Elasticity

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After studying this chapter you will be able to

 Define, calculate, and explain the factors that influence

the price elasticity of demand
 Define, calculate, and explain the factors that influence
the cross elasticity of demand and the income elasticity
of demand
 Define, calculate, and explain the factors that influence
the elasticity of supply

2
Price Elasticity of Demand

In Figure 4.1(a), an

increase in supply
brings
 A large fall in price
 A small increase in the
quantity demanded

3
Price Elasticity of Demand
In Figure 4.1(b), an
increase in supply
brings
 A small fall in price
 A large increase in
the quantity
demanded

4
Price Elasticity of Demand
The contrast between the two outcomes in Figure 4.1
highlights the need for
 A measure of the responsiveness of the quantity
demanded to a price change.
The price elasticity of demand is a units-free
measure of the responsiveness of the quantity
demanded of a good to a change in its price when all
other influences on buying plans remain the same.

5
Price Elasticity of Demand
 Calculating Price Elasticity of Demand
The price elasticity of demand is calculated by using
the formula:
Percentage change in quantity demanded
Percentage change in price

1STEasy
formula [Link] D
ed
tap

6
Price Elasticity of Demand
To calculate the price elasticity of demand:
We express the change in price as a percentage of the
average price—the average of the initial and new price,
and we express the change in the quantity demanded as
a percentage of the average quantity demanded—the
average of the initial and new quantity.
2nd formula
A QD
ed
Qarg
AP
Pang 7
 I

Price Elasticity of Demand

Figure 4.2 calculates
the price elasticity of
demand for pizza.
The price initially is
$20.50 and the
quantity demanded is
9 pizzas an hour.

8
Price Elasticity of Demand
The price falls to
$19.50 and the quantity
demanded increases to
11 pizzas an hour.

The price falls by $1 and

the quantity demanded
increases by 2 pizzas an
hour.
DQD
100
Qarg 8.100
APD 100 100
20
pay 4 9
Price Elasticity of Demand
The average price is
$20 and the average
quantity demanded
is 10 pizzas an hour.

10
Price Elasticity
The percentage
of Demand
change in quantity
demanded, %DQ, is
calculated as
DQ/Qave x 100, which is
(2/10) x 100 = 20%.
The percentage
change in price, %DP,
is calculated as DP/Pave
x 100, which is
 ($1/$20) x 100 = 5%.

11
Price Elasticity of Demand
The price elasticity of
demand is
%DQ / %DP = 20% /
5%
 = 4.

12
Price Elasticity of Demand
Average Price and Quantity
By using the average price and average quantity, we get
the same elasticity value regardless of whether the price
rises or falls.
Percentages and Proportions
The ratio of two proportionate changes is the same as
the ratio of two percentage changes.
%DQ / %DP = (DQ/Qav) / (DP/Pav)

T
Formulal T
Formula 2

13
Price Elasticity of Demand
A Units-Free Measure
Elasticity is a ratio of percentages, so a change the units
of measurement of price or quantity leaves the elasticity
value the same.
Minus Sign and Elasticity
The formula yields a negative value, because price and
quantity move in opposite directions.
But it is the magnitude, or absolute value, that reveals
how responsive the quantity change has been to a price
change.
No units or
negativesigns

in elastic unit 14
Deman c
inelastic or elastic
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cross of demand ec
elasticity
I DQp
complimentary
or
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goods good

signs sign
tags
DP
complimentarygood

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IDP substitute
good
Price Elasticity of Demand
edh ed ed

t
 Inelastic and Elastic Demand t t
Demand can be inelastic, unit elastic, or elastic, and
can range from zero to infinity.
If the quantity demanded doesn’t change when the
price changes, the price elasticity of demand is zero and
the good has a perfectly inelastic demand.
T ed O

15
Price Elasticity of Demand
inelastic
Figure 4.3(a) Perfectly
illustrates the case of a
good that has a
ed O
perfectly inelastic
demand.
The demand curve is
vertical.

16
Price Elasticity of Demand
unit elastic
If the percentage
change in the quantity
demanded equals the
percentage change in
price, the price elasticity
of demand equals 1 and
the good has unit
elastic demand.
Figure 4.3(b) illustrates
this case.

17
Price Elasticity of Demand
If the percentage change in the quantity demanded is
smaller than the percentage change in price,
the price elasticity of demand is less than 1 and the
good has inelastic demand. eds l
If the percentage change in the quantity demanded is
greater than the percentage change in price,
the price elasticity of demand is greater than 1 and the
good has elastic demand.
ed 21

18
Price Elasticity of Demand
DR Pt
If the percentage change barely
Elastic demand no
in the quantity demanded
is infinitely large when
elastic
the price barely changes, Perfectly
…
the price elasticity of
demand is infinite and
the good has a perfectly
elastic demand.
Figure 4.3(c) illustrates
the case of perfectly
elastic demand—a
horizontal demand curve.

19
Price Elasticity of Demand
 Elasticity Along a
Linear Demand
Curve
Figure 4.4 shows
how the elasticity
of demand changes
along a linear
demand curve.
een
At the mid-point
of the demand
curve, demand is
unit elastic.

20
Price Elasticity of Demand

At prices above

the mid-point of
the demand curve,
inelastic
demand is elastic.

At prices below the

mid-point of the
demand curve,
demand is inelastic.

21
Price Elasticity of Demand
Pi 25 P2215
Q p 2 20
For example, if the price
78.100
falls from $25 to $15, the 4
quantity demanded 0100
increases from 0 to 20
pizzas an hour.
The average price is $20 unit elastic
and the average quantity 801
is 10 pizzas.
The price elasticity of
demand is
(20/10)/(10/20), which
equals 4.
22
Price Elasticity of Demand
Pa O
Pi 10
Q 30 92 50
If the price falls from
$10 to $0, the quantity 290
244
demanded increases
from 30 to 50 pizzas
an hour.
The average price is
$5 and the average
quantity is 40 pizzas.
The price elasticity is
(20/40)/(10/5), which
equals 1/4.

23
Price Elasticity of Demand
Pa 10
If the price falls
from $15 to $10, the
If 2 30

É
quantity demanded
increases from 20 to
30 pizzas an hour.
The average price is
$12.50 and the
average quantity is 25
pizzas.
The price elasticity
is (10/25)/(5/12.5),
which equals 1.

24
Price Elasticity of Demand
 Total Revenue and Elasticity
The total revenue from the sale of good or service
equals the price of the good multiplied by the quantity
sold.
When the price changes, total revenue also changes.
But a rise in price doesn’t always increase total revenue.

Revenue x
price quantitysold

25
Price Elasticity of Demand
The change in total revenue due to a change in price
depends on the elasticity of demand:
 If demand is elastic, a 1 percent price cut increases
the quantity sold by more than 1 percent, and total
revenue increases.
 If demand is inelastic, a 1 percent price cut increases
the quantity sold by less than 1 percent, and total
revenues decreases.
 If demand is unit elastic, a 1 percent price cut increases
the quantity sold by 1 percent, and total revenue
remains unchanged.

26
Price Elasticity of Demand
The total revenue test is a method of estimating the
price elasticity of demand by observing the change in
total revenue that results from a price change (when all
other influences on the quantity sold remain the same).
 If a price cut increases total revenue, demand is
elastic.
 If a price cut decreases total revenue, demand is inelastic.
 If a price cut leaves total revenue unchanged, demand is
unit elastic.

27
Price Elasticity of Demand
Figure 4.5 shows the
relationship between
ed
elasticity of demand and yn
the total revenue.
As the price falls from
$25 to $12.50, the quantity
demanded increases
from 0 to 25 pizzas.
Demand is elastic, and
total revenue increases.

28
Price Elasticity of Demand
In part (b), as the
quantity increases from
0 to 25 pizzas, demand
is elastic, and total
revenue increases.

29
Price Elasticity of Demand
At $12.50, demand
is unit elastic and
total revenue stops
increasing.

total revenue
At unit elastic
is at its maximum

30
Price Elasticity of Demand
At 25, demand is unit
elastic, and total
revenue is at its
maximum.

31
Price Elasticity of Demand
As the price falls from
$12.50 to zero, the
quantity demanded
increases from 25 to 50
pizzas.

Demand is inelastic, and

total revenue decreases.

32
Price Elasticity of Demand ed l
As the quantity increases
from 25 to 50 pizzas,
demand is inelastic, and
total revenue decreases. ed l

east

33
 Price Elasticity of Demand PU
 Your Expenditure and Your Elasticity total ve v T
f
ed  If your demand is elastic, a 1 percent price cut increases
the quantity you buy by more than 1 percent and your
expenditure on the item increases. total very PI
f
del  If your demand is inelastic, a 1 percent price cut increases
the quantity you buy by less than 1 percent and your
expenditure on the item decreases.
edel  If your demand is unit elastic, a 1 percent price cut
increases the quantity you buy by 1 percent and yourPd
expenditure on the item does not change. total rev doesnot
change
Lomax
34
Price Elasticity of Demand
 The Factors That Influence the Elasticity of Demand
 The elasticity of demand for a good depends on:
 The closeness of substitutes
 The proportion of income spent on the good
 The time elapsed since a price change
Income of demand
elasticity
FAQD
IS income

ei I demand is income elastic and it is a 35

 normal
good
I demand is income inelastic and it
Osei
normal
is a
good
its inferior
is O
an
good
price of
elasticity supply
the
Through origin 8 01 4
p 7
Pa 16 92 8
G

g
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4 8 Q

Unit elastic
supply
Hits the vertical axis

P 15 Qi 10
0 9
i
5
g 72 20 92 20
Oo I I
1 1
10
i i 15 205
I
0 10 20
Fs
Elastic
supply
 I y
Hits the horizontal axis

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Pa 15 92 7
i
is i i
t
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s i iI gI
i Is
5 67
Inelastic 93
supply
inelastic
Perfectly
p supply
s

Q
elastic
Perfectly
p supply

s
 Q
Three factors that can influence
of demand
elasticity the closer the
Closeness of substitutes
substitutes the more elastic
the
Proportion of income
spent greater
of income on a
proportion
of
spent goo
the demand
larger elasticity more time
Time elapsed since price
change
have to to a ch
consumers
adjust pricethe any
be stored
or the food can
longer larger
the
elasticity
Cross of demand
elasticity
TD QD
IDP compliment or substitute
For substitute
a
positive
For a
compliment negative
Two factors that influence the
of
elasticity
supply substitution the easier it is to
Resource
resources used to

prod elasticity
ce
substitute
among
the the
good greater
Time frame for decision the
time that
supply after a
more

the
passes
is the
priceof
change greater elasticity
supply
Price Elasticity of Demand
Closeness of Substitutes
The closer the substitutes for a good or service, the
more elastic are the demand for the good or service.
Necessities, such as food or housing, generally have
inelastic demand.
Luxuries, such as exotic vacations, generally have
elastic demand.

36
Price Elasticity of Demand
Proportion of Income Spent on the Good
The greater the proportion of income consumers spend
on a good, the larger is the elasticity of demand for that
good.
Time Elapsed Since Price Change
The more time consumers have to adjust to a price
change, or the longer that a good can be stored without
losing its value, the more elastic is the demand for that
good.

37
More Elasticities of Demand
 Cross Elasticity of Demand
The cross elasticity of demand is a measure of the
responsiveness of demand for a good to a change in the
price of a substitute or a complement, other things
remaining the same.
The formula for calculating the cross elasticity is:
Percentage change in quantity demanded
Percentage change in price of substitute or complement

38
More Elasticities of Demand
 The cross elasticity of demand for
 a substitute is positive.
 a complement is negative.

39
More Elasticities of Demand
Figure 4.6 shows the
increase in the
quantity of pizza
demanded when the
price of burger (a
substitute for pizza)
rises.
The figure also shows the
decrease in the quantity of
pizza demanded when the
price of a soft drink (a
complement of pizza)
rises.

40
More Elasticities of Demand
 Income Elasticity of Demand
The income elasticity of demand measures how the
quantity demanded of a good responds to a change in
income, other things remaining the same.
The formula for calculating the income elasticity of
demand is:
Percentage change in quantity demanded
Percentage change in income

41
More Elasticities of Demand
If the income elasticity of demand is greater than 1,
demand is income elastic and the good is a normal good.
If the income elasticity of demand is greater than zero
but less than 1, demand is income inelastic and the good
is a normal good.
If the income elasticity of demand is less than zero
(negative) the good is an inferior good.

42
Elasticity of Supply
When demand
increases, is the change
in the quantity supplied
small or large?
In Figure 4.7(a), an
increase in demand
brings
 A large rise in price
 A small increase in
the quantity
supplied

43
Elasticity of Supply
In Figure 4.7(b), an
increase in demand
brings
 A small rise in price
 A large increase in
the quantity supplied

44
Elasticity of Supply
The contrast between the two outcomes in Figure 4.7
highlights the need for
 A measure of the responsiveness of the quantity
supplied to a price change.
The elasticity of supply measures the responsiveness
of the quantity supplied to a change in the price of a
good when all other influences on selling plans remain
the same.

Copyright © 2013 Pearson Canada Inc., Toronto, Ontario 45

Elasticity of Supply
Calculating the Elasticity of Supply
The elasticity of supply is calculated by using the
formula:
Percentage change in quantity supplied
Percentage change in price

46
Elasticity of Supply
Figure 4.8 on the next slide shows three cases of the
elasticity of supply.
Supply is perfectly inelastic if the supply curve is
vertical and the elasticity of supply is 0.
Supply is unit elastic if the supply curve is linear and
passes through the origin. (Note that slope is irrelevant.)
Supply is perfectly elastic if the supply curve is
horizontal and the elasticity of supply is infinite.

47
Elasticity of Supply

48
Elasticity of Supply
 The Factors That Influence the Elasticity of Supply
The elasticity of supply depends on
 Resource substitution possibilities
 Time frame for supply decision
Resource Substitution Possibilities
The easier it is to substitute among the resources used
to produce a good or service, the greater is its elasticity
of supply.

49
Elasticity of Supply
Time Frame for Supply Decision
The more time that passes after a price change, the
greater is the elasticity of supply.
Momentary supply is perfectly inelastic. The quantity
supplied immediately following a price change is
constant.

Demand p 16
0.29 80
9d sp
10 4 0
Supply iq qs 10p 40
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eq 0.29 q
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equilibrium which one demand or

is more elastic
supply
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a
change price change