5/6/2023

CHAPTER 3: ELASTICITY

1. Elasticity of demand
2. Elasticity of supply
3. Applications

1. Elasticity of Demand
1.1. Price elasticity of demand
1.2. Cross elasticity of demand
1.3. Income elasticity of demand

1.1. Price elasticity of demand

• Price elasticity of demand (Edp) measures how much Qd

responds to a change in P.
• The percentage change in quantity demanded resulting
from 1% change in price.
• Loosely speaking, it measures the price-sensitivity of
buyers’ demand.

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Calculating Edp

• Standard method;
• Midpoint method.

Standard method
% change in Qd
Edp =
% change in

Midpoint method
Edp = %%change in Qd
change in

% change = (end value – start value/midpoint) x 100%

Note: Ed < 0, |Ed|

The Determinants of Price Elasticity

• The extent to which close substitutes are available

• Whether the good is a necessity or a luxury
• How broadly or narrowly the good is defined
• The time horizon—elasticity is higher in the long run
than the short run

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“Perfectly inelastic demand” (one extreme case)

Price elasticity % change in Q 0%
= = =0
of demand % change in P 10%

D curve: P
D
vertical
P1
Consumers’
price sensitivity: P2
none
P falls Q
Elasticity: by 10% Q1
0 Q changes
by 0%

“Inelastic demand”
Price elasticity % change in Q < 10%
= = <1
of demand % change in P 10%

D curve: P
relatively steep
P1
Consumers’
price sensitivity: P2
relatively low D
P falls Q
Elasticity: by 10% Q1 Q2
<1
Q rises less
than 10%

“Unit elastic demand”

Price elasticity % change in Q 10%
= = =1
of demand % change in P 10%

D curve: P
intermediate slope
P1
Consumers’
price sensitivity: P2
intermediate D

P falls Q
Elasticity: by 10% Q1 Q2
1
Q rises by 10%

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“Elastic demand”
Price elasticity % change in Q > 10%
= = >1
of demand % change in P 10%

D curve: P
relatively flat
P1
Consumers’
price sensitivity: P2 D
relatively high
P falls Q
Elasticity: by 10% Q1 Q2
>1
Q rises more
than 10%

“Perfectly elastic demand” (the other extreme)

Price elasticity % change in Q any %
= = = infinity
of demand % change in P 0%

D curve: P
horizontal
P2 = P1 D
Consumers’
price sensitivity:
extreme
P changes Q
Elasticity: by 0% Q1 Q2
infinity
Q changes
by any %

The flatter the D curve, the higher price -

The Variety of Demand Curves sensitivity of consumers

• The price elasticity of demand is closely related to the slope of the

demand curve.
Price elasticity is higher in the long run than the
• Rule of thumb: short run
The flatter the curve, the greater the elasticity.
The steeper the curve, the smaller the elasticity.

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The Variety of Demand Curves

5 classifications of D curve:
• |Ed| = 0: Perfectly Inelastic;
• |Ed| <1: Inelastic;
• |Ed| = 1: Unit elastic;
• |Ed| > 1: Elastic;
• |Ed| = ∞ : Perfectly elastic.

Edp and Total Revenue

Total revenue - TR: the amount paid by buyers

and received by sellers of a good.
TR = P x Q

Edp and Total Revenue

Ex: P = 4$, Qd = 100 units

TR = 4 x 100 = 400

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Edp and Total Revenue

|Ed| < 1: P rises  TR rises

At

At

Edp and Total Revenue

|Ed| > 1: P falls  TR falls

1.2. Cross elasticity of demand

Cross-price elasticity of demand: measures the response of
demand for one good to changes in the price of another good

Cross-price elast. % change in Qd for good 1

=
of demand % change in price of good 2

Ex: Edx,y = 1,5  PY changes by 1%, QdX changes by1,5%

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1.2. Cross elasticity of demand

For substitutes, cross-price elasticity > 0 (e.g., an
increase in price of beef causes an increase in demand for
chicken)

For complements, cross-price elasticity < 0 (e.g., an

increase in price of computers causes decrease in demand
for software)

1.3. Income elasticity of demand

Income elasticity of demand: measures the
response of Qd to a change in consumer income.

Income elasticity Percent change in Qd

=
of demand Percent change in income

For normal goods, income elasticity > 0.

For inferior goods, income elasticity < 0.

2. Elasticity of supply
• Price elasticity of supply measures how much
Qs responds to a change in P.
• The percentage change in quantity supplied
resulting from 1% change in price.
• Loosely speaking, it measures sellers’ price-
sensitivity.

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Standard method
% change in Q
Es =
% change in

Midpoint method
Es = %%change in Q
change in

% change = (end value – start value/midpoint) x 100%

Note: Es > 0

The Variety of Supply Curves

Five classifications of S curve:
• Es = 0: Perfectly Inelastic;
• Es <1: Inelastic;
• Es = 1: Unit elastic;
• Es > 1: Elastic;
• Es = ∞ : Perfectly elastic.

“Perfectly inelastic” (one extreme)

Price elasticity % change in Q 0%
= = =0
of supply % change in P 10%

S curve: P
S
vertical
P2
Sellers’
price sensitivity: P1
none
P rises Q
Elasticity: by 10% Q1
0
Q changes
by 0%
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product or service or otherwise on a password-protected website for classroom use.

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“Inelastic”
Price elasticity % change in Q < 10%
= = <1
of supply % change in P 10%

S curve: P
S
relatively steep
P2
Sellers’
price sensitivity: P1
relatively low
P rises Q
Elasticity: by 10% Q1 Q2
<1
Q rises less
than 10%
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product or service or otherwise on a password-protected website for classroom use.

“Unit elastic”
Price elasticity % change in Q 10%
= = =1
of supply % change in P 10%

S curve: P
intermediate slope S
P2
Sellers’
price sensitivity: P1
intermediate
P rises Q
Elasticity: by 10% Q1 Q2
=1
Q rises
by 10%
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product or service or otherwise on a password-protected website for classroom use.

“Elastic”
Price elasticity % change in Q > 10%
= = >1
of supply % change in P 10%

S curve: P
relatively flat S
P2
Sellers’
price sensitivity: P1
relatively high
P rises Q
Elasticity: by 10% Q1 Q2
>1
Q rises more
than 10%
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product or service or otherwise on a password-protected website for classroom use.

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“Perfectly elastic” (the other extreme)

Price elasticity % change in Q any %
= = = infinity
of supply % change in P 0%

S curve: P
horizontal
P2 = P1 S
Sellers’
price sensitivity:
extreme
P changes Q
Elasticity: by 0% Q1 Q2
infinity
Q changes
by any %
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product or service or otherwise on a password-protected website for classroom use.

The Variety of Supply Curves

 The slope of the supply curve is closely related to price elasticity of
supply.
 Rule of thumb:
The flatter the curve, the greater the elasticity.
The steeper the curve, the smaller the elasticity.

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product or service or otherwise on a password-protected website for classroom use.

The Determinants of Supply Elasticity

• How easy the sellers can change the quantity they

produce

• The time horizon—elasticity is higher in the long run

than the short run

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product or service or otherwise on a password-protected website for classroom use.

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3. Applications

Elasticity and tax incidence

If the government imposes a tax on the supplier,

which group will bear most of the burden?

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product or service or otherwise on a password-protected website for classroom use.

Elasticity and tax incidence

Who bill bear most of the burden?
Short explanation and Illustrating by graphs (Work in groups)

The buyer’s price-

sensitivity is higher then The buyer is perfectly
the seller’s A sensitive with the change
in price
C
The buyer’s price-sensitivity
B
is lower than the seller’s D The buyer is not
sensitive with the change
in price

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product or service or otherwise on a password-protected website for classroom use.

Elasticity and tax incidence

A. The buyer’s price-sensitivity is higher then the seller’s

Tax drops on:

Buyer (td) =
Seller (ts) =
 ……………bears the most

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product or service or otherwise on a password-protected website for classroom use.

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Elasticity and tax incidence

B. The buyer’s price-sensitivity is lower than the seller’s

Tax drops on:

Buyer (td)= P2 – P1
Seller (ts) = t – td
 …………….bears the most

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product or service or otherwise on a password-protected website for classroom use.

Elasticity and tax incidence

C. The buyer is perfectly sensitive with the change in price

The equilibrium price…………..

after tax


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product or service or otherwise on a password-protected website for classroom use.

Elasticity and tax incidence

D. The buyer is not sensitive with the change in price

The change in equilibrium price =

…………………………..


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product or service or otherwise on a password-protected website for classroom use.

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