Survey of Economics 9th Edition Tucker

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Chapter 5
Price Elasticity of Demand
CHAPTER SUMMARY

The price elasticity of demand measures consumer responsiveness to a price change. This can be
accomplished by using the midpoints formula or by using the total revenue test.
If one uses the midpoints formula, then by observing the absolute value of the coefficient, one is
able to determine the degree of elasticity, inelasticity or whether the product is unitary elastic. If the absolute
value of the coefficient is greater than one, the product has an elastic demand; if it is equal to one, then the
product has an unitary elastic demand; if it’s less than one, then the product has an inelastic demand. It is
also possible to observe perfect elasticity (a horizontal line) or perfect inelasticity (a vertical line).
When using the total revenue test to determine the degree of price elasticity one focuses on the
relationship between the change in the price and the resulting change in total revenue. An elastic product
exhibits an inverse relationship between a change in the price of the product and the change in total revenue;
unitary elasticity exhibits no relationship; an inelastic product exhibits a direct relationship.
The degree of elasticity (consumer responsiveness to a price change) is determined by: 1) the
availability of substitutes, 2) the share of a budget spent on the product, and 3) the amount of time under
consideration. The price elasticity of demand also varies along a given demand curve.

NEW CONCEPTS INTRODUCED

price elasticity of demand inelastic demand perfectly inelastic demand
elastic demand unitary elastic demand
total revenue perfectly elastic demand

LEARNING OBJECTIVES
After completing this chapter, students should be able to:
1. Determine whether a good is more elastic than another according to the determinants that affect the
price elasticity of demand.
2. Given data on demand, calculate the price elasticity of demand using the midpoint method.
3. Given data on the price elasticity of demand, identify the effect of a price change on total revenue.
4. Given data on the price elasticity of demand, identify a region of the demand curve as elastic,
inelastic, or unit elastic.
5. Identify a demand curve as perfectly elastic or perfectly inelastic.

ADDITIONAL SUGGESTED INSTRUCTIONAL OBJECTIVES

After completing this chapter, students should be able to:

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40 Survey of Economics

1. Understand that the price elasticity of demand is a measure of consumer responsiveness to a price
change.
2. Interpret an elastic, inelastic, unitary elastic, perfectly elastic and perfectly inelastic.
3. Determine those factors which contribute to an inelastic and elastic demand for a product.
CHAPTER OUTLINE
5-1 Price Elasticity of Demand
a. The Price Elasticity of Demand Midpoints Formula
b. The Total Revenue Test of Price Elasticity of DemanD
c. Elastic Demand
d. Inelastic Demand
e. Unitary Elastic Demand
Exhibit 5-1 "The Impact of a Decrease in Price on Total Revenue"
f. Perfectly Elastic Demand
g. Perfectly Inelastic Demand
Exhibit 5-2 "Perfectly Elastic and Perfectly Inelastic Demand"
Exhibit 5-3 "Price Elasticity of Demand Terminology"

5-2 Price Elasticity of Demand Variations along a Demand Curve

Exhibit 5-4 "The Variation in Elasticity and Total Revenue along a Hypothetical Demand
Curve"
Exhibit 5-5 "Relationships among Elasticity, Price Change, and Total Revenue"

Checkpoint: "Will Fliers Flock to Low Summer Fares?"

5-3 Determinants of Price Elasticity of Demand

a. Availability of Substitutes
b. Share of Budget Spent on the Product
c. Adjustment of a Price Change over Time
Exhibit 5-6 "Estimated Price Elasticities of Demand"

Checkpoint: "Can Trade Sanctions Affect Elasticity of Demand for Cars?"

Economics in Practice:
"Cigarette Smoking Price Elasticity of Demand" Applicable Concept: price elasticity of
demand

HINTS FOR EFFECTIVE TEACHING

1. Indicate that the whole focus on the price elasticity of demand is really taking a closer look at the
law of demand. Students already know that there is an inverse relationship between the price and
the quantity demanded. However, the price elasticity of demand enables them to quantify the extent
to which the quantity demanded changes given a change in the price---especially if one uses the
midpoints formula.
2. Mention that businesspeople are often quite interested in the extent to which their sales will change
given a change in the price of their product---hence the total revenue test.
3. Indicate that "elasticity" means "responsiveness"---much like tugging on a rubber band. Therefore,
if a product has an elastic demand then consumers are responsive to the price change (and that's
why the percentage change in the quantity demanded is greater than the percentage change in the
price giving rise to a coefficient that is greater than one and total revenue changing in the opposite
direction from the change in the price).

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 Chapter 5: Price Elasticity of Demand 41

4. List several goods and services and ask students to determine whether these goods would likely
have an elastic or inelastic demand and predict the impact of a price change on total revenue. They
will need to think in terms of the determinants of the price elasticity of demand.

CRITICAL THINKING/GROUP DISCUSSION QUESTIONS

1. If good X has a price elasticity of demand equal to 2 and the price increases by 10 percent then by
what percent will the quantity demanded change?
The quantity demanded will decrease by 20 percent. Note: multiply the coefficient by the
percentage change in the price to determine the percentage change in the quantity demanded.
2. If good X has a price elasticity of demand equal to 2 and good Y has a coefficient equal to 2.5
which has a more elastic demand?
Good Y because the coefficient is greater than one by the greatest amount. Could also
interpret both as has been done in number 1 above.
3. What is the advantage of using the midpoints formula as opposed to the total revenue test in
determining the degree of price elasticity?
You can only determine whether the product is elastic, unitary elastic, or inelastic when
using the total revenue test. However, in addition to that, you can determine the degree of elasticity
or inelasticity by observing the value of the coefficient if you use the midpoints formula. See number
2 above.
4. Why are convenience stores able to charge so much more for some goods, like milk, than grocery
stores?
Because of the time consideration for those shopping at convenience stores. Convenience
store shoppers are usually in a hurry and are experiencing a more inelastic demand for milk, or
whatever, at the time.
5. What would an elastic income elasticity of demand mean?
That consumers are relatively responsive to the amount that they buy as their income
changes.
6. If a firm wished to maximize its revenues then what price should it charge?
That price in which there is unitary elasticity. If the price is above that level, there is an
elastic demand and a lower price will increase total revenue. At a price below that level there is
an inelastic demand and a higher price will increase total revenue.

CLASSROOM GAMES
Approximately 170 non-computerized economic games (experiments) for use in the classroom are
available for free at http://www.marietta.edu/~delemeeg/games/. The following games are recommended
to help teach some of the concepts in this chapter:

Game #7—Objective: To demonstrate the effect of different price elasticities on price convergence in the
market (the more price elastic, the faster the convergence).
Game #133—Objective: To illustrate the derivation of market demand curves and various measures of
elasticity.

ANSWERS TO: "Global Economics"

CIGARETTE SMOKING PRICE ELASTICITY OF DEMNAD
According to the above excerpt, what factors influence the price elasticity of demand for cigarettes? What
other factors not mentioned in the article might also influence the price elasticity of demand for cigarettes?
Factors include education and age. The demand for cigarettes by less educated people is more
inelastic because they are more present-oriented. According to age, the 17-24 year old group had
the lowest price elasticity of demand for cigarettes. Other factors might include the availability of
substitutes such as a nicotine patch, share of the budget on cigarettes, and the time period under

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except for use as permitted in a license distributed with a certain product or service or otherwise on a password-
protected website for classroom use.
42 Survey of Economics

consideration. For example, over the long run less-addicted smokers may be more responsive to
price changes than more-addicted smokers, or vice versa.

ANSWERS TO EVEN-NUMBERED "Study Questions and Problems"

2. Because the demand for farm products is inelastic, the total revenue (farm income) increases when
the price of farm products rises. The government would therefore enact programs such as price
supports (price floors) or production control.
4. (a) Ed = 3 (c) Ed = .71
(b) Ed = 1.4 (d) Ed = .33
6. (a) increase
(b) decrease
(c) remain unchanged
(d) remain unchanged
(e) decrease
(f) increase
8. Because the total revenue is constant at any price, Charles's price elasticity of demand for Mello
Yello is unit elastic.
10. A successful ad campaign convinces buyers to think that there are few substitutes for Energizer
batteries. The objective is to make demand more inelastic; then Energizer can raise the price of
batteries and raise total revenue.

CHAPTER 5 PRACTICE QUIZ

1. If a good has a price elasticity of demand coefficient less than one, then:
a. this good has an elastic demand.
b. this good has an inelastic demand.
c. a 10% increase in the price will result in a greater than 10% decrease in the quantity
demanded.
d. the demand curve will be vertical.
2. If the price elasticity of demand is elastic, then:
a. Ed < 1.
b. consumers are relatively not very responsive to a price increase.
c. an increase in the price will increase total revenue.
d. there are likely a large number of substitute products available.
3. If the price elasticity of demand coefficient equals 2 then:
a. a 7% decrease in the price will result in a 14% decrease in the quantity demanded.
b. a price decrease will increase total revenue.
c. the good has an inelastic demand.
d. there is likely few substitutes, a short time period under consideration, or this good
accounts for a relatively small percentage of consumers' budgets.
4. Which of the following statements is true?
a. A perfectly inelastic demand curve is vertical.
b. The price elasticity of demand equals the percentage change in quantity demanded divided
by the percentage change in price
c. If price falls and total revenue rises then demand is elastic.
d. Along a downward sloping straight-line demand curve, the price elasticity of demand is
elastic in the upper portion of the demand curve, but inelastic in the lower portion.
e. All of the above.

ANSWERS TO CHAPTER 5 PRACTICE QUIZ

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except for use as permitted in a license distributed with a certain product or service or otherwise on a password-
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 Chapter 5: Price Elasticity of Demand 43

1. b 3. b
2. d 4. e

© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, 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 for classroom use.