Chapter 4:

Elasticity

Copyright © 2014 Pearson Canada Inc.

 Chapter Outline/Learning Objectives
Section Learning Objectives
After studying this chapter, you will be able to

4.1 Price Elasticity 1. explain what price elasticity of demand is and how
of Demand it is measured.
2. explain the relationship between total expenditure
and price elasticity of demand.

4.2 Price Elasticity 3. explain what price elasticity of supply is and how
of Supply it is measured.

4.3 An Important 4. see how elasticity of demand and supply determine the
Example Where effects of an excise tax.
Elasticity Matters

4.4 Other Demand 5. measure the income elasticity of demand and be able
Elasticities to distinguish between normal and inferior goods.
6. measure cross elasticity of demand and be able to
distinguish between substitute and complement goods.
Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 2
 4.1 Price Elasticity of Demand

Demand is said to be elastic when quantity demanded is very

responsive to a change in the products own price.

Demand is inelastic if quantity demanded is very unresponsive to

changes in its price.

Elasticity is related to the slope of the demand curve, but it is not

exactly the same.

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 3

 Fig. 4-1(i) Elastic Demand

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 4

 Fig. 4-1(ii) Inelastic Demand

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 5

 The Measurement of Price Elasticity

Elasticity (Greek letter eta:) is defined as:

percentage change in quantity demanded

 =
percentage change in price

 QD / Q D
 =
 p/p
Demand elasticity is negative, but economists usually emphasize
the absolute value.

Elasticity usually measures the change in p and Q relative to some

"base" values of p and Q.

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 6

 Demand elasticity between point "0" and point "1" on some demand
curve is:
(Q1 - Q0)/Q
 =
(p1 - p0)/p
where p and Q are the average price and average quantity, respectively.

Thus p = (p1+p0)/2 and Q = (Q1+Q0)/2. After a little simplifying, we get:

(Q1 - Q0)/(Q1 + Q0)

 =
(p1 - p0)/(p1 + p0)

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 7

 A Numerical Example of Price Elasticity

Product Original New Average Original New Average

Price Price Price Quantity Quantity Quantity
Corona
Beer $9.00 $8.00 $8.50 2000 3000 2500
(6-pack)

= (3000 - 2000)/(3000 + 2000)/2

(8 - 9)/(8 + 9)/2

= (1000)/(2500)
(1)/(8.5)

0.4
= 0.1176 = 3.40

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 8

 Fig. 4-2 Elasticity Along a Linear Demand Curve

Perfectly Elastic Elasticity falls as

= you move down
Elastic a linear demand
>1 curve.
Unit Elastic
=1

Inelastic
<1
Perfectly Inelastic

=0

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 9

 For more details about demand elasticity, including the use of
MyEconLa calculus to measure elasticity along a non-linear demand curve,
b look for Some Further Details About Demand Elasticity in the
www.myeconlab.com Additional Topics section of this book's MyEconLab.

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 10

 What Determines Elasticity of Demand?

Demand elasticity tends to be high when there are many

close substitutes.

The availability of substitutes is determined by:

• the length of the time interval considered

• whether the good is a necessity or a luxury
• how specifically the product is defined

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 11

 Fig. 4-3 Three Demand Curves with Constant Elasticity

D1 is perfectly inelastic

D2 is perfectly elastic
at p0

D3 is unit elastic

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 12

 Fig. 4-4 Short-Run and Long-Run Equilibrium
Following an Increase in Supply

The changes depend on

the time that consumers
have to respond.

In the long run, demand

is more elastic.

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 13

 Fig. 4-5 Total Expenditure and Quantity Demanded

When demand is elastic,

TE increases when price falls.

When demand is inelastic,

TE decreases when price falls.

TE reaches a maximum
when demand is unit elastic.

Example: What happens when

OPEC's output restrictions raise
the world price of oil?

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 14

 4.2 Price Elasticity of Supply

Price elasticity of supply measures the responsiveness of the

quantity supplied to a change in the product's own price.

It is denoted by s and is defined as:

percentage change in quantity supplied

S =
percentage change in price

S =  QS / QS
 p/p

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 15

 Determinants of Supply Elasticity

The elasticity of supply depends on how easily firms can increase

output in response to an increase in the product’s price.

This depends on:

• the technical ease of substitution in production
• the nature of production costs
• the time span under consideration

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 16

 Fig. 4-6 Computing Price Elasticity of Supply

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 17

 4.3 An Important Example Where Elasticity Matters

Fig. 4-8 The Effect of a Cigarette Excise Tax

An excise tax raises

the price paid by
consumers but reduces
the price received by
producers.

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 18

 The burden of an excise tax is independent of who actually remits the
tax to the government—it depends only on the relative elasticities of
demand and supply.

Fig. 4-9 Elasticity and the Incidence of an Excise Tax

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 19

 EXTENSIONS IN THEORY 4-1
The Algebra of Tax Incidence

Another application of the concept of tax incidence relates to payroll

MyEconLa taxes such as premiums that workers and firms pay for employment
b insurance and the Canada Pension Plan. For more information on
www.myeconlab.com this application of tax incidence, look for Who Really Pays for
Payroll Taxes? in the Additional Topics section of this book's
MyEconLab.

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 20

 4.4 Other Demand Elasticities

Income Elasticity of Demand

Y = percentage change in quantity demanded

percentage change in income

If Y > 0, the good is said to be normal

If Y < 0, the good is said to be inferior

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 21

 Luxuries Versus Necessities

The more necessary an item is in the consumption pattern

of consumers, the lower its income elasticity.

Income elasticities for any one product also vary with the level
of a consumer’s income.

The distinction between luxuries and necessities also helps to

explain differences in income elasticities between countries.

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 22

 Cross Elasticity of Demand

XY = percentage change in quantity demanded of good X

percentage change in price of good Y

If XY > 0, then X and Y are substitutes

If XY < 0, then X and Y are complements

EXTENSIONS IN THEORY 4-2

The Terminology of Elasticity

Copyright © 2014 Pearson Canada Inc. Chapter 4, Slide 23