N.

GREGORY MANKIW
PRINCIPLES OF

ECONOMICS
Eight Edition

CHAPTER Elasticity and Its

5 Application
Premium PowerPoint Slides by:
V. Andreea CHIRITESCU
Eastern Illinois University

A scenario:
• You design websites for local businesses.
– You charge $200 per website, and currently sell
12 websites per month.
• Your costs are rising (including the
opportunity cost of your time)
– You consider raising the price to $250.
• The law of demand: you won’t sell as many
websites if you raise your price.
– How many fewer websites?
– How much will your revenue fall, or might it
increase?
2

The Elasticity of Demand

• Elasticity
– Measure of …
• To a change in …
• Price elasticity of demand
– How much the quantity demanded of a
good responds to a change in the price of
that good
• Loosely speaking, it measures ….

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
1
 Price Elasticity of Demand
Price elasticity of demand =
P

P …
P1
D Along a D curve, P and Q
move in opposite directions,
Q which would make price
Q1
elasticity _____________.
Q …

We will drop the minus sign and report all price elasticities as positive
numbers.

Calculating Percentage Changes

Standard method of computing the
Demand for your
percentage (%) change:
websites
P
end value  start value
B  100%
$250 start value
A Going from A to B:
$200
• the % change in P = …
D
Q • the % change in Q = …
8 12 • Price elasticity = …
Going from B to A:
• the % change in P = …
• the % change in Q = … We get different values!
• Price elasticity = …
5

The Price Elasticity of Demand

• Midpoint method
– The midpoint is …

• The average of those values

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
2
 Calculating Percentage Changes
Demand for your websites
P
B
$250 Using the midpoint method of
A computing % changes:
$200
D % change in P =
Q
8 12
% change in Q =

Price elasticity =

Active Learning 1 Calculate an elasticity

Use the following information to calculate the
price elasticity of demand for iPhones:
• if P = $400, Qd = 10,600
• if P = $600, Qd = 8,400
• Use the midpoint method to calculate
percentage changes.

The Price Elasticity of Demand

• Determinants of price elasticity of demand
– We look at a series of examples comparing
two common goods
• In each example:
– Suppose prices of both goods rise by 20%
– Which good has the highest price elasticity
of demand? Why?
– What lesson we learn about the
determinants of price elasticity of demand?
9

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
3
 The Price Elasticity of Demand
Example 1: Breakfast cereal vs. Sunscreen
– Prices of both of these goods rise by 20%.
For which good does Qd drop the most?
Why?
•…

•…
• Price elasticity is higher when …

10

The Price Elasticity of Demand

Example 2: Blue Jeans vs. Clothing
– Prices of both of these goods rise by 20%.
For which good does Qd drop the most?
Why?
•…

Price elasticity is higher ...

11

The Price Elasticity of Demand

Example 3: Insulin vs. Yachts
– Prices of both of these goods rise by 20%.
For which good does Qd drop the most?
Why?
•…

•…

• Price elasticity is higher …

12

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed 4
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 The Price Elasticity of Demand
Example 4: Gasoline in the Short Run vs.
Gasoline in the Long Run
– The price of gasoline rises 20%. Does Qd
drop more in the short run or the long run?
Why?
• ...

• ...

• Price elasticity is higher …

13

The Price Elasticity of Demand

• Variety of demand curves
– Demand is elastic
• Price elasticity of demand …
– Demand is inelastic
• Price elasticity of demand …
– Demand has unit elasticity
• Price elasticity of demand …

14

The Price Elasticity of Demand

• Variety of demand curves
– Demand is perfectly inelastic
• Price elasticity of demand …
• Demand curve is …
– Demand is perfectly elastic
• Price elasticity of demand …
• Demand curve is …
• The flatter the demand curve
– The _____ the price elasticity of demand
15

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
5
 Perfectly inelastic demand

Price elasticity % change in Q

= =
of demand % change in P

P
D D curve
…
P1
Consumers’ price
sensitivity:
…
Q
Q1
Elasticity:
…
16

Inelastic demand

Price elasticity % change in Q

= =
of demand % change in P
P
D curve
P1 …

Consumers’ price
D sensitivity:
Q …
Q1
Elasticity:
…
17

Unit elastic demand

Price elasticity % change in Q

= =
of demand % change in P

P D curve
…
P1
Consumers’ price
D
sensitivity:
…
Q
Q1 Elasticity:
…

18

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 6
 Elastic demand

Price elasticity % change in Q

= =
of demand % change in P
P
D curve
P1 …

D Consumers’ price
sensitivity:
Q …
Q1
Elasticity:
…
19

Perfectly elastic demand

Price elasticity % change in Q

= =
of demand % change in P
P
D curve
…
P2 = P1 D

Consumers’ price
sensitivity:
…
Q
Q1
Elasticity:
…

20

A Few Elasticities from the Real World

21

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
7
 Elasticity along a Linear Demand Curve

P The slope of a
$30 linear demand
curve is constant,
but its elasticity
20 is not.

10

$0 Q
0 20 40 60

22

Price Elasticity and Total Revenue

Continuing our scenario, if you raise your
price from $200 to $250, would your revenue
rise or fall?
Total Revenue (TR) = P x Q
• A price increase has two effects on revenue:
–…
–…
• Which of these two effects is bigger?
– It depends on the price elasticity of demand

23

Price Elasticity and Total Revenue

• For a price increase, if demand is elastic
 E > 1: % change in Q > % change in P
 TR …

• For a price increase, if demand is

inelastic
 E < 1: % change in Q < % change in P
 TR …

24

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
8
 Price Elasticity and Total Revenue
Demand for your websites
Elastic demand
(elasticity = 1.8)
P
If P = $200, Q = 12,
and revenue = _____
$250
$200 If P = $250, Q = 8, and
D revenue = _____

When D is elastic,
Q a price increase
8 12
causes revenue to
___.
25

Price Elasticity and Total Revenue

Demand for your websites
Inelastic demand
(elasticity = 0.82)
P
If P = $200, Q = 12,
and revenue = _____
$250
$200 If P = $250, Q = 10,
and revenue = _____
D
When D is inelastic,
Q a price increase
10 12 causes revenue to
___.
26

Active Learning 2 Elasticity and revenue

A. Pharmacies raise the price of insulin by
10%.
– Does total expenditure on insulin rise or fall?

B. As a result of a fare war, the price of a

luxury cruise falls 20%.
– Does luxury cruise companies’ total revenue
rise or fall?

27

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
9
 Active Learning 2 Answers
A.

B.

28

Does Drug Interdiction Increase

or Decrease Drug-related Crime?
1. Increase the number of federal agents
devoted to the war on drugs
– Illegal drugs: supply curve shifts left
• Higher price and lower quantity
– Amount of drug-related crimes
• Inelastic demand for drugs
• Higher drugs price: higher total revenue
• Increase drug-related crime

29

Policy 1: Interdiction
Interdiction
reduces the Price of
supply of drugs. Drugs D1
S1
Demand for drugs is
inelastic: …
P1

Result: …
Q1 Quantity
of Drugs

30

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
10
 Does Drug Interdiction Increase
or Decrease Drug-related Crime?
2. Policy of drug education
– Reduce demand for illegal drugs
– Left shift of demand curve
– Lower quantity
– Lower price
– Reduce drug-related crime

31

Policy 2: Education
Education
reduces the Price of
demand for drugs. Drugs
D1
S
P and Q _____.

Result: P1
….

Q1 Quantity
of Drugs

32

The Price Elasticity of Supply

• Price elasticity of supply
–…

– Percentage change …
• Divided by …
– Loosely speaking, it measures sellers’
price-sensitivity

33

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
11
 Price Elasticity of Supply

Price elasticity percentage change in Q s

of supply   
percentage change in P

P
S

P1
Again, we use the
midpoint method to
Q
compute the Q1
percentage changes.

34

The Price Elasticity of Supply

• Variety of supply curves
– Supply is unit elastic
• Price elasticity of supply …
– Supply is elastic
• Price elasticity of supply …
– Supply is inelastic
• Price elasticity of supply …

35

The Price Elasticity of Supply

• Variety of supply curves
– Supply is perfectly inelastic
• Price elasticity of supply …
• Supply curve is …
– Supply is perfectly elastic
• Price elasticity of supply …
• Supply curve is …
• The flatter the supply curve
– The greater the price elasticity of supply
36

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
12
 Perfectly inelastic supply

Price elasticity % change in Q

= =
of supply % change in P
S curve:
P
… S

Sellers’ price
sensitivity: P1
…
Q
Elasticity: Q1
…

37

Inelastic supply

Price elasticity % change in Q

= =
of supply % change in P
S curve:
P
… S

Sellers’ price
sensitivity: P1
…

Elasticity: Q
Q1
…

38

Unit elastic supply

Price elasticity % change in Q

= =
of supply % change in P
S curve:
… P
S

Sellers’ price sensitivity:

.. P1

Elasticity:
… Q
Q1

39

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
13
 Elastic supply

Price elasticity % change in Q

= =
of supply % change in P
S curve:
P
…
S

Sellers’ price
sensitivity: P1
…
Q
Elasticity: Q1
…

40

Perfectly elastic supply

Price elasticity % change in Q

= =
of supply % change in P
S curve:
… P

Sellers’ price P2 = P1 S
sensitivity:
…

Elasticity: Q
Q1
…

41

The Determinants of Supply Elasticity

• Greater price elasticity of supply
–…

• Supply of beachfront property - harder to vary

and thus less elastic than supply of new cars
• Price elasticity of supply is greater in the
…
– In the long run: firms can build new factories,
or new firms may be able to enter the market

42

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed 14
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Active Learning 3
Elasticity and changes in equilibrium
The supply of beachfront property is inelastic.
The supply of new cars is elastic.
Suppose population growth causes demand
for both goods to double (at each price, Qd
doubles).

• For which product will P change the most?

• For which product will Q change the most?

43

Active Learning 3 Answers

Beachfront property
When supply is (inelastic supply):
inelastic, ... P

D1 D2

44

Active Learning 3 Answers

New cars
When supply (elastic supply):
is elastic, P
... D1 D2

45

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
15
 How the Price Elasticity of Supply Can Vary

Price Supply
Supply often
$15
becomes less
12 elastic as Q …

4
3

0 100 200 500 525 Quantity

46

Other Elasticities of Demand

• Income elasticity of demand
–…

– Percentage change in …
• Divided by the …
– Normal goods: income elasticity _____
– Inferior goods: income elasticity _____

47

Other Elasticities of Demand

• Cross-price elasticity of demand
–…

– Percentage change in ….
• Divided by the percentage change in ….

– Substitutes: cross-price elasticity _____

– Complements: cross-price elasticity ____

48

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
16
 Applications
• Can Good News for Farming Be Bad
News for Farmers?
– New hybrid of wheat – increase
production per acre 20%
• Supply curve shifts to the _____
• ______ quantity and ______ price
• Demand is ______: total revenue ______
– Paradox of public policy: induce farmers
not to plant crops

49

An Increase in Supply in the Market for Wheat

Price of
Wheat
S1

$3

Demand
0 100 Quantity of Wheat

50

Applications
• Why Did OPEC Fail to Keep the Price of
Oil High?
– Increase in prices 1973-1974, 1971-1981
– Short-run: supply and demand are
_______
• Decrease in supply: ______________in price
– Long-run: supply and demand are ______
• Decrease in supply: ____________in price

51

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
17
 A Reduction in Supply in the World Market for Oil

(a) The Oil Market in the Short Run (b) The Oil Market in the Long Run

Price
Price

S1
S1

P1 P1

Demand Demand

0 Quantity 0 Quantity

52

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed 18
with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.