What is the definition of elasticity?

What is the meaning and

importance of:
 price elasticity of demand?
WHAT YOU  Cross-price elasticity of demand?
WILL LEARN  income elasticity of demand?
IN THIS  price elasticity of supply?
CHAPTER What factors influence the size of
these various elasticities?
How the cross-price elasticity of
demand measures the
responsiveness of demand for one
good to changes in the price of
another good 1
ELASTICITY . . .
 … allows us to analyze supply and demand with
greater precision.

 … is a measure of how much buyers and sellers

respond to changes in market conditions

2
DEFINING AND MEASURING PRICE ELASTICITY OF
DEMAND

 Price elasticity of demand is a measure of

how much the quantity demanded of a good
responds to a change in the price of that
good.

3
DEFINING AND MEASURING PRICE
ELASTICITY OF DEMAND

 The price elasticity of demand is the

ratio of the percent change in the quantity
demanded to the percent change in the
price as we move along the demand curve.

%DQD
PED =
%D P
4
DEFINING AND MEASURING PRICE
ELASTICITY OF DEMAND

 Two methods calculating price

elasticity of demand
- Point elasticity
- Arc elasticity

5
POINT ELASTICITY

 This method is applied when change

in price is relatively small.
 Percentage changes in price and
quantity demanded is calculated
with respect to the initial levels.

6
POINT ELASTICITY OF DEMAND

7
 8

POINT ELASTICITY

%DQD DQD P
PED = = ´
%D P DP QD
P
Þ PED = QD¢ ´
QD
 9

POINT ELASTICITY

 If demand function is QD = aP+ b

P
PED = a ´
QD
ARC ELASTICITY - THE MIDPOINT METHOD

The midpoint method is a technique

for calculating the percent change. In
this approach, we calculate changes in
a variable compared with the average,
or midpoint, of the starting and final
values.
10
USING THE MIDPOINT METHOD

11
USING THE MIDPOINT METHOD

12
SOME ESTIMATED PRICE ELASTICITIES OF DEMAND

Good Price Elasticity

Inelastic demand

 Eggs 0.1
 Beef 0.4
Price elasticity of
 Stationery 0.5
demand < 1
 Gasoline 0.5

Elastic demand

 Housing 1.2
 Restaurant meals 2.3
 Airline travel 2.4 Price elasticity of
 Foreign travel 4.1 demand > 1

13
 14
CASES OF PRICE ELASTICITY OF
DEMAND
 |E| < 1: Relatively inelastic demand.
Quantity demanded does not respond
strongly to price change
 Consumers are relatively price-insensitive
 |E| > 1: Relatively elastic demand

Quantity demanded responds strongly to

price change
 Consumers are relatively price-sensitive
 |E| = 1: Unit elastic demand

Nguyễn Thị Minh Thư 3/30/2020

INTERPRETING THE PRICE ELASTICITY OF DEMAND

Two Extreme Cases of Price Elasticity of

Demand

 Demand is perfectly inelastic when the quantity

demanded does not respond at all to changes in the
price.
When demand is perfectly inelastic, the demand
curve is a vertical line.

 Demand is perfectly elastic when any price

increase will cause the quantity demanded to drop to
zero.
When demand is perfectly elastic, the demand curve
is a horizontal line.
15
 UNIT ELASTICITY OF DEMAND
(a) Unit-Elastic Demand: Price Elasticity of Demand = 1

Price of bridge crossing

B
A 20% $1.10
A
increase in
0.90
the price . . .

D1

0 900 1,100
Quantity of bridge
crossings (per day)
. . . generates a 20% decrease in 16
the quantity of crossings
demanded.
INELASTIC DEMAND
(b) Inelastic Demand: Price Elasticity of Demand = 0.5

Price of bridge crossing

B
A 20% $1.10
increase in A
the price . . . 0.90

D
2
0 950 1,050 Quantity of bridge
crossings (per day)
17
. . . generates a 10% decrease in the
quantity of crossings demanded.
ELASTIC DEMAND
(c) Elastic Demand: Price Elasticity of Demand = 2
Price of bridge crossing

B
A 20% increase $1.10
A
in the price . . . 0.90

D
3

0 800 1,200
Quantity of bridge
crossings (per day)
… generates a 40% 18
decrease in the quantity of
crossings demanded.
CASES OF PRICE ELASTICITY OF DEMAND
Perfectly Inelastic Demand:
Price Elasticity of Demand = 0
Price )

D
1

$3
An increase in
price…
$2
… leaves the quantity
demanded unchanged.

0 1
Quantity)
19
 TWO EXTREME CASES OF PRICE ELASTICITY OF DEMAND

Price Elastic Demand: Price Elasticity of Demand = ∞

Price

At exactly P*,
At any price above P*, consumers
quantity demanded is will buy any
zero quantity

P* D
2

At any price below

P*, quantity
demanded is infinite

0 Quantity

20
RULE OF THUMB

 The flatter the demand curve that passes

through a given point, the greater the
price elasticity of demand.

 The steeper the demand curve that passes

through a given point, the smaller the
price elasticity of demand
21
 22

SLOPE VS. ELASTICITY

P
EA= ∞
A
|E| >1

|EM|= 1
M
|E| < 1

EB= 0

0 B
Q

Nguyễn Thị Minh Thư 3/30/2020

THE PRICE ELASTICITY OF DEMAND
AND ITS DETERMINANTS

 Availability of Close Substitutes

 Necessities versus Luxuries

 Definition of the Market

 Time Horizon

23
THE PRICE ELASTICITY OF DEMAND
AND ITS DETERMINANTS

 Demand tends to be more elastic :

 the larger the number of close substitutes.
 if the good is a luxury.
 the more narrowly defined the market.
 the longer the time period if the good is
non-durable.
 The shorter the time period if the good is
durable.
HOW MAD?

25
WHY DOES ELASTICIY MATTER?

 Because this classification predicts how changes

in the price of a good will affect the total revenue
earned by producers from the sale of that good.
 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:
Total Revenue = Price × Quantity Sold

26
TOTAL REVENUE BY AREA
Price

P0

Total revenue =
price x quantity
D

0 Q0 27
Quantity
 ELASTICITY AND TOTAL REVENUE

When a seller raises the price of a good, there are two

countervailing effects in action (except in the rare case of
a good with perfectly elastic or perfectly inelastic
demand):

 A price effect: After a price increase, each unit sold sells

at a higher price, which tends to raise revenue.

 A quantity effect: After a price increase, fewer units are

sold, which tends to lower revenue.

28
ELASTICITY AND TOTAL REVENUE
 TR =P✕Q
TR’(P) = Q’.P + P’.Q
TR’(P) = Q. (1+ Q’.P/Q)
TR’(P) = Q(1 + E)
 Demand is unit-elastic : |E| = 1
E = -1
TR’ = 0
TR is max 29
ELASTICITY AND TOTAL REVENUE
 Demand is relatively inelastic: |E|
<1
TR’(P) >0
 TR is increasing
An increase in price leads to an
increase in total revenue.

30
ELASTICITY AND TOTAL REVENUE
 Demand is relatively elastic: |E| >1
TR’(P)<0
 TR is decreasing
An increase in price generates a
decrease in total revenue.

31
Other Demand Elasticities: Cross-Price
Elasticity
 The cross-price elasticity of demand between two
goods measures the effect of the change in one
good’s price on the quantity demanded of the other
good.

 It is equal to the percent change in the quantity

demanded of one good divided by the percent
change in the other good’s price.

The Cross-Price Elasticity of Demand

between Goods A and B
32
CROSS-PRICE ELASTICITY

 Goods are substitutes when the cross-

price elasticity of demand is positive.

 Goods are complements when the

cross-price elasticity of demand is
negative.

33
THE INCOME ELASTICITY OF DEMAND

 The income elasticity of demand is the

percent change in the quantity of a good
demanded when a consumer’s income
changes divided by the percent change in the
consumer’s income.

34
NORMAL GOODS AND INFERIOR GOODS

 When the income elasticity of demand is positive, the

good is a normal good; that is, the quantity
demanded at any given price increases as income
increases.

 When the income elasticity of demand is negative,

the good is an inferior good; that is, the quantity
demanded at any given price decreases as income
increases.

35
 MEASURING THE PRICE ELASTICITY OF SUPPLY

 The price elasticity of supply is a measure of the

responsiveness of the quantity of a good supplied to the
price of that good.
 It is the ratio of the percent change in the quantity
supplied to the percent change in the price as we move
along the supply curve.

36
TWO EXTREME CASES OF PRICE ELASTICITY OF SUPPLY

(a) Perfectly Inelastic Supply:

Price Elasticity of Supply = 0

Price of cell phone frequency

S
1

$3,000
An increase in price…
2,000 … leaves the quantity
supplied unchanged

0 100
Quantity of cell
phone frequencies

37
TWO EXTREME CASES OF PRICE ELASTICITY OF SUPPLY

(b) Perfectly Elastic Supply: Price

Elasticity of Supply = ∞

Price of
pizza

At exactly $12,
At any price above $12,
producers will
quantity supplied is
produce any
infinite
quantity
$12 S2

At any price below $12,

quantity supplied is zero

0
Quantity of pizzas

38
 TWO EXTREME CASES OF PRICE ELASTICITY OF
SUPPLY

 There is perfectly inelastic supply when the price

elasticity of supply is zero, so that changes in the price of
the good have no effect on the quantity supplied. A
perfectly inelastic supply curve is a vertical line.

 There is perfectly elastic supply when even a tiny

increase or reduction in the price will lead to very large
changes in the quantity supplied, so that the price
elasticity of supply is infinite. A perfectly elastic supply
curve is a horizontal line.

39
WHAT FACTORS DETERMINE THE PRICE ELASTICITY OF SUPPLY?

 The Availability of Inputs: The price elasticity of

supply tends to be large when inputs are readily
available and can be shifted into and out of
production at a relatively low cost. It tends to be
small when inputs are difficult to obtain.

 Time: The price elasticity of supply tends to grow

larger as producers have more time to respond to a
price change. This means that the long-run price
elasticity of supply is often higher than the short-run
elasticity.

40
SUMMARY

1. Elasticity is a general measure of

responsiveness that can be used to answer such
questions.

2. The price elasticity of demand—the percent

change in the quantity demanded divided by the
percent change in the price (dropping the minus
sign)—is a measure of the responsiveness of the
quantity demanded to changes in the price.

41
SUMMARY

3. The responsiveness of the quantity demanded to

price can range from perfectly inelastic
demand, where the quantity demanded is
unaffected by the price, to perfectly elastic
demand, where there is a unique price at which
consumers will buy as much or as little as they are
offered.

When demand is perfectly inelastic, the demand

curve is a vertical line; when it is perfectly elastic,
the demand curve is a horizontal line.

42
SUMMARY

4. The price elasticity of demand is classified

according to whether it is more or less than 1. If it
is greater than 1, demand is elastic; if it is less
than 1, demand is inelastic; if it is exactly 1,
demand is unit-elastic. This classification
determines how total revenue, the total value of
sales, changes when the price changes.

5. The price elasticity of demand depends on whether

there are close substitutes for the good, whether
the good is a necessity or a luxury, the share of
income spent on the good, and the length of time
that has elapsed since the price change.
43
SUMMARY

6. The cross-price elasticity of demand measures

the effect of a change in one good’s price on the
quantity of another good demanded.

7. The income elasticity of demand is the percent

change in the quantity of a good demanded when
a consumer’s income changes divided by the
percent change in income. If the income elasticity
is greater than 1, a good is income elastic; if it is
positive and less than 1, the good is income-
inelastic.

44
SUMMARY
8. The price elasticity of supply is the percent
change in the quantity of a good supplied divided
by the percent change in the price. If the quantity
supplied does not change at all, we have an
instance of perfectly inelastic supply; the
supply curve is a vertical line. If the quantity
supplied is zero below some price but infinite
above that price, we have an instance of perfectly
elastic supply; the supply curve is a horizontal
line.

9. The price elasticity of supply depends on (1) the

availability of resources to expand production, and
(2) time. It is higher when inputs are available at
relatively low cost and the longer it has been since
45
the price change.
KEY TERMS

 Price elasticity of  Income elasticity of

demand demand
 Midpoint method  Income-elastic demand

 Perfectly inelastic  Income-inelastic demand

demand  Price elasticity of supply
 Perfectly elastic demand  Perfectly inelastic supply
 Elastic demand  Perfectly elastic supply
 Inelastic demand

 Unit-elastic demand

 Total revenue

 Cross-price elasticity of
demand 46