The Elasticity of Demand

and Supply
 The Meaning of Elasticity
Elasticity is many things
◦ First, elasticity is a number
 An Ep greater than 1 is elastic
 This means that demand is relatively sensitive to price
changes
 The larger the number, the greater will be the sensitivity to
price changes
◦ This number represents the percent change in
quantity demanded resulting from each 1% change
in a goods price
 An Ep of 10 means that for every 1% change in price there
will be a 10% change in QD
The Meaning of Elasticity
An Ep less than 1 is inelastic
 This means that demand is relatively less
sensitive to price changes
 The smaller the number, the greater the
insensitivity to price changes
 An Ep of .1 means that for every 1% change in
price there will be a .1% change in quantity
demanded
The Meaning of Elasticity
◦ An Ep that is exactly 1 is unit elastic
 This means that demand is neither elastic nor
inelastic
 An Ep of 1 means that for every 1% change in
price there will be a 1% change in QD
 The Elasticity of Demand
The elasticity of demand for a good or service
measures the change in quantity demanded in
response to a change in price
◦ In other words, elasticity measures the sensitivity
(measured in percentage change) of quantity
demanded because of a change (percentage) in price
◦ When price goes up, we know that quantity
demanded declines.
 But we don’t know by how much?
◦ Elasticity provides us a way of measuring this
response
 Elasticity answers the “how much” question
 Measuring Elasticity

Calculate the coefficient of price elasticity (Ep)

Percentage change in quantity demanded

Ep =
Percentage change in price

Q2 - Q1 P2 + P1
Ep = X
Q2 + Q1 P2 - P1
P1 is the initial price; P2 is the new price
Q1 is the initial quantity sold; Q2 is the new quantity sold
A firm has been selling 100 chairs a week.
It runs a sale, charging $8 instead of the
usual $10. Sales go up to 140 chairs.

Q2 - Q1 P2 + P1
Ep = X
Q2 + Q 1 P2 - P1
Ep =
140 -100 8 + 10
X
140 + 100 8 - 10
40 18
-2 =
Ep = X - 1.4999994
240
Ep = 1.5
Note: the answer is always negative
So the negative sign is ignored
Price is raised from $40 to $41, and
quantity sold declines from 15 to 12

Q2 - Q1 P2 + P1
Ep = X
Q2 + Q 1 P2 - P1
Ep =
15 - 12 41 + 40
X
12 + 15 41 - 40
-3 81
1 = -8.9999991
Ep = X
27
Ep = 9.0
Note: the answer is always negative
So the negative sign is ignored
Elastic demand
(>1)

• flatter curve
P
small change in P
big change in Qd

Q
Perfectly elastic demand
• horizontal line
P
any change in P
Qd falls to zero
D

Q
Inelastic demand
(<1)

• steep curve
P
big change in P
small change in Qd

Q
Perfectly inelastic demand
• vertical line
P
change in P
no change in Qd

Q
Straight Line Demand Curve
11

10

1
D
0
0 1 2 3 4 5 6 7 8 9 10 11
Quantity
Elasticity of Straight Line Demand Curve
11
Very elastic
10
e = 6.33

8
Slightly elastic
7
Unit elastic
6 e = 1.0
Slightly inelastic
5

3 e = .29
Very
inelastic
2

1
D
0
0 1 2 3 4 5 6 7 8 9 10 11
Quantity
Determinants of the Degree of
Elasticity of Demand

What makes demand elastic or inelastic?

1. Is it a luxury or necessity
– if luxury, demand is elastic
– if necessity, demand is inelastic
Example
• mocha latte at Starbucks
is a luxury
• a liver transplant is not
2. Definition of good
– latte at Starbucks,
narrow definition= many substitutes
(other brands of coffee, tea)
demand is elastic

– coffee in general,
broad definition = fewer substitutes
demand is less elastic
3. Time since price change
– short time
no time to adjust,
demand is inelastic
– long time
time to adjust,
demand is elastic
Example
• Price of gas per gallon
• the day price rises
– demand inelastic
• years later
– demand much more elastic
as carpool or buy smaller car
factors 1-3
All get at same issue:
• Can consumers substitute a cheaper good
easily?
– if yes, demand is elastic
– if no, demand is inelastic
4. Is item large part of your budget?
– if yes, then demand elastic
(forced to change behavior)
– if no, then demand inelastic
(no need to change behavior)
Example
• soap
– if price doubles, will you buy less?
• rent
– if rent doubles?
-- stay on campus?
-- more roommates?
 Elasticity and Total Revenue
Elastic Demand and Total Revenue
Prices were raised from $10 to $12 and quantity demanded fell from 20 to 12

Calculate Ep Solution: P1 = 10; P2 = 12; Q1 = 20; Q2 = 12

.
12-20 12+10 8 22
=
12+20 12-10 32 2
. = .25 X 11 = 2.75

Price QD TR
$10 20 $200
12 12 144
When demand is elastic, a price increase will lead to a
fall in total revenue!
 Elasticity and Total Revenue
Elastic Demand and Total Revenue
Prices were raised from $10 to $12 and quantity demanded fell from 20 to 12

Calculate Ep Solution: P1 = 10; P2 = 12; Q1 = 20; Q2 = 12

.
12-20 12+10 8 22
=
12+20 12-10 32 2
. = .25 X 11 = 2.75

Price QD TR
$10 20 $200
12 12 144
When demand is elastic, a price decrease will lead to a
rise in total revenue!
 Elasticity and Total Revenue
Inelastic Demand and Total Revenue
Prices were raised from $2 to $3 and quantity demanded fell from 9 to 8

Calculate Ep Solution: P1 = 2; P2 = 3; Q1 = 9; Q2 = 8

8-9
8+9
. 33+2-2
- -1
=17 .125 = -.0588235 X 5 = 0.29

Price QD TR
$2 9 $18
$3 8 $24
When demand is inelastic, a price increase will lead to
a rise in total revenue!
 Elasticity and Total Revenue
Inelastic Demand and Total Revenue
Prices were raised from $2 to $3 and quantity demanded fell from 9 to 8

Calculate Ep Solution: P 1= 2; P2 = 3; Q1 = 9; Q2 = 8

8-9
8+9
. 33+2-2 1
=17 .125 = .0588235 X 5 = 0.29

Price QD TR
$2 9 $18
$3 8 $24
When demand is inelastic, a price decrease will lead
to a fall in total revenue!
Elasticity of Supply
Elasticity of supply is the
responsiveness of quantity to changes in
price
◦ Elasticity of supply parallels the
elasticity of demand
◦ Elasticity of supply measures the
responsiveness of quantity supplied to
changes in price
Price Elasticity of Supply

Percentage change in quantity supplied

Es =
Percentage change in price
 If price elasticity of supply
= 1
unit elastic
% change Qs = % change P
> 1
elastic
% change Qs > %change P
sensitive to P changes
< 1
inelastic
% change Qs < %change P
not sensitive to P changes
Elastic supply
flatter curve
P
small change in P
S
big change in Qs

Q
Perfectly elastic supply
horizontal line
P
any change in P
Qs falls to zero
S

Q
Inelastic supply
steep curve
P
big change in P
small change in Qs

Q
Perfectly inelastic supply
vertical line
P
change in P
no change in Qs

Q
What makes supply elastic or
inelastic?

1. Production possibilities
Can you make more easily?
NO
then supply is inelastic
YES
then supply is elastic
Example
oceanfront property
◦ can’t make more
◦ inelastic supply
salt
◦ almost an infinite amount
◦ elastic supply
2. Time since price change
◦ it takes time to produce
◦ if a short time,
supply is inelastic
◦ if a long time
supply is elastic

Example
• hotel rooms
– takes time to build
– supply inelastic in short-run,
elastic in long-run
 3. Can you store it easily/cheaply?
◦ if yes, then elastic
◦ if no, then inelastic
Example

• bananas
– storage time limited
– supply inelastic
Elasticity over Time
Remember, supply grows more elastic over
time, especially when enough time has passed
for new firms to enter the industry and for
existing firms to increase their output
Economists have identified three distinct time
periods
◦ The market period
◦ The short run
◦ The long run
The Market Period
The market period is short that elasticity of
supply is inelastic; it could be almost perfectly
inelastic or vertical.

In this situation it is virtually impossible for

producers to adjust their resources and change
the quantity supplied.

For example, think of adjustments on a farm

once the crop has been planted.
 The Short Run
In the short run a firm has an essentially
fixed productive capacity
The short run supply elasticity is more
elastic than market period and will depend
on the ability of producers to respond to
price changes.
Industrial producers are able to make some
output changes by having workers work
overtime or by bringing on an extra shift.
 The Long Run

In the long run there is sufficient time for a

firm to alter its productive capacity

The long run supply is the most elastic, because

more adjustments can be made over time and
quantity can be changes more relative to a
small change in price

The producer has time to build a new plant.