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Ch. 5elasticity
Ch. 5elasticity
Elasticity . . .
… allows us to analyze supply and
demand with greater precision.
Inelastic Demand
– Quantity demanded does not respond
strongly to price changes.
– Price elasticity of demand is less than one.
Elastic Demand
– Quantity demanded responds strongly to
changes in price.
– Price elasticity of demand is greater than one.
The Variety of Demand Curves
Perfectly Inelastic
– Quantity demanded does not respond to price
changes.
Perfectly Elastic
– Quantity demanded changes infinitely with any
change in price.
Unit Elastic
– Quantity demanded changes by the same
percentage as the price.
The Variety of Demand Curves
Price
Demand
$5
4
1. An
increase
in price . . .
0 100 Quantity
Price
ΔQ<ΔP
$5
4
1. A 22% Demand
increase
in price . . .
0 90 100 Quantity
$5
4
1. A 22% Demand
increase
in price . . .
0 80 100 Quantity
$5
4 Demand
1. A 22%
increase
in price . . .
0 50 100 Quantity
1. At any price
above $4, quantity
demanded is zero.
$4 Demand
2. At exactly $4,
consumers will
buy any quantity.
0 Quantity
3. At a price below $4,
quantity demanded is infinite.
Total Revenue and the Price Elasticity
of Demand
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.
TR = P x Q
Figure 2 Total Revenue
Price
$4
P × Q = $400
P
(revenue) Demand
0 100 Quantity
Q
Copyright©2003 Southwestern/Thomson Learning
Elasticity and Total Revenue along a
Linear Demand Curve
With an inelastic demand curve, an
increase in price leads to a decrease in
quantity that is proportionately smaller.
Thus, total revenue increases.
Figure 3 How Total Revenue Changes When Price
Changes: Inelastic Demand
Price Price
An Increase in price from $1 … leads to an Increase in
to $3 … total revenue from $100 to
$240
$3
Revenue = $240
$1
Revenue = $100 Demand Demand
Price Price
$5
$4
Demand
Demand
0 50 Quantity 0 20 Quantity
P e rc e n ta g e c h a n g e
in q u a n tity d e m a n d e d
In c o m e e la s tic ity o f d e m a n d =
P e rc e n ta g e c h a n g e
in in c o m e
Income Elasticity
Types of Goods
– Normal Goods
– Inferior Goods
Higher income raises the quantity
demanded for normal goods but lowers
the quantity demanded for inferior goods.
Income Elasticity
Price
Supply
$5
4
1. An
increase
in price . . .
0 100 Quantity
Price
Supply
$5
4
1. A 22%
increase
in price . . .
Supply
$5
4
1. A 22%
increase
in price . . .
Supply
$5
4
1. A 22%
increase
in price . . .
1. At any price
above $4, quantity
supplied is infinite.
$4 Supply
2. At exactly $4,
producers will
supply any quantity.
0 Quantity
3. At a price below $4,
quantity supplied is zero.
$3
Demand
0 .0 9 5
0 .2 4
0 .4 Supply is inelastic
Summary
Price elasticity of demand measures how much the
quantity demanded responds to changes in the
price.
Price elasticity of demand is calculated as the
percentage change in quantity demanded divided
by the percentage change in price.
If a demand curve is elastic, total revenue falls
when the price rises.
If it is inelastic, total revenue rises as the price rises.
Summary
The income elasticity of demand measures how
much the quantity demanded responds to
changes in consumers’ income.
The cross-price elasticity of demand measures
how much the quantity demanded of one good
responds to the price of another good.
The price elasticity of supply measures how much
the quantity supplied responds to changes in the
price. .
Summary
In most markets, supply is more elastic in
the long run than in the short run.
The price elasticity of supply is calculated
as the percentage change in quantity
supplied divided by the percentage
change in price.
The tools of supply and demand can be
applied in many different types of markets.
Demand Elasticity
Demand elasticity – the extent to which a
change in price causes a change in the quantity
demanded.
A given change in price will cause a relatively
larger, a relatively smaller, or a proportional
change in quantity demanded.
A corporation must estimate if they change the
price either up or down will demand increase,
decrease or stay the same.
Elastic
Elastic – when the change in price causes a relatively
larger change in quantity demanded
During the summer price of vegetables decreases so the
amount purchased is increased.
But during the winter the price of vegetables increases
so the amount purchased decreases drastically. A big
change in the amount purchased over the seasons.
If a change in price causes a relatively large change
in the quantity demanded, demand is elastic.
Inelastic
Inelastic – means that a given change in the price
causes a relatively smaller change in quantity
demanded.
If table salt dropped in price by half going from $1 to $.50
then demand would not change because you can
consume only so much salt. And if salt goes from $1 to
$2 then demand would not change because it is still a
small percentage of your budget.
If change in price causes a relatively smaller change in
quantity demanded, demand is inelastic
Unit elastic
Unit elastic – a given change in price
causes a proportional change in quantity
demanded
So if there is a 5% change in price then
there will be a 5% change in quantity.
Price elasticity
Price elasticity = percentage change in quantity
percentage change in price
Perfectly inelastic: elasticity equals 0
Inelastic: elasticity is less than 1
Unit elastic: elasticity equals 1
Elastic: elasticity is greater than 1
Perfectly elastic: elasticity equals infinity
“Perfectly inelastic demand” (one
extreme case)
% change in Q 0%
Price elasticity
= = =0
% change in P 10%
of demand
D P
D
curve: vertical
P1
Consumers’
price sensitivity: P2
0
P falls Q
Elasticity: by 10% Q1
0 Q changes
by 0%
“Inelastic demand”
Price elasticity % change in Q < 10%
= = <1
% change in P 10%
of demand
D P
curve: relatively steep
P1
Consumers’
price sensitivity: P2
relatively low D
P falls Q
Elasticity: < 1 by 10% Q1 Q2
Q rises less
than 10%
“Unit elastic demand”
Price elasticity % change in Q 10%
= = =1
% change in P 10%
of demand
D curve: P
intermediate slope
P1
Consumers’
price sensitivity: P2
D
intermediate
P falls Q
Elasticity: 1 by 10% Q1 Q2
Q rises by 10%
“Elastic demand”
Price elasticity % change in Q > 10%
= = >1
% change in P 10%
of demand
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)
% change in Q any %
Price elasticity
= = = infinity
% change in P 0%
of demand
D curve: P
horizontal
P2 = P1 D
Consumers’
price sensitivity:
extreme
P changes Q
Elasticity: by 0% Q1 Q2
infinity Q changes
by any %
Elasticity of a Linear Demand
Curve
P
200%
$30 E = = 5.0
40% The slope
67% of a linear
20 E = = 1.0
67%
demand
40% curve is
10 E = = 0.2
200% constant,
but its
$0 Q elasticity
0 20 40 60
is not.
Supply Elasticity
Supply Elasticity – describes how a change in quantity
supplied responds to a change in price
What is the difference between supply elasticity and
demand elasticity?
– If quantities are being purchased, the concept is demand
elasticity. If quantities are being brought to market for sale, the
concept is supply elasticity
If supply is elastic, a given change in price will cause a
more than proportional change in quantity supplied.
If supply is inelastic, a given change in price will cause a
less than proportional change in quantity supplied.
If supply is unit elastic, a given change in price will cause
a proportional change in quantity supplied.
Price Elasticity Problems
Are the following examples elastic,
inelastic, or unit elastic
1) change in price = 30%;
change in quantity demanded = 50%
2) change in price = 30%;
change in quantity supplied = 30%
3) change in price = 30%
change in quantity demanded = 15%
Price Elasticity Answers
1) 50/30 = 1.66… Elastic demand
2) 30/30 = 1 Unit Elastic supplied
3) 15/30 = 0.50 Inelastic demand
A C T I V E L E A R N I N G 2:
Elasticity and expenditure/revenue
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A C T I V E L E A R N I N G 2:
Answers
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A C T I V E L E A R N I N G 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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Calculating Percentage Changes
Demand for
your websites
P
B
$250
A
$200
D
Q
8 12
Calculating Percentage
Changes
So, we instead use the midpoint method:
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A C T I V E L E A R N I N G 1:
Answers
Use midpoint method to calculate
% change in Qd
(5000 – 3000)/4000 = 50%
% change in P
($90 – $70)/$80 = 25%
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