Elasticity and Its Applications

UNIT 5

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 Elasticity...

...is a measure of how much buyers and

sellers respond to changes in market
conditions...
...allows us to analyse supply and demand
with greater precision.

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 Three Types of Elasticities

 Price elasticity of demand

 Income elasticity of demand
 Price elasticity of supply

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 Price Elasticity of Demand

 Price elasticity of demand is the

percentage change in quantity demanded
given a one percent change in the price.

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 Ranges of Elasticity

 Inelastic Demand
 Quantity demanded does not respond strongly
to price changes.
 Elastic Demand
 Quantity demanded responds strongly to
changes in price.

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 Ranges of Elasticity

 Perfectly Inelastic
 Quantity demanded does not respond to price
changes.
 Perfectly Elastic
 Quantity demanded changes infinitely with any
change in price.
 Unit Elastic
 Quantity demanded changes by the same
percentage as the price.

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 The Price Elasticity of
Demand: Perfectly Inelastic

Price
Demand

$5

4
1. An
increase
in price...

0 100 Quantity

2. ...leaves the quantity demanded unchanged.

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 The Price Elasticity of
Demand: Perfectly Elastic

Price

1. At any price
above $4, quantity
demanded is zero.

$4 Demand

2. At exactly $4,
consumers will
buy any quantity.

0 Quantity
3. At a price below $4,
quantity demanded is infinite.
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 The Price Elasticity of
Demand: Unit Elastic

Price

$5

4
1. A 12.5% Demand
increase
in price...

0 80 100 Quantity

2. ...leads to a 12.5% decrease in quantity demanded.

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 The Price Elasticity of
Demand: Elastic Demand
Price

$5

4 Demand
1. A 12.5%
increase
in price...

0 50 100 Quantity

2. ...leads to a 50% decrease in quantity demanded.

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 The Price Elasticity of
Demand: Inelastic Demand

Price

$6

4
1. A 25% Demand
increase
in price...

0 90 100 Quantity

2. ...leads to an 11% decrease in quantity demanded.

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 Determinants of
Price Elasticity of Demand

 Demand tends to be more elastic...

...if the good is a luxury.
... the longer the time period.
... the larger the number of close
substitutes.
...the more narrowly defined the market.

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 Determinants of
Price Elasticity of Demand

 Demand tends to be more inelastic...

...if the good is a necessity.
...the shorter the time period.
...the fewer the number of close
substitutes.
... the more broadly defined the market.

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 Computing the Price
Elasticity of Demand

 The price elasticity of demand is

computed as the percentage change in
the quantity demanded divided by the
percentage change in price.

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 Computing the Price
Elasticity of Demand

 The price elasticity of demand is

computed as the percentage change in
the quantity demanded divided by the
percentage change in price.

Percentage Change
in Quantity Demanded
Price Elasticity of Demand =
Percentage Change
in Price

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 Computing the Price
Elasticity of Demand

Price

110

90 Demand

0 160 240 Quantity

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 Computing the Price
Elasticity of Demand
A= P1 – 90 Q1 – 240
Price B= P1 – 110 Q2 – 160

110

90 Demand

0 160 240 Quantity

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 Elasticity and Total Revenue

 Total revenue is the amount paid by

buyers and received by sellers of a good.
 Computed as the price of the good times
the quantity sold.
TR = P X Q

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 Elasticity and Total Revenue

Price

$4

P X Q = $400
P
(total revenue) Demand

0 100 Quantity
Q
 Elasticity and Total Revenue

 With an elastic demand curve, an increase

in the price leads to a decrease in quantity
demanded that is proportionately larger.
Thus, total revenue decreases.

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 Elasticity and Total Revenue:
Elastic Demand

Price Price

$5
$4

Demand Demand
Revenue = $200 Revenue = $100

0 50 Quantity 0 20 Quantity

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 Elasticity and Total Revenue

 With an inelastic demand curve, an

increase in price leads to a decrease in
quantity that is proportionately smaller.
Thus, total revenue increases.

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 Elasticity and Total Revenue:
Inelastic Demand

Price Price

$3

Revenue = $240
$1
Revenue = $100 Demand Demand
0 100 Quantity 0 80 Quantity

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 Income Elasticity of Demand

 Income elasticity of demand measures

how much the quantity demanded of a
good responds to a change in consumers’
income.
 It is computed as the percentage change
in the quantity demanded divided by the
percentage change in income.

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 Computing Income Elasticity

Percentage Change in
Quantity Demanded
Income Elasticity of Demand=
Percentage Change
in Income

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 Income Elasticity... Types

 Higher income raises the quantity

demanded for normal goods but lowers
the quantity demanded for inferior goods.

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 Income Elasticity... Types

 Goods consumers regard as necessities

tend to be income inelastic.
 Examples include food, fuel, clothing, utilities,
and medical services.

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 Income Elasticity... Types

 Goods consumers regard as luxuries tend

to be income elastic.
 Examples include sports cars, furs, and
expensive foods.

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 Recap!

 Define the price

elasticity of
demand.

 Explain the
relationship
between total
revenue and
elasticity of
demand.

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 Price Elasticity of Supply

 Price elasticity of supply is the percentage

change in quantity supplied resulting from
a one percent change in price.

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 Ranges of Elasticity

 Perfectly Elastic
ES = 
 Relatively Elastic
ES > 1
 Unit Elastic
ES = 1

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 Ranges of Elasticity

 Relatively Inelastic
ES < 1
 Perfectly Inelastic
ES = 0

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 Price Elasticity of Supply:
Perfectly Inelastic Supply

Price
Supply

$5

1. An
increase
in price...

0 100 Quantity

2. ...leaves the quantity supplied unchanged.

 Price Elasticity of Supply:
Inelastic Supply

Price

$6

1. A larger%
increase
in price...

100 110 Quantity

2. ...leads to a 10% increase in quantity supplied.

 Price Elasticity of Supply:
Elastic Supply

Price

$5

1. A 12.5%
increase
in price...

100 200 Quantity

2. ...leads to a 50% increase in quantity supplied.

 Price Elasticity of Supply:
Perfectly Elastic Supply

Price
1. At any price
above $4, quantity
$5 supplied is infinite.

1. A 12.5%
2. At exactly $4,
increase
producers will
in price...
supply any quantity.

100 Quantity
3. At a price below $4,
quantity supplied is zero.
 Determinants of
Elasticity of Supply

 Ability of sellers to change the amount of

the good they produce.
 Beach-front land is inelastic.
 Books, cars, or manufactured goods are
elastic.
 Time period.
 Supply is more elastic in the long run.

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 Computing the Price
Elasticity of Supply

 The price elasticity of supply is computed

as the percentage change in the quantity
supplied divided by the percentage
change in price.

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 Computing the Price
Elasticity of Supply

 The price elasticity of supply is computed

as the percentage change in the quantity
supplied divided by the percentage
change in price.

P
er
cent
ag eChan
g ei
n
Quan
ti
tySu p
pl
ied
E
l
a s
ti
c i
tyo
fSu
ppl
y =
Per
cent
a g
e Cha
n g
e
inPri
c e

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 Recap!

 Define the elasticity

of supply.

 Explain why the

price elasticity of
supply might be
different in the long
run than the short
run.

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 Application of Elasticity

 Can good news for farming be bad news

for farmers?
 What happens to wheat farmers and the
market for wheat when university agronomists
discover a new wheat hybrid that is more
productive than existing varieties?

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 Application of Elasticity

 Examine whether the supply or demand

curve shifts.
 Determine the direction of the shift of the
curve.
 Use the supply-and-demand diagram to
see how the market equilibrium changes.

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An Increase in Supply in the
Market for Wheat
Price of
Wheat

S1

$3

Demand

0 100 Quantity of Wheat

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An Increase in Supply in the
Market for Wheat
Price of
Wheat 1. When demand is inelastic,
an increase in supply...
S1 S2

$3

Demand

0 100 Quantity of Wheat

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An Increase in Supply in the
Market for Wheat
Price of
Wheat 1. When demand is inelastic,
an increase in supply...
S1 S2

$3

Demand

0 100 110 Quantity of Wheat

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 An Increase in Supply in the
Market for Wheat
Price of
Wheat 1. When demand is inelastic,
an increase in supply...
S1 S2

2. ...leads $3
to a large
fall in 2
price...

Demand

0 100 110 Quantity of Wheat

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 An Increase in Supply in the
Market for Wheat
Price of
Wheat 1. When demand is inelastic,
an increase in supply...
S1 S2

2. ...leads $3
to a large
fall in 2
price...

Demand

0 100 110 Quantity of Wheat

3. ...and a proportionately smaller
increase
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in quantity sold. As a result,
revenue falls from $300 to $220.
Compute Elasticity

100 -110
ED = 100
3.00 - 2.00
3.00
-0.10
  -0.30
0.33

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Compute Elasticity

100 -110
ED = 100
3.00 - 2.00
3.00
-0.10
  -0.30
0.33
Demand is inelastic

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 Conclusion

 Price elasticity of demand measures how

much the quantity demanded responds to
changes in the price.
 If a demand curve is elastic, total revenue
falls when the price rises.
 If it is inelastic, total revenue rises as the
price rises.

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 Conclusion

 The price elasticity of supply measures

how much the quantity supplied responds
to changes in the price.
 In most markets, supply is more elastic in
the long run than in the short run.

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