Unit 3 - Elasticity

 Price Elasticity of Demand

Price elasticity of demand measures the

responsiveness of buyers’ purchasing habits to a
price change.

Microeconomics
 Unit 3 - Elasticity

 Price Elasticity of Demand

Definition:
Ep = the percentage change in a product’s
quantity demanded divided by the
percentage change in its price.

Microeconomics
 Unit 3 - Elasticity

 Price Elasticity of Demand

Formula:
(change in Qd / average Qd)
Ep =
(change in Pr / average Pr)

Where Qd = quantity demanded, and Pr = price.

Microeconomics
 Unit 3 - Elasticity
 Price Elasticity of Demand

Example 1
Let’s say that a grocery store observes that at $2.00
per gallon of milk, buyers purchase 800 gallons
per day. The next week, the grocery store
increases its price to $3.00 per gallon and buyers
purchase 700 gallons per day.
What is the price elasticity of demand for milk?

Microeconomics
 Unit 3 - Elasticity
 Price Elasticity of Demand
Example 1 answer
 the change in quantity demanded = 100
 the average quantity demanded = 750
 the change in price = $1
 the average price = $2.50

100/750 .133
$1/$2.50 .4
Ep = = .3325
Microeconomics
 Unit 3 - Elasticity

 Price Elasticity of Demand

Example 1 answer
Officially, the answer is - . 3325, because
the quantity demanded decreased (change
of -100). However, because price elasticity
of demand is always negative, we ignore
the negative sign.
Microeconomics
 Unit 3 - Elasticity

 Price Elasticity of Demand

If a product’s elasticity is less than 1, then we say

that it is inelastic.
If a product’s elasticity is greater than 1, then we
say that it is elastic.
If a product’s elasticity is equal to 1, then we say
that it is unit elastic.

Microeconomics
 A product with a price elasticity
of demand equal to 3.5 is:
1. Inelastic
2. Unit elastic
3. Elastic
4. None of the above
 A product with a price elasticity
of demand equal to 3.5 is:
1. Inelastic
2. Unit elastic
3. Elastic
4. None of the above

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 Unit 3 - Elasticity
 Price Elasticity of Demand

Example 2
A movie theatre sells 1,800 tickets when it charges
a price of $11. After it lowers its price to $9, it
sells 2,600 tickets.

What is the price elasticity of demand for tickets

for this movie theatre?

Microeconomics
 In the previous example (1,800 and
2,600 tickets, and price of $11 and $9),
what is the price elasticity of demand?
1. .55
2. 1.818
3. 1.55
4. 2.83
5. 5.151

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 Unit 3 - Elasticity
 Price Elasticity of Demand

Example 2 answer
800/2200 .3636 = 1.818
Ep =
2/10 .2

Because the value is greater than 1, movie tickets

at this theatre are price elastic.

Microeconomics
 Unit 3 - Elasticity
 Price Elasticity of Demand

Determinants of price elasticity of demand are:

 The availability of close substitutes. The more
substitutes, the greater the elasticity.
 The product’s expense to the consumer relative to
her/his income or wealth. The higher the expense, the
greater the elasticity.
 The period of time under consideration. The longer the
time period, the greater the elasticity.

Microeconomics
 Unit 3 - Elasticity
 Price Elasticity of Demand
Price elasticity determinants of gasoline
 The availability of close substitutes. Gasoline does not
have many substitutes. This makes gasoline inelastic.
 The product’s expense to the consumer relative to
her/his income or wealth. For many people gasoline is a
considerable expense. This makes gasoline elastic.
 The period of time under consideration. Within a short
period of time, people cannot change their driving
behavior much. This makes gasoline inelastic when
looking at a short-run demand curve.
 Overall, especially in the short run, gasoline is probably
inelastic.
Microeconomics
 Unit 3 - Elasticity
 Price Elasticity of Demand

Elasticity and Revenue

Revenue = quantity demanded x price

If quantity demanded increases by 10%, and price

decreases by 5% (this means that the product is elastic),
then revenue increases.

Microeconomics
 If a product is elastic and its price
decreases, then the supplier’s total
1. Decreases revenue:
2. Increases
3. Stays the same
4. None of the above

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 If a product is inelastic and its price
decreases, then the supplier’s total
1. Decreases
revenue:
2. Increases
3. Stays the same
4. None of the above

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 If a product is unit elastic and its price
decreases, then the supplier’s total
revenue:
1. Decreases
2. Increases
3. Stays the same
4. None of the above

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 Unit 3 - Elasticity
 Price Elasticity of Demand
Elasticity and Revenue Summary
 If a product is elastic and price increases, then revenue
decreases.
 If a product is inelastic and price increases, then
revenue increases.
 If a product is elastic and price decreases, then revenue
increases.
 If a product is inelastic and price decreases, then
revenue decreases.
 If a product is unit elastic and price changes, then
revenue stays the same.

Microeconomics
 When you graph a demand curve, you notice
that a flatter (closer to horizontal) demand
curve is associated with a:
1. Higher price
elasticity of demand
2. Lower price
elasticity of demand
3. Perfectly inelastic
demand situation
4. None of the above

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 Unit 3 - Elasticity
Price D1 (inelastic demand curve)

$9.00
D2 (elastic demand curve)
$8.00

60 68 100 Quantity
 Unit 3 - Elasticity

 Elasticity and Competition

A perfectly competitive firm faces a demand

curve which is perfectly elastic (horizontal).
The more elastic the product, the flatter the
curve.

Microeconomics
 Unit 3 - Elasticity
Price

D1 (Perfectly
Elastic Demand Curve)
$9.00

D2 (Perfectly
Inelastic Demand Curve)

60 Quantity
 Unit 3 - Elasticity

 Income Elasticity of Demand

Income elasticity of measures the

responsiveness of buyers’ purchasing habits in
response to an income change.

Microeconomics
 Unit 3 - Elasticity
 Income Elasticity of Demand

Definition:
Ei = the percentage change in a product’s
quantity demanded divided by the percentage
change in buyers’ incomes.

The value can be positive (normal good) or negative

(inferior good).

Microeconomics
 Unit 3 - Elasticity

 Income Elasticity of Demand

Formula:
(change in Qd / average Qd)
Ei =
(change in Y / average Y)

Where Qd = quantity demanded, and Y = income.

Microeconomics
 Unit 3 - Elasticity
 Cross Price Elasticity of Demand

The price change of a substitute or complementary

product affects the quantity demanded of the other
substitute or complementary product.

Substitutes have a positive cross price

elasticity of demand. Complements
have a negative cross price elasticity of demand.

Microeconomics
 Unit 3 - Elasticity
 Cross Price Elasticity of Demand

The formula for cross price elasticity of

demand is:

the % change in the quantity demanded of product

Ecp A
=
the % change in the price of related product B

Microeconomics