVENUE
Total revenue rises
with price to a
P point...
TR
D
Q Quantity Demanded

34. PRICE ELASTICITY & TOTAL REVENUE
Total revenue rises then declines
with price to a
P point...
TR
D
Q Quantity Demanded

35. PRICE ELASTICITY & TOTAL REVENUE
Total revenue rises then declines
with price to a
P point...
TR
D
Q Quantity Demanded

36. PRICE ELASTICITY & TOTAL REVENUE
Total revenue rises then declines
with price to a
P point...
TR
Total Revenue Test
D
Q Quantity Demanded

37. PRICE ELASTICITY & TOTAL REVENUE
Total revenue rises then declines
with price to a
P point...
TR
Inelastic
Demand D Inelastic
Demand
Q Quantity Demanded

38. PRICE ELASTICITY & TOTAL REVENUE
Total revenue rises then declines
with price to a
P point...
TR
Elastic
Demand
Inelastic
Demand D Elastic Inelastic
Demand Demand
Q Quantity Demanded

39. PRICE ELASTICITY & TOTAL REVENUE
Total revenue rises then declines
with price to a
P point...
TR
Elastic Unit
Elastic
Demand
Inelastic
Demand D Elastic Inelastic
Demand Demand
Q Quantity Demanded

40. PRICE ELASTICITY & TOTAL REVENUE
Price Elasticity is...
Inelastic from 0 to 1
Typical of necessities one must have
Elastic from 1 to 
Typical of luxuries one wants
Unit elastic when exactly = 1
Price change does not reduce total
revenue

41. DETERMINANTS OF PRICE
ELASTICITY OF DEMAND
Applications...
Excise Taxes
Decriminalization of Illegal Drugs
Minimum Wage

42. PRICE ELASTICITY OF SUPPLY
Percentage change in quantity
supplied of good X
Es= Percentage change in
the price of good X
Now, compare the immediate
market period, the short-run,
and long run...

43. PRICE ELASTICITY OF SUPPLY
Immediate Market period
P Sm An increase in
demand without
enough time to
change supply
causes…
Po
D1
Qo Q

44. PRICE ELASTICITY OF SUPPLY
Immediate Market period
P Sm An increase in
demand without
enough time to
change supply
Pm causes… an
increase in price
Po
D2
D1
Qo Q

45. PRICE ELASTICITY OF SUPPLY
Short Run
P Ss
An increase in
demand with
less intensity
supply use
causes...
Po
D1
Qo Q

46. PRICE ELASTICITY OF SUPPLY
Short Run
P Ss
An increase in
demand with
less intensity
Ps supply use
causes...a lower
Po increase in price
D2
D1
QoQs Q

47. PRICE ELASTICITY OF SUPPLY
Long Run An increase in
P demand in the
long run allows
greater change
causing...
SL
Po
D1
Qo Q

48. PRICE ELASTICITY OF SUPPLY
Long Run An increase in
P demand in the
long run allows
greater change
causing...
SL
PL Even more elastic
Po response - less
price increase
D2
D1
Qo QL Q

49. PRICE ELASTICITY OF SUPPLY
Applications of
Price Elasticity of
Supply
Antiques and
Reproductions
Volatile Gold Prices

50. CROSS ELASTICITY OF DEMAND
Percentage change in quantity
demanded of good X
Exy = Percentage change in
the price of good y
Positive Sign
Goods are Substitutes
Negative Sign
Goods are Complementary
Zero or Near-Zero Value
Goods are Independent

51. INCOME ELASTICITY OF DEMAND
Percentage change in quantity
demanded
Ei = Percentage change in
income
Positive Sign
Goods are Normal or
Superior
Negative Sign
Goods are Inferior

52. price elasticity of total-revenue test
demand price elasticity of
elastic demand supply
inelastic demand market period
short run
unit elasticity
long run
perfectly inelastic
cross elasticity of
demand demand
perfectly elastic income elasticity of
Copyright McGraw-Hill/Irwin, 2005 BACK END

53. Next: Chapter 21
Consumer Behavior
and
Utility Maximization