02/12/2023

ELASTICITY
• Elasticity measures the degree of responsiveness or sensitivity of a certain
change like price. There are different natures of elasticity such as elastic,
inelastic, and unitary. Further, perfectly elastic and perfectly inelastic are
considered special cases of elasticity since these are applicable for selected
situations only.

• Elastic is considered when the consumer’s or supplier’s response is greater

than the change in price while inelastic shows that the consumer’s response
is less than the change. On the other hand, unitary means the response of
the consumer & suppliers and the change are equal. A horizontal curve
represents perfectly elastic, and a vertical curve represents perfectly
inelastic.

The Elasticity of Demand

• Elasticity
– Measure of the responsiveness of Qd or Qs
• To a change in one of its determinants

• 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 the price-sensitivity of buyers’ demand

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Price Elasticity of Demand

Price elasticity of demand =
𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄
=
P 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃

15%
= = 𝟏. 𝟓
P rises P2 10%
by 10% P1
D Along a D curve, P and Q
move in opposite directions,
Q which would make price
Q2 Q1
elasticity negative.
Q falls
by 15%

We will drop the minus sign and report all price elasticities as positive numbers.
6

Calculating Percentage Changes

The standard method of computing the
Demand for your
percentage (%) change:
websites
P 𝑒𝑛𝑑 𝑣𝑎𝑙𝑢𝑒 − 𝑠𝑡𝑎𝑟𝑡 𝑣𝑎𝑙𝑢𝑒
= × 100%
𝑠𝑡𝑎𝑟𝑡 𝑣𝑎𝑙𝑢𝑒
B
$250
A Going from A to B:
$200
• the % change in P = ($250–$200)/$200 = 25%
D • the % change in Q = (8-12)/12 = - 33%
Q • Price elasticity = 33/25 = 1.33
8 12
Going from B to A:
• the % change in P = (200-250)/250 = - 20%
• the % change in Q = (12-8)/8 = 50%
• Price elasticity = 50/20 = 2.5
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The Price Elasticity of Demand

• Midpoint method
– The midpoint is the number halfway between the start and end
values
• The average of those values

end value − start value

percentage change = × 100%
midpoint
(𝑸𝟐 − 𝑸𝟏 )/[(𝑸𝟐 + 𝑸𝟏 )/𝟐]
Price elasticity of demand =
(𝑷𝟐 − 𝑷𝟏 )/[(𝑷𝟐 + 𝑷𝟏 )/𝟐]
8

Calculating Percentage Changes

Using the midpoint method of

computing % changes:
Demand for your websites
end value − start value
percentage change = × 100%
midpoint
P
(𝑸𝟐 − 𝑸𝟏 )/[(𝑸𝟐 + 𝑸𝟏 )/𝟐]
B Price elasticity of demand =
(𝑷𝟐 − 𝑷𝟏 )/[(𝑷𝟐 + 𝑷𝟏 )/𝟐]
$250
A
$200 $250 − $200
% change in P = × 100% = 22.2%
D $225

12 − 8
Q % change in Q = × 100% = 40%
8 12 10

40%
Price elasticity = = 1.8
22.2%

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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?

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The Price Elasticity of Demand

Example 1: Burger vs. Sunscreen
– Prices of both of these goods rise by 20%.
For which good does Qd drop the most? Why?

• Burger has close substitutes, so buyers can easily switch if the price
rises
• Sunscreen has no close substitutes, so a price increase would not
affect demand very much

• Price elasticity is higher when close substitutes are available.

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The Price Elasticity of Demand

Example 2: 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?
• There’s not much people can do in the short run, other than ride the bus
or carpool.

• In the long run, people can buy smaller cars or live closer to work.

• Price elasticity is higher in the long run

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The Price Elasticity of Demand

• Variety of demand curves
– Demand is elastic
• Price elasticity of demand > 1

– Demand is inelastic
• Price elasticity of demand < 1

– Demand has unit elasticity

• Price elasticity of demand = 1

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The Price Elasticity of Demand

• Variety of demand curves
– Demand is perfectly inelastic
• Price elasticity of demand = 0
• Demand curve is vertical

– Demand is perfectly elastic

• Price elasticity of demand = infinity
• Demand curve is horizontal

• The flatter the demand curve

– The greater the price elasticity of demand 14

The Types of Elasticity of Demand

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Perfectly inelastic demand

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

P
D D curve
Vertical
P1

P2 Consumers’ price
sensitivity:
P falls
None
Q
by 10% Q1
Q changes
Elasticity:
by 0% 0
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otherwise on a password-protected website or school-approved learning management system for classroom use.

Inelastic demand
Price elasticity % change in Q <10%
= = <1
of demand % change in P 10%
P
D curve
P1 relatively steep

P2 Consumers’ price
D sensitivity:
P falls Q relatively low
by 10% Q1 Q2

Q rises less Elasticity:

than 10% <1
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Unit elastic demand

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

P D curve
intermediate slope
P1
Consumers’ price
P2 sensitivity:
D
intermediate
P falls Q
by 10% Q1 Q2 Elasticity:
Q rises =1
by 10%
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otherwise on a password-protected website or school-approved learning management system for classroom use.

Elastic demand
Price elasticity % change in Q >10%
= = >1
of demand % change in P 10%
P
D curve
P1 relatively flat

P2 D Consumers’ price
sensitivity:
P falls Q relatively high
by 10% Q1 Q2
Q rises more Elasticity:
than 10% >1
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otherwise on a password-protected website or school-approved learning management system for classroom use.

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Perfectly elastic demand

Price elasticity % change in Q any %
= = = infinity
of demand % change in P 0%
P
D curve
horizontal
P2 = P1 D
P changes Consumers’ price
by 0%
sensitivity:
extreme
Q
Q1 Q2
Elasticity:
Q changes
by any % infinity
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otherwise on a password-protected website or school-approved learning management system for classroom use.

A Few Elasticities from the Real World

INELASTIC

ELASTIC

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LET’S TRY THIS: Elasticity along a Linear Demand Curve

The slope of a linear demand curve is
P constant, but its elasticity is not.
200%
$30 E = = 5.0 (𝑄 − 𝑄 )/[(𝑄 + 𝑄 )/2]
40% PED =
(𝑃 − 𝑃 )/[(𝑃 + 𝑃 )/2]
67% (𝟐𝟎 − 𝟎)/[(𝟐𝟎 + 𝟎)/𝟐]
20 E = = 1.0 PED = = 2 / 0.4 = 5
67% (𝟐𝟎 − 𝟑𝟎)/[(𝟐𝟎 + 𝟑𝟎)/𝟐]
40% (𝟒𝟎 − 𝟐𝟎)/[(𝟒𝟎 + 𝟐𝟎)/𝟐]
10 E = = 0.2 PED = = 0.67 / 0.67 = 1
200% (𝟏𝟎 − 𝟐𝟎)/[(𝟏𝟎 + 𝟐𝟎)/𝟐]

$0 Q (𝟔𝟎 − 𝟒𝟎)/[(𝟔𝟎 + 𝟒𝟎)/𝟐]

PED = = 0.4 / 2 = 0.2
0 20 40 60 (𝟎 − 𝟏𝟎)/[(𝟎 + 𝟏𝟎)/𝟐]

Elastic Unit Elastic Inelastic

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otherwise on a password-protected website or school-approved learning management system for classroom use.

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:
– Higher revenue: because of the higher P
– Lower revenue: you sell fewer units (lower Q)

• Which of these two effects is bigger?

– It depends on the price elasticity of demand

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otherwise on a password-protected website or school-approved learning management system for classroom use. 23

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Price Elasticity and Total Revenue

• For a price increase, if demand is elastic
 E > 1: % change in Q > % change in P
 TR decreases: the fall in revenue from lower Q > the increase in
revenue from higher P

• For a price increase, if demand is inelastic

 E < 1: % change in Q < % change in P
 TR increases: the fall in revenue from lower Q < the increase in
revenue from higher P

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Price Elasticity and Total Revenue

Demand for your websites
Elastic demand
increased (elasticity = 1.8 > 1)
P revenue
due to lost If P = $200, Q = 12, and
higher P revenue revenue = $2400
$250 due to
lower Q
$200 If P = $250, Q = 8, and
D revenue = $2000

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

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otherwise on a password-protected website or school-approved learning management system for classroom use.

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Price Elasticity and Total Revenue

Demand for your websites
Elastic demand
lost (elasticity = 1.8 > 1)
P revenue
due to Increased If P = $250, Q = 8, and
lower P revenue revenue = $2000
$250 due to
higher Q
$200 If P = $200, Q = 12, and
D revenue = $2400

When D is elastic,
Q a price reduction causes
8 12
revenue to rise.

© 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 26
otherwise on a password-protected website or school-approved learning management system for classroom use.

Price Elasticity and Total Revenue

Demand for your websites
Inelastic demand
increased (elasticity = 0.82 < 1)
P revenue
due to lost If P = $200, Q = 12, and
higher P revenue revenue = $2400
$250 due to
lower Q If P = $250, Q = 10, and
$200
revenue = $2500
D
When D is inelastic,
Q a price increase causes
10 12 revenue to rise.

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otherwise on a password-protected website or school-approved learning management system for classroom use.

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28

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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?

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otherwise on a password-protected website or school-approved learning management system for classroom use. 30

Active Learning 2 Answers

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

• Expenditure = P x Q
• Since demand is inelastic, Q
will fall less
than 10%, so expenditure rises.

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otherwise on a password-protected website or school-approved learning management system for classroom use. 31

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Active Learning 2 Answers

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?
• Revenue = P x Q
• The fall in P reduces revenue, but Q
increases, which increases revenue.
Which effect is bigger?
• Since demand is elastic, Q will increase
more than 20%, so revenue rises.
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otherwise on a password-protected website or school-approved learning management system for classroom use. 32

Does Drug Interdiction Increase

or Decrease Drug-related Crime?

1. Increase the number of police 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

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product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

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Policy 1: Interdiction
Interdiction new value of drug-
reduces the Price of related crime
Drugs S2
supply of drugs. D1
S1
Demand for drugs is P2
inelastic: P rises
proportionally more than P1 initial value
Q falls. of drug-
related
crime
Result: an increase in
total spending on drugs, Q2 Q1 Quantity
and in drug-related crime of Drugs

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otherwise on a password-protected website or school-approved learning management system for classroom use.

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

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product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

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Policy 2: Education
Education reduces new value of drug-
the demand for Price of related crime
drugs. Drugs
D2 D1
S
P and Q fall.

Result: P1 initial value

of drug-
A decrease in total
P2 related
spending on drugs, crime
and in drug-related
crime. Q2 Q1 Quantity
of Drugs

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otherwise on a password-protected website or school-approved learning management system for classroom use.

ELASTICITY

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The Price Elasticity of Supply

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product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

The Price Elasticity of Supply

• Price elasticity of supply
– How much the quantity supplied of a good responds to a change
in the price of that good
– Percentage change in quantity supplied
• Divided by the percentage change in price
– Loosely speaking, it measures sellers’
price-sensitivity

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product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

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Price Elasticity of Supply

Price elasticity =
percentage change in Q
=
16%
=2
percentage change in P 8%
of supply

P
S

P rises P2
by 8% P
1
Again, we use the
midpoint method to
Q
compute the percentage Q1 Q2
changes. Q rises
by 16%
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otherwise on a password-protected website or school-approved learning management system for classroom use.

The Price Elasticity of Supply

• Variety of supply curves
– Supply is unit elastic
• Price elasticity of supply = 1

– Supply is elastic
• Price elasticity of supply > 1

– Supply is inelastic
• Price elasticity of supply < 1

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product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

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The Price Elasticity of Supply

• Variety of supply curves
– Supply is perfectly inelastic
• Price elasticity of supply = 0
• Supply curve is vertical

– Supply is perfectly elastic

• Price elasticity of supply = infinity
• Supply curve is horizontal

• The flatter the supply curve

– The greater the price elasticity of supply
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product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Perfectly inelastic supply

Price elasticity % change in Q 0%

= = =0
of supply % change in P 10%
S curve:
P
vertical S

P
Sellers’ price P rises 2
sensitivity: by 10% P
1
none
Q
Elasticity: Q1
0 Q changes
by 0%
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Inelastic supply

Price elasticity % change in Q < 10%

= = <1
of supply % change in P 10%
S curve:
P
relatively steep S

Sellers’ price P2
P rises
sensitivity: by 10% P
1
relatively low
Q
Elasticity: Q1 Q2
<1 Q rises less
than 10%
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otherwise on a password-protected website or school-approved learning management system for classroom use.

Unit elastic supply

Price elasticity % change in Q 10%

= = =1
of supply % change in P 10%
S curve: P
intermediate slope S
P2
Sellers’ price sensitivity:
intermediate P1
P rises
Elasticity: by 10% Q
=1 Q1 Q2
Q rises
by 10%
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otherwise on a password-protected website or school-approved learning management system for classroom use.

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Elastic supply

Price elasticity % change in Q > 10%

= = >1
of supply % change in P 10%

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

Perfectly elastic supply

Price elasticity % change in Q any %

= = = infinity
of supply % change in P 0%
S curve: P
horizontal
P2 = P1 S
Sellers’ price
sensitivity: P changes
extreme by 0%

Q
Elasticity: Q1 Q2
infinity Q changes
by any %
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otherwise on a password-protected website or school-approved learning management system for classroom use.

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How the Price Elasticity of Supply Can Vary

Price Elasticity is small Supply

(less than 1). Supply often
$15
becomes less
12 elastic as Q
Elasticity is large rises, due to
(greater than 1).
capacity limits.
4
3

0 100 200 500 525 Quantity

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product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Other Elasticities of Demand

• Cross-price elasticity of demand
– How much the Qd of one good respond to a change in the price
of another good
– Percentage change in Qd of the first good
• Divided by the percentage change in the price of the second good

– Substitutes: cross-price elasticity > 0

– Complements: cross-price elasticity < 0

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product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

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Cross Elasticity of Demand

Percentage Change in
Quantity Demanded for Product X
• Cross Elasticity of Demand = × 100%
Percentage Change in
Price of Product Y

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otherwise on a password-protected website or school-approved learning management system for classroom use.

Other Elasticities of Demand

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product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

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Other Elasticities of Demand

• Income elasticity of demand
– How much the quantity demanded of a good responds to a
change in consumers’ income
– Percentage change in quantity demanded
• Divided by the percentage change in income

– Normal goods: income elasticity > 0

– Inferior goods: income elasticity < 0

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product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Income Elasticity of Demand

Percentage Change in Quantity Demanded
• Income Elasticity of Demand = × 100%
Percentage Change in Income

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Summary
• Elasticity measures the responsiveness of Qd or Qs to one of its
determinants.
• Price elasticity of demand equals percentage change in Qd divided by
percentage change in P. When it’s less than one, demand is “inelastic.”
When greater than one, demand is “elastic.”
• When demand is inelastic, total revenue rises when price rises. When
demand is elastic, total revenue falls when price rises.

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otherwise on a password-protected website or school-approved learning management system for classroom use.

Summary
• Demand is less elastic in the short run, for necessities, and goods with
few close substitutes.
• Price elasticity of supply equals percentage change in Qs divided by
percentage change in P.
• When it’s less than one, supply is “inelastic.” When greater than one,
supply is “elastic.”
• Price elasticity of supply is greater in the long run than in the short run.

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Summary
• The income elasticity of demand measures how much quantity
demanded responds to changes in buyers’ incomes.

• The cross-price elasticity of demand measures how much demand for

one good responds to changes in the price of another good.

• The tools of supply and demand can be applied in many different kinds
of markets such as illegal drugs.

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Elastic Demand – Luxury Goods, Goods

that are not purchased frequently

Inelastic Demand – Monopolized Goods,

Goods that are purchased frequently,
Basic Goods

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Elastic Supply – Basic Goods

Inelastic Supply – Luxury Goods

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