2. Elasticity Learning Objectives
• What is the best way of measuring the
responsiveness of demand?
• What is the best way of measuring the
responsiveness of supply?
3. 1. THE PRICE ELASTICITY OF
DEMAND
Learning Objectives
2. Explain the concept of price elasticity of
demand and its calculation.
3. Explain what it means for demand to be price
inelastic, unit price elastic, price elastic,
perfectly price inelastic, and perfectly price
elastic.
4. Explain how and why the value of the price
elasticity of demand changes along a linear
demand curve.
5. Understand the relationship between total
revenue and price elasticity of demand.
6. Discuss the determinants of price elasticity of
demand.
4. Elasticity
• The elasticity of demand is the percentage
decrease in quantity that results from a small
percentage increase in price.
• Represented by the Greek letter Epsilon ε
• A one-percent increase in price will increase
total revenue when the elasticity of demand is
less than one
– defined as an inelastic demand
• A price increase will decrease total revenue
when the elasticity of demand is greater than
one is defined as an elastic demand
5. Elasticity
• The price elasticity of demand is the
percentage change in quantity demanded
of a particular good or service divided by
the percentage change in the price of
that good or service, all other things
unchanged.
eD = % change in quantity demanded
% change in price
6. 1.1 Computing the Price
Elasticity of Demand
• arc elasticity is a measure of elasticity
based on percentage changes relative to
the average value of each variable
between two points.
∆Q / Q
EQUATION 1.2 eD =
∆P / P
7. Movement from Point A to B (or B to A)
A shows that a $.10 change in price
changes the number of rides per day by
B 20,000.
9. 1.3 The Price Elasticity of Demand
and Changes in Total Revenue
• Total Revenue (TR=P*Q) is a firm’s
output multiplied by the price at which it
sells that output.
• Price elastic refers to a situation in
which the absolute value of the price
elasticity of demand is greater than 1.
• Unit price elastic refers to a situation
in which the absolute value of the price
elasticity of demand is equal to 1.
• Price inelastic refers to a situation in
which the absolute value of the price of
elasticity of demand is less than 1.
10. Changes in Total Revenue and a
Linear Demand Curve
Elastic Region
A Unit elastic
B
Inelastic Region
E
F
11. Price Elastic
An increase in price ... reduces total revenue.
A reduction in price... Increases total revenue.
Total revenue moves in the direction of the quantity change.
Price Inelastic
An increase in price… Increases total revenue.
A reduction in price… Reduces total revenue.
Total revenue moves in the direction of the price change.
Unit price Elastic
An increase in price… No change in total revenue.
A reduction in price… No change in total revenue.
Total revenue does not change as price changes.
12. 1.4 Constant Price Elasticity of
Demand Curves
• Perfectly inelastic (insensitive to price
changes) refers to a situation in which
the price elasticity of demand is zero.
• Perfectly elastic (sensitive to price
changes) refers to a situation in which
the price elasticity of demand is infinite.
14. 1.5 Determinants of the Price
Elasticity of Demand
• Availability of substitutes
– If there are lots of close substitute goods to
choose from consumers can switch easily
• Importance in household budgets
– Price of good relative to income
• Time
– In the short run it is often difficult to find
substitutes.
15. 2. RESPONSIVENESS OF DEMAND TO
OTHER FACTORS
Learning Objectives
2. Explain the concept of income elasticity of demand and its
calculation.
3. Classify goods as normal or inferior depending on their income
elasticity of demand.
4. Explain the concept of cross price elasticity of demand and its
calculation.
5. Classify goods as substitutes or complements depending on
their cross price elasticity of demand.
16. 2.1 Income Elasticity of Demand
• Income elasticity of demand is the
percentage change in quantity demanded at a
specific price divided by the percentage change
in income that produced the demand change,
all other things unchanged.
EQUATION 2.1
% change in quantity demanded
eY =
% change in income
17. 2.1 Income Elasticity of Demand
Normal Good (e.g. DVD’s)
An increase in income… Increases demand.
A decrease in income… Decreases demand.
Inferior Good (e.g. used clothing)
An increase in income… Decreases demand.
A decrease in income… Increases demand.
18. 2.2 Cross Price Elasticity of Demand
• Cross price elasticity of demand is the percentage change in
the quantity demanded of one good or service at a specific price
divided by the percentage change in the price of a related good
or service.
EQUATION 2.2
% change in quantity demanded of good A
e A, B =
% change in price of good B
19. 2.2 Cross Price Elasticity of Demand
Normal Good (e.g. DVD’s)
An increase in PB… Increases demand for good A.
A decrease in PB… Decreases demand for good A.
Inferior Good (e.g. used clothing)
An increase in PB… Decreases demand for good A.
A decrease in PB… Increases demand for good A.
20. 3. PRICE ELASTICITY OF SUPPLY
Learning Objectives
2. Explain the concept of elasticity of supply and its calculation.
3. Explain what it means for supply to be price inelastic, unit price
elastic, price elastic, perfectly price inelastic, and perfectly price
elastic.
4. Explain why time is an important determinant of price elasticity
of supply.
5. Apply the concept of price elasticity of supply to the labor
supply curve.
21. 3. PRICE ELASTICITY OF SUPPLY
• Price elasticity of supply is the ratio of the
percentage change in quantity supplied of a
good or service to the percentage change in its
price, all other things unchanged.
EQUATION 3.1
% change in quantity supplied
es =
% change in price
22. Increase in Apartment Rents Depends on How
Responsive Supply Is
S1
R1 S2
R2
R0
D1 D2
Q0 Q1 Q2
24. 3.1 Time: An Important Determinant of
the Elasticity of Supply
• In the short run supply is likely to
be inelastic.
• In the long run supply is likely to be
more elastic.
25. Selected Elasticity Estimates
Product Price Income Product Cross price
elasticity elasticity elasticity
Food -2.58 0.20 Alcohol with respect to -0.05
(long-run) the price of heroin
Beer -0.90 to -1.50 0.40 Fuel with respect to the -0.48
price of transport
Heroin -1.00 0.00 Beer with respect to the 0.00
price of wine
Coke -1.90 0.60 Poultry with respect to 0.23
the price of ground beef
Pepsi -2.22 1.72 Coke with respect to 0.61
the price of Pepsi
Gasoline -0.10 ----- Pepsi with respect to 0.80
(short-run) the price of Coke
Transportation -2.08 -----
(long-run)
27. Elasticity of supply
• The percentage increase in quantity supplied
resulting from a small percentage increase in
price.
• Analogous to the elasticity of demand
– A unit-free measure of the responsiveness of supply
to a price change
– Defined as the percentage increase in quantity
supplied resulting from a small percentage increase in
price.
28. Supply and Demand Changes Learning
Objectives
• What are the effects of changes in supply
and demand on price and quantity?
• What is a useful approximation of these
changes?
29. When the price of a complement
changes…
• What happens to the equilibrium price and
quantity of the good?
• How much do the price and quantity traded
change in response to a change in demand?
• The equilibrium price p* is given determined at
the point where the quantity supplied equals to
the quantity demanded, or by the solution to the
equation:
qd(p*)=qs(p*)
