In this chapter, look for the answers to

Elasticity these questions:

What is elasticity? What kinds of issues
can elasticity help us understand?
What is the price elasticity of demand?
How is it related to the demand curve?
How is it related to revenue & expenditure?
What is the price elasticity of supply?
How is it related to the supply curve?
What are the income and cross-price
elasticities of demand?

Elasticity Outline
Elasticity measures how much one variable
I. Price elasticity of demand
responds to changes in another variable.
II. Cross price elasticity of demand
ex = %ΔQ / %ΔX
III. Income elasticity of demand
IV. Price elasticity of supply
Definition: Elasticity is a numerical
measure of the responsiveness of Qd or
Qs to one of its determinants.

Price elasticity of demand (ep) Price elasticity of demand (ep)

Price Percentage change in Qd
Price elasticity Percentage change in Qd =
elasticity of
of demand = Percentage change in P
Percentage change in P demand
Example: P rises P
Price elasticity of demand measures how Price by 10%
much Qd responds to a change in P. elasticity P2
of demand P1
equals D
15%
= 1.5 Q
10% Q2 Q1
Q falls
by 15%

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 Calculating Percentage Changes
Price elasticity of demand (ep)
Standard method
Price elasticity Percentage change in Qd
= Demand for of computing the
of demand Percentage change in P your percentage (%) change:
websites
Along a D curve, P and Q P
move in opposite directions, end value – start value
P x 100%
which would make price P2
start value
B
elasticity negative. $250
P1 Going from A to B,
We drop the minus sign and A
$200
report all price elasticities as
D the % change in P equals
D
positive numbers. Q
Q2 Q1
Q ($250–$200)/$200 = 25%
8 12

Calculating Percentage Changes Calculating Percentage Changes

Problem:
Demand for  So, we instead use the midpoint method:
your
The standard method gives
websites different answers end value – start value
depending on where you
x 100%
P midpoint
start.
$250
B  The midpoint is the number halfway
From A to B, P rises 25%,
A between the start & end values, also the
$200 Q falls 33%,
average of those values.
D elasticity = 33/25 = 1.33
Q From B to A, P falls 20%,
 It doesn’t matter which value you use as the
8 12 “start” and which as the “end” – you get the
Q rises 50%, elasticity = same answer either way!
50/20 = 2.50

Total Revenue
Calculating Percentage Changes
Price

• Using the midpoint method, the % change

in P equals Total revenue = P x Q

$250 – $200
x 100% = 22.2%
$225 $4

 The % change in Q equals

12 – 8 P × Q = $400
x 100% = 40.0% P
(revenue) Demand
10
 The price elasticity of demand equals
0 100 Quantity
40/22.2 = 1.8 Q

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 How Total Revenue Changes When Price Changes: How Total Revenue Changes When Price Changes:
Inelastic Demand Elastic Demand

An Increase in price … leads to an Increase in total

Price from $1 to $3 … Price revenue from $100 to $240 Price Price

An Increase in … leads to a decrease in

price from $4 total revenue from $200 to
to $5 … $100
$5

$4

$3 Demand
Demand

Revenue = $240 Revenue = $200 Revenue = $100

$1
Revenue = $100 Demand Demand

0 100 Quantity 0 80 Quantity

0 50 Quantity 0 20 Quantity

An increase in price leads to a decrease in An increase in the price leads to a decrease in quantity
quantity that is proportionately smaller: total demanded that is proportionately larger: total revenue
revenue increases. decreases.

Calculating Elasticity
Elasticity: A Units-Free Measure
• because the percentage change in a
Price elasticity of demand: %Q
e
variable is independent of the units in which %P
the variable is measured. Arc elasticity:
Q P
• Minus sign and elasticity: To compare e
elasticities, we use the magnitude of the P Q
price elasticity of demand and ignore the Point elasticity:

minus sign. dQ P
ep 
dP Q

Inelastic and Elastic Demand

Inelastic Demand: ep < 1
Elastic Demand: ep > 1
Unit Elastic: ep = 1
Perfectly Inelastic: ep = 0
 Perfectly Elastic: ep = ∞


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 Elasticity Along a Straight-Line
Inelastic and Elastic Demand
Demand Curve

Elasticity Along a Straight-Line Elasticity, Total Revenue, and

Demand Curve Expenditure

Q/P: constant $ ep >1 • When ep >1: P

ep = 1
The lower the average price, the greater is cuts → TR rises
the average quantity demanded. So the ep <1 • When ep = 1: P
D cuts → TR
lower the average price, the less elastic is Q
demand. $ M unchanged
Above the midpoint: elastic (ep > 1) R (midpoint of the
At the midpoint: unit elastic (ep = 1) demand curve)
TR • When ep <1: P
Below the midpoint: inelastic (ep < 1)
Q cuts → TR falls

The Factors that Influence the

Summary Table
Elasticity of Demand
1) The closeness of substitutes: The closer
Ed > 1 Ed < 1 Ed = 1 the substitutes for a good or service, the
more elastic is the demand for it.
Price Revenue Revenue Revenue
Increase falls rises constant  Necessity: has poor substitutes and
that is crucial for our well-being:
Price Revenue Revenue Revenue inelastic demand.
Decrease rises falls constant  Luxury: has many substitutes: elastic
demand.
•

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The Factors that Influence the The Factors that Influence the
Elasticity of Demand Elasticity of Demand
2) Proportion of Income Spent on the Good:
The degree of substitutability between
Other things remaining the same, the greater
two goods also depends on how narrowly
the proportion of income spent on a good,
(or broadly) we define them. More
the more elastic is the demand for it.
narrowly : more elastic
3) Time Elapsed Since Price Change: The
Note: What is a necessity and what is a
longer the time that has elapsed since a
luxury depend on the level of income: For
price change, the more elastic is demand.
people with a low income, food and
Why? given enough time, consumers can find
clothing can be luxuries.
out acceptable and less costly substitutes.

Cross (price) elasticity of demand

%Δ QD
eab =
%Δ P of a substitute or a complement

eab > 0 : substitute

eab < 0 : complement
eab = 0 : no relationship

Income Elasticity of Demand

Income Elasticity of Demand
eI> 0: normal good
a measure of the responsiveness of the demand for a
 eI > 1: normal good, income elastic
good or service to a change in income, other things
remaining the same.  0 < eI < 1: normal good, income
inelastic
%ΔQD  I< 0 : inferior good
e
eI =
%ΔI

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 Income Elasticity of Demand

Necessities: income inelastic

Examples: food, fuel, clothing, utilities,
and medical services.
Figure (a): eI > 1. As I increases, the QD increases, but QD
increases faster than income. Ex: ocean cruises, custom Luxuries: income elastic.
clothing, international travel, jewelry, and works of arts. Examples: sports cars, furs, and
Figure (b): 0 < eI < 1. In this case, the QD increases as I expensive foods.
increases but I increases faster than the QD. Ex: food,
clothing, furniture, newspapers, and magazines.
Figure (c): eI < 0. The eI is positive but less than 1 up to
income m. Beyond income m, the income elasticity of
demand is negative.

Elasticity of supply Elasticity of supply

measures the responsiveness of the Two extreme cases:
quantity supplied of a good to a change in  Supply curve is vertical: the elasticity of
its price. supply is zero, supply is perfectly inelastic.
%ΔQS  Supply curve is horizontal: the elasticity of
eS = supply is infinite, supply is perfectly elastic.
%ΔP

Resource Substitution Possibilities

Elasticity of supply
The magnitude of the elasticity of supply Some goods and services can be produced only by using
unique or rare productive resources: low, and perhaps a
depends on:
zero, elasticity of supply.
 Resource Substitution Possibilities
 Time Frame for the supply decisions

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 Portrait of Doctor Gachet của Van Gogh (82,5 triệu USD).

Elasticity of Supply and the Time Frame

for Supply Decisions

Momentary supply
Long-run supply
Short-run supply