Applications of Supply &

Demand
Chapter 4
Samuelson, Nordhaus 18e
Applications of Supply & Demand
► Basics

► How to Calculate Elasticity

► Applications to Major Economic Issues

Syed Arshad Hussain

Jr. Lecturer
 Basics
► Restaurant meals
prices, are very
elastic (meaning
price changes greatly
affect our purchase
of them).

Syed Arshad Hussain

Jr. Lecturer
 Basics
► Gasoline is considered
inelastic (meaning
price changes have
little effect on the
quantity we buy).

Syed Arshad Hussain

Jr. Lecturer
 Basics
Several factors that affect the price
elasticity of a good:
1. Availability of substitutes
2. The degree of necessity
3. The proportion of a purchaser's budget
consumed by the item
4. The time period involved
5. Raising productivity
Syed Arshad Hussain
Jr. Lecturer
Applications of Supply & Demand
► Elasticity A general concept used to
quantify the response in one variable when
another variable changes.

► Ifsome variable, A, changes in response to

a change in another variable, B, then:
 Elasticity of A with respect B = % change in A
% change in B

Syed Arshad Hussain

Jr. Lecturer
Applications of Supply & Demand
► Price elasticity of demand The ratio of the
percentage of change in quantity demanded to the
percentage of change in price; measures the
responsiveness of quantity demanded to changes
in price.

% change in quantity demanded

price elasticity of demand 
% change in price

Syed Arshad Hussain

Jr. Lecturer
 Chapter 4
Figure 4-1

Elastic Demand Shows Large Quantity

Response to Price Change

Syed Arshad Hussain

Jr. Lecturer
Price Elasticity of Demand

Types of Elasticity

TABLE 5.1 Hypothetical Demand Elasticities for Four Products

% Change
% Change In In Quantity
Price Demanded Elasticity
Product (% P) (% QD) (% QD ÷ %P)
Insulin +10% 0% .0 Perfectly inelastic
Basic telephone service +10% -1% -.1 Inelastic

Beef +10% -10% -1.0 Unitarily elastic

Bananas +10% -30% -3.0 Elastic

perfectly inelastic demand Demand in which

quantity demanded does not respond at all to a
change in price.

Syed Arshad Hussain

Jr. Lecturer
Price Elasticity of Demand

Types of Elasticity

 FIGURE 5.2 Perfectly Inelastic and Perfectly Elastic Demand Curves

Figure 5.2(a) shows a perfectly inelastic demand curve for insulin. Price elasticity of demand
is zero. Quantity demanded is fixed; it does not change at all when price changes.
Figure 5.2(b) shows a perfectly elastic demand curve facing a wheat farmer. A tiny price
increase drives the quantity demanded to zero. In essence, perfectly elastic demand implies
that individual producers can sell all they want at the going market price but cannot charge a
Syed Arshad Hussain
higher price.
Jr. Lecturer
 Chapter 4
Figure 4-2

Price Elasticity of Demand Falls into

Three Categories

Syed Arshad Hussain

Jr. Lecturer
Price Elasticity of Demand

Types of Elasticity

inelastic demand Demand that responds

somewhat, but not a great deal, to changes in
price. Inelastic demand always has a numerical
value between zero and -1.

A warning: You must be very careful about signs.

Because it is generally understood that demand
elasticities are negative (demand curves have a
negative slope), they are often reported and
discussed without the negative sign.

Syed Arshad Hussain

Jr. Lecturer
Price Elasticity of Demand

Types of Elasticity

unitary elasticity A demand relationship in which

the percentage change in quantity of a product
demanded is the same as the percentage change in
price in absolute value (a demand elasticity of -1).

elastic demand A demand relationship in which

the percentage change in quantity demanded is
larger than the percentage change in price in
absolute value (a demand elasticity with an absolute
value greater than 1).

perfectly elastic demand Demand in which

quantity drops to zero at the slightest increase in
price.
Syed Arshad Hussain
Jr. Lecturer
Price Elasticity of Demand

Types of Elasticity

A good way to remember the difference between

the two “perfect” elasticities is:

Syed Arshad Hussain

Jr. Lecturer
Calculating Elasticities

Calculating Percentage Changes

To calculate percentage change in quantity

demanded using the initial value as the base, the
following formula is used:

change in quantity demanded

% change in quantity demanded  x 100%
Q1

Q -Q
 2
x 100%
1

Q 1

Syed Arshad Hussain

Jr. Lecturer
Calculating Elasticities

Calculating Percentage Changes

We can calculate the percentage change in price in a

similar way. Once again, let us use the initial value of
P—that is, P1—as the base for calculating the
percentage. By using P1 as the base, the formula for
calculating the percentage of change in P is

change in price
% change in price  x 100%
P 1

P -P
 2
x 100%1

P 1

Syed Arshad Hussain

Jr. Lecturer
Calculating Elasticities

Elasticity Is a Ratio of Percentages

Once all the changes in quantity demanded and

price have been converted to percentages,
calculating elasticity is a matter of simple division.
Recall the formal definition of elasticity:

% change in quantity demanded

price elasticity of demand 
% change in price

Syed Arshad Hussain

Jr. Lecturer
 Basics
► Estimated Price Elasticities of Demand
for Various Goods and Services

Inelastic-Demand:

Salt, Matches, Toothpicks, Airline travel short-run

Residential natural gas, short-run ~0.1
Gasoline short-run, Automobiles long-run, Coffee ~0.2 Tobacco products short-
run Legal services short-run
~0.4 Residential natural gas long-run ~0.5 Fish (cod)
consumed at home ~0.5 Physician services, Taxi short-run
~0.6 Gasoline long-run ~0.7

Syed Arshad Hussain

Jr. Lecturer
 Basics
► Estimated Price Elasticities of Demand for Various
Goods and Services

Approximately Unitary Elasticity:

Movies, Shellfish, consumed at home, Tires short-run ~ 0.9

Oysters consumed at home, Private education ~ 1.1
Housing, owner occupied long-run, Tires long-run, Radio
and television receivers ~ 1.2

Syed Arshad Hussain

Jr. Lecturer
 Basics
► Estimated Price Elasticities of Demand for Various
Goods and Services

Elastic Demand:

Automobiles- short-run 1.2 - 1.5

Restaurant meals ~2.3
Airline travel- long-run ~2.4
Fresh green peas ~2.8
Chevrolet automobiles ~4.0 Fresh
tomatoes ~4.6

Syed Arshad Hussain

Jr. Lecturer
 How to calculate
Numerical calculation:

ΔQ ΔP
ED = (Q1+Q2)/2 (P1+P2)/2

Syed Arshad Hussain

Jr. Lecturer
Applications of Supply & Demand

Read Chapter 5

Syed Arshad Hussain

Jr. Lecturer