Price Elasticity of

Demand and Supply

• Key Concepts
• Summary
 How is the percent
increase or decrease of
two numbers calculated?
Percent change is the
difference between the
two numbers divided by
the original number
2
 Suppose the price of a
rock concert increases
by 10%, what effect will
this have on sales?
That all depends on the
price elasticity of demand
for this rock concert
3
 What is Elasticity?
A term economists use to
describe responsiveness,
or sensitivity, to a
change in price

4
 What is Price
Elasticity of Demand?
The ratio of the percentage
change in the quantity
demanded of a product to a
percentage change in its
price
5
 Price Elasticity of Demand

%  in Q demanded
Ed = %  in price

6
 Supposing a university’s
enrollment drops by 20%
because tuition rises by
10%, what is the Price
Elasticity of Demand?

7
 -20% -.20
Ed =
+10%
=
+.10
= 2

8
 Why is Elasticity 2 in
the previous example
and not -2?
Economists drop the negative
sign because we know from
the law of demand that
quantity demanded and
price are inversely related
9
 If there is an increase
from 3 units to 5, what is
the percentage increase?

2/3 = 66%

10
 If there is a decrease
from 5 units to 3, what is
the percentage decrease?

2/5 = 40%

11
 Problem - When we
move along a demand curve
between two points, we get
different answers to elasticity
depending on whether we are
moving up or down the
demand curve
12
P A
2
B
D
3

Q
13
 Economists can solve this
problem of different base points
by using the midpoints as the
base points of changes in prices
and quantity demanded

14
Price elasticity equals the
 in quantity demanded
sum of quantities/2
divided by
 in price
sum of prices/2
15
What is Elastic Demand?
A condition in which the
percentage change in
quantity demanded is
greater than the percentage
change in price
16
 P
Elastic Demand Ed > 1
P40
A
P30
B
P20
P10

10 20 30 40 Q 17
 Why is the Demand
curve in the previous
slide Elastic?
The percentage change in
the quantity demanded is
greater than the
percentage change in price
18
 Elastic Demand
Increase in total
revenue

Price decrease

19
% change in Q = 10 .66
=
15
% change in P = 10 .40
=
25
Ed = % change in Q .66
=
% change in P .40
Ed = 1.65
20
 Inelastic Demand Ed < 1
P40
A
P30
P20 B
P10

10 20 30 40 21
 Why is the Demand
curve in the previous
slide Inelastic?
The percentage change in
the quantity demanded is
less than the percentage
change in price
22
 Inelastic Demand
Decrease in
total revenue

Price decrease

23
 5
% change in Q = = .38
13
10
% change in P = = .40
25
% change in Q .38
Ed = % change in P =
.40
24
 What is a Unitary
Elastic Demand Curve?
The percentage change in
the quantity demanded is
equal to the percentage
change in price

25
 Unitary Elastic Demand Ed = 1
P40
P30 E
F
P20 D
P10

10 20 30 40 26
Unitary Elastic Demand
No change in
total revenue

Price decrease

27
 What is a Perfectly
Elastic Demand Curve?
A condition in which a
small percentage
change in price brings
about an infinite
percentage change in
the quantity demanded
28
P40
P30
P20
Perfectly Elastic Demand Ed =

8
P10

10 20 30 40 29
Perfectly Elastic Demand
Infinite change in
quantity demanded

Price change
30
 What is a Perfectly
Inelastic Demand Curve?
A condition in which the
quantity demanded
does not change as the
price changes

31
 Perfectly Inelastic Demand Ed = 0
P40
P30
P20
P10

10 20 30 40 32
Perfectly Inelastic Demand
Zero change in
quantity demanded

Price change
33
If a college raises tuition,
what happens to revenue?
If demand is elastic -
total revenue goes down
If demand is inelastic -
total revenue goes up
34
If price increases and the
revenue gained is greater
than the revenue lost, the
demand curve is price
inelastic, < 1
35
If price increases and
the revenue gained is
less than the revenue
lost, the demand curve
is price elastic, > 1

36
If total revenue does
not change when
price increases, the
demand curve is
unitary elastic,
value equals 1
37
P40 Price Elasticity of
El Demand Ranges
P35 as
tic
P30
P25
P20 In
e las
P15 Un tic
ela ita
P10 sti ry
P5 c
5 10 15 20 25 30 35 40 45 38
 Total Revenue Curve
P400

c
P350
sti

In
P300

ela
Ela
P250

sti
c
P200
Unitary
P150
Elastic
P100
P50
5 10 15 20 25 30 35 40 45 39
What factors influence
Demand sensitivity?
• Availability of substitutes
• Share of budget on the
product
• Adjustment to a price
change over time
40
What do Substitutes have
to do with a price change?
The more substitutes a
product has, the more
sensitive consumers are to a
price change, and the more
elastic the demand curve
41
P A P B

D D
0 Q 0 Q
Which demand curve is for a vital
medicine and which is for candy?
42
Why is A the Demand
Curve for medicine?
Because medicine is a
necessity with few
substitutes, and the
price can change with
little effect on the
quantity demanded
43
Why is B the Demand
curve for candy?
Because candy has many
substitutes, a price
change can bring about a
big change in the
quantity demanded
44
 What does the Share of
One’s Budget have to do
with a price change?
The larger the purchase is to
one’s budget, the more
sensitive consumers are to a
price change, and the more
elastic the demand curve
45
What does Time have to
do with sensitivity?
The longer consumers have
to adjust, the more
sensitive they are to a
price change, and the more
elastic the demand curve
46
 What are other
Elasticity measures?
Income elasticity of demand
Cross-elasticity of demand

47
 What is Income
Elasticity of Demand?
The ratio of the percentage
change in the quantity
demanded of a good to a
given percentage change
in income
48
Income Elasticity of Demand

%  in Q demanded
Ed = %  in income

49
What is Cross-elasticity
of Demand?
The ratio of the percentage
change in quantity
demanded of a good to a
given percentage change
in price of another good
50
Cross-elasticity of Demand
%  Q demanded of good A
Ec = %  price of good B

51
 What is the Price
Elasticity of Supply?
The ratio of the percentage
change in the quantity
supplied of a product to
the percentage change in
its price
52
Price Elasticity of Supply
%  in Q supplied
Es = %  in price

53
P40
P30
P20 Perfectly Elastic Supply =

8
P1
0
10 20 30 40 54
P40
Perfectly Inelastic Supply Es = 0
P30
P20
P1
0
10 20 30 40 55
 Unit Elastic Supply Es = 1
P40
P30 S
.5%
P20
.5%
P1
0
10 20 30 40 56
Who pays the tax levied
on sellers of goods such
as gasoline, cigarettes,
and alcoholic beverages?
It all depends; the
corporation pays all, some,
or very little of the tax
57
 What decides who
pays what part of the
tax increase?
The more elastic the
demand, the more the
corporation pays; the less
elastic the demand, the
more the consumer pays
58
 Partially shifted tax to buyers
P2.00
P1.75
P1.50 s2
P1.25
P1.00 Buyers s1
P.75 Sellers
P.50
P.25 D
5 10 15 20 25 30 35 40 45 59
 Consumers and
suppliers share
burden of tax

Decrease in
supply

Increase in
gasoline tax
60
 Fully shifted tax to buyers
P2.00
P1.75
P1.50 2s
P1.25
P1.0
Buyers
1 s
0P.75
P.50
P.2 D
5 5 10 15 20 25 3035 40 45 61
 Consumers bear
full burden of tax

Decrease in
supply

Increase in
gasoline tax
62
Key Concepts

63
 Key Concepts
• What is Elasticity?
• What is Price Elasticity of Demand?
• What is Elastic Demand?
• What is a Unitary Elastic Demand Curve?
• What is a Perfectly Elastic Demand Curve?
• What is a Perfectly Inelastic Demand Curve?

64
 Key Concepts cont.
• What factors influence Demand
sensitivity?
• What are other Elasticity measures?
• What is Income Elasticity of Demand?
• What is Cross-elasticity of Demand?
• What is the Price Elasticity of Supply?

65
Summary

66
 Price elasticity of demand is a
measure of the responsiveness of the
quantity demanded to a change in price.
Specifically, price elasticity of demand
is the ratio of the percentage change in
quantity demanded to the percentage
change in price.

67
 Price Elasticity of Demand

%  in Q demanded
Ed = %  in price

68
 What is the midpoint formula for
the price elasticity of demand?

69
Price elasticity equals the
 in quantity demanded
sum of quantities/2
divided by
 in price
sum of prices/2
70
 Elastic demand is a change of
more than one percent in quantity
demanded in response to a one percent
change in price. Demand is elastic
when the elasticity coefficient is greater
than one and total revenue (price time
quantity) varies inversely with the
direction of the price change.

71
 Elastic Demand
P40
P30
P20
P1
0
10 20 30 40 72
 Inelastic demand is a change of
less than one percent in quantity
demanded in response to a one
percent change in price. Demand is
inelastic when the elasticity
coefficient is less than one and total
revenue varies directly with the
direction of the price change.

73
 Inelastic Demand
P40
P30
P20
P1
0
10 20 30 40 74
 Unitary elastic demand is a one
percent change in quantity demanded in
response to a one percent change in
price. Demand is unitary elastic when
the elasticity coefficient equals one and
total revenue remains constant as the
price changes.

75
 Unitary elastic Demand
P40
P30
P20
P1
0
10 20 30 40 76
 Perfectly elastic demand is a
decline in quantity demanded to zero
for even the slightest rise or fall in
price. This is an extreme case in which
the demand curve is horizontal and the
elasticity coefficient equals infinity.

77
P40
P30
P20 Perfectly Elastic Supply =

8
P1
0
10 20 30 40 78
 Perfectly inelastic demand is no
change quantity demanded in response
to price changes. This is an extreme
case in which the the demand curve is
vertical and the elasticity coefficient
equals zero.

79
P40
Perfectly Inelastic Supply Es = 0
P30
P20
P1
0
10 20 30 40 80
 Determinants of price elasticity of
demand include (a) the availability of
substitutes, (b) the percentage of
budget spent on the product, and (c) the
length of time allowed for adjustment.
Each of these factors is directly related
to the elasticity coefficient.

81
 Income elasticity of demand is the
percentage change in quantity
demanded divided by the percentage
change in income. For a normal good
or service, income elasticity of demand
is positive. For an inferior good or
service, income elasticity of demand is
negative.

82
 Cross elasticity of demand is the
percentage change in the quantity
demanded of one product caused by a
change in the price of another product.
When the cross-elasticity of demand is
negative, the two products are
complements.

83
 Price elasticity of supply is a
measure of the responsiveness of the
quantity demanded to a change in
price. Price elasticity of supply is the
ratio of the percentage change in
quantity supplied to the percentage
change in price.

84
 Tax incidence is the share of a
tax ultimately paid by buyers and
sellers. Facing a downward-sloping
demand curve and an upward-
sloping supply curve, sellers cannot
raise the price by the full amount of
the tax. If the demand curve is
vertical, sellers will raise the price
by the full amount of a tax.

85
 Fully shifted tax to buyers
P2.00
P1.75
P1.50 2s
P1.25
P1.0
Buyers
1 s
0P.75
P.50
P.2 D
5 5 10 15 20 25 3035 40 45 86
 Partially shifted tax to buyers
P2.00
P1.75
P1.50 s
2
P1.25
Buyers 1 s
P1.0
0P.75 Sellers
P.50
P.2 D
5 5 10 15 20 25 30 35 40 45 87
END