06 Mill Micro1ce PPT ch06

Economics Today
A Canadian Perspective Microeconomics, First Edition
Chapter 6
Demand and Supply
Elasticity
Copyright © 2023 Pearson Canada Inc. 6-1

Introduction
• Vaping has increased drastically in Canada, especially
in young adults. A 30 percent tax hike on vape
products has been recommended. A higher vape
product price induces, via the law of demand, a
reduction in the quantity of vape products demanded.
• In this chapter, you will learn about the price elasticity
of demand, which measures the proportionate
response in quantity demanded to a proportionate
change in price.

Learning Objectives
6.1 Calculate price elasticity of demand
6.2 Explain the relationship between price elasticity of
demand and total revenues
6.3 Describe the factors that determine the price
elasticity of demand
6.4 Explain the cross price elasticity of demand and the
income elasticity of demand
6.5 Classify supply elasticities and explain how the
length of time for adjustment affects the price
elasticity of supply

Chapter Outline
6.1 Price Elasticity
6.2 Elasticity and Total Revenues
6.3 Determinants of the Price Elasticity of Demand
6.4 The Cross Price and Income Elasticities of Demand
6.5 Price Elasticity of Supply

Did You Know That ...
• During a recent holiday season, the prices paid by
people who used ride-sharing services provided by
firms such as Uber and Lyft decreased by 10 to 50
percent, which resulted in such a substantial increase
in the quantity of rides demanded that on net these
companies’ total revenues increased?
• The only way to understand this event is to
understand the concept of quantity responsiveness—
elasticity.

6.1 Price Elasticity (1 of 12)
• Price elasticity of demand (Ep)
– The responsiveness of quantity demanded of a
commodity to changes in its price
– Defined as the percentage change in quantity
demanded divided by the percentage change in price

• Price elasticity of demand (Ep)
Percentage change in quantity demanded

Ep 
Percentage change in price

• Example:
– Price of oil increases 10 percent
– Quantity demanded decreases 2 percent
2%
EP   0.2
10%

Example: The Price Elasticity of
Demand for Illicit Cannabis in Canada
• The illicit cannabis market price, on average, was
$6.60 per gram. It was estimated that a price
decrease of 10 percent would cause an approximate 5
percent increase in the use of cannabis.
• Other things being equal, the price elasticity of
demand is, therefore:
5%
EP   0.5
10%

• Question:
– How would you interpret an elasticity of –0.2?
• Answer:
– A 10 percent increase in the price of a good will lead to
a 2 percent decrease in quantity demanded.
Copyright © 2023 Pearson Canada Inc. 6 - 10

• Relative quantities only:
– Elasticity is measuring the change in quantity relative to
the change in price.
• Always negative:
– An increase in price decreases the quantity demanded,
ceteris paribus.
– By convention, the minus sign is ignored.

• Calculating elasticity:
Change in Q Change in P
Ep  /
Sum of quantities / 2 Sum of prices / 2
or:
 in Q  in P
Ep  /
(Q1  Q2 ) / 2 (P1  P2 ) / 2

International Policy Example: The Price
Elasticity of Demand for Tesla Vehicles in
Hong Kong (1 of 2)
• Recently, the Hong Kong government temporarily
eliminated all subsidies offered to purchasers of
Tesla’s electric vehicles.
• As a consequence, the price of a Tesla vehicle
increased from about $75,000 to $130,000, and the
quantity of Tesla vehicles demanded decreased from
about 500 per month to about 30.
• Assuming other things equal, what is the price
elasticity of demand?

International Policy Example: The Price
Elasticity of Demand for Tesla Vehicles in Hong
Kong (2 of 2)
• Use the elasticity formula:
500  30 $130,000  $75,000

  3.3
(500  30) / 2 ($130,000  $75,000) / 2
• The price elasticity of 3.3 means that a 1 percent

increase in price generated a 3.3 percent decrease in
the quantity of Tesla vehicles purchased.

• Elastic demand
– The percentage change in quantity demanded is larger
than the percentage change in price.
– Total expenditures and price are inversely related in the
elastic region of the demand curve.
– Ep > 1

• Unit elasticity of demand
– The percentage change in quantity demanded is equal
to the percentage change in price.
– Total expenditures are invariant to price changes in the
unit-elastic region of the demand curve.
– Ep = 1

• Inelastic demand
– The percentage change in quantity demanded is
smaller than the percentage change in price.
– Total expenditures and price are directly related in the
inelastic region of the demand curve.
– Ep < 1

• Elastic demand:
% change in Q > % change in P; Ep > 1
• Unit-elastic demand:
% change in Q = % change in P; Ep = 1
• Inelastic demand:
% change in Q < % change in P; Ep < 1

• Extreme elasticities:
– Perfectly inelastic demand
 The demand curve is a vertical line.
 It has only one quantity demanded for each price.
 No matter what the price, the quantity demanded does
not change.
 The demand exhibits zero responsiveness to price
changes.

Figure 6-1 Extreme Price Elasticities, Panel (a) and
(b)
In panel (a), we show complete price unresponsiveness. The demand curve is vertical at the quantity
of 8 million units per year. This means that the price elasticity of demand is zero. In panel (b), we
show complete price responsiveness. At a price of 30 cents in this example, consumers will demand
an unlimited quantity of the particular good in question over the relevant range of quantities. This is a
case of infinite price elasticity of demand.

• Extreme elasticities:
– Perfectly elastic demand
 The demand curve is a horizontal line.
 It has only one price for every quantity.
 The slightest increase in price leads to zero quantity
demanded.

What Happens When … a government requires
firms to collect a per-unit tax on sales of a
product for which demand is highly elastic?
• A per-unit tax shifts the market supply curve upward
and to the left.
• If the demand for an item subject to a newly imposed
per-unit tax is very elastic, the resulting upward and
leftward shift of the market supply curve yields a
relatively small increase in the market clearing price.
• Thus, consumers pay a rather small fraction of the
tax, and firms pay a large fraction of the tax, which
becomes a “cost of doing business.”

6.2 Elasticity and Total Revenues (1 of 3)
• When demand is elastic, a negative relationship exists

between changes in price and changes in total
revenues.
• When demand is unit-elastic, changes in price do not
change total revenues.
• When demand is inelastic, a positive relationship
exists between changes in price and total revenues.

Figure 6-2 The Relationship between Price Elasticity of
Demand and Total Revenues for App-Enabled Restaurant
Reservation, Panel (a)

Reservation, Panel (b)

Reservation, Panel (c)

• Elasticity-revenue relationship:
– Total revenues are the product of price times units sold.
– The law of demand states that along a given curve,
price and quantity move in opposite directions.

• What happens to the product of price times quantity

depends on which of the opposing forces exerts a
greater force on total revenues.
• This is what price elasticity of demand is designed to
measure: responsiveness of quantity demanded to a
change in price.

Table 6-1 Relationship between Price Elasticity of
Demand and Total Revenues
Price Elasticity of Blank Effect of Price Change Blank

Demand (Ep) on Total Revenues (TR)
Blank Blank Price Decrease Price Increase
Inelastic (Ep < 1) TR ↓ TR ↑
Unit-elastic (Ep = 1) No change in TR No change in TR
Elastic (Ep > 1) TR ↑ TR ↓

AI—Decision Making Through Data: In
the Pursuit of “Price Optimization”
• The inverse-U-shaped relationship between price
elasticity of demand and total revenues provides a
means for firms to engage in so-called price
optimization.
• Companies utilize AI-guided data analytics techniques
to try to infer the revenue-increasing price.
• If all firms were able to infer these quantities and act
on these inferences, the result would be jointly
maximized profits for all firms.

6.3 Determinants of the Price Elasticity
of Demand (1 of 3)
• Existence of substitutes:
– The closer the substitutes and the more substitutes
there are, the more elastic the demand.
• Share of the budget:
– The greater the share of the consumer’s total budget
spent on a good, the greater the price elasticity.

of Demand (2 of 3)
• The length of time allowed for adjustment:
– The longer any price change persists, the greater the
elasticity of demand, other things held constant.
– Elasticity of demand is greater in the long run than in
the short run.

Figure 6-4 Short-Run and Long-Run Price Elasticity
of Demand
Consider a situation in which the market price is Pe and the quantity demanded is Qe. Then there
is a price increase to P1. In the short run, as evidenced by the demand curve D1, we move from
equilibrium quantity demanded, Qe, to Q1. After more time is allowed for adjustment, the demand
curve rotates at original price Pe to D2. Quantity demanded falls again, now to Q2. After even more
time is allowed for adjustment, the demand curve rotates at price Pe to D3. At the higher price P1 in
the long run, the quantity demanded falls all the way to Q3.

of Demand (3 of 3)
• How to define the short run and the long run:
– The short run is a time period too short for consumers
to fully adjust to a price change.
– The long run is a time period long enough for
consumers to fully adjust to a change in price, other
things being constant.

Table 6-2 Price Elasticities of Demand for Selected
Goods
Blank Blank Estimated Elasticity
Category Short Run Long Run
Air travel (business) 0.4 1.2
Air travel (vacation) 1.1 2.7
Beef 0.6 N.A.
Cheese 0.3 N.A.
Electricity 0.1 1.7
Fresh tomatoes 4.6 N.A.
Gasoline 0.2 0.5
Hospital services 0.1 0.7
Intercity bus service 0.6 2.2
Physician services 0.1 0.6
Private education 1.1 1.9
Restaurant meals 2.3 N.A.
Tires 0.9 1.2

6.4 The Cross Price and Income
Elasticities of Demand (1 of 7)
• Cross price elasticity of demand (Exy)
– The percentage change in the demand for one good
(holding its price constant) divided by the percentage
change in the price of a related good

• Formula for computing cross price elasticity of
demand between good X and good Y:
% change in amount of good X demanded

E xy 
% change in price of good Y

• Substitutes:
– Exy would be positive.
 An increase in the price of X would increase the quantity
of Y demanded at each price.
• Complements:
– Exy would be negative.
 An increase in the price of X would decrease the quantity
of Y demanded at each price.

• Income elasticity of demand (Ei)
– The percentage change in demand for any good,
holding its price constant, divided by the percentage
change in income
– The responsiveness of demand to changes in income,
holding the good’s relative price constant

• Formula for computing income elasticity of

demand:
Percentage change in amount of a good demanded

Ei 
Percentage change in income

• Calculating the income elasticity of demand:
Change in quantity Change in income

Ei  
Average quantity Average income
– The income elasticity of demand can be either negative

or positive.
– Remember that in calculating the income
elasticity of demand, the price of the good is assumed
to be constant.

Table 6-3 How Income Affects Quantity of Digital
Apps Demanded
Period Number of Digital Apps Demanded per Month Income per Month
1 6 $4,000
2 8 $6,000

• From Table 6-3, income elasticity of demand for digital
apps:
2 / [(6 + 8) / 2] 2/7
Ei    0.71
$2,000 / [($4,000 + $6,000 / 2] 2 / 5

6.5 Price Elasticity of Supply (1 of 5)
• Price elasticity of supply (Es)

– The responsiveness of the quantity supplied of a
commodity to a change in its price
– The percentage change in quantity supplied divided by
the percentage change in price

• Formula for computing price elasticity of supply:
Percentage change in quantity supplied

Es 
Percentage change in price

• Classifying supply elasticities:

– Perfectly elastic supply
 Quantity supplied falls to zero when there is the slightest
decrease in price.
 The supply curve is horizontal at a given price.

• Classifying supply elasticities:

– Perfectly inelastic supply
 Quantity supplied is constant, no matter what happens to
price.
 The supply curve is vertical at a given price.

Figure 6-5 The Extremes in Supply Curves
Here we have drawn two extremes of supply schedules: S is a perfectly elastic supply curve; S′ is a
perfectly inelastic one. In the former, an unlimited quantity will be supplied within the relevant range
of quantities at price P1. In the latter, no matter what the price, the quantity supplied will be Q1. An
example of S′ might be the supply curve for fresh (unfrozen) fish on the morning the boats come in.

Behavioural Example: Getting Paid to
Work Out (1 of 2)
• In a recent experimental study, behavioural
economists offered 690 people cash payments for
exercise workouts at a gymnasium.
• Every participant received $30, but those who
exercised an average of 1.33 times per week over a
six-week period received an additional $30.
• The additional payment induced participants to
increase the number of workouts to 1.47 times per
week.

Behavioural Example: Getting Paid to Work
Out (2 of 2)
• What is the price elasticity of supply of gym-exercise
workouts?
1.47  1.33 $60  $30
  0.15
(1.47  1.33) / 2 ($60  $30) / 2
• The price elasticity of 0.15 means that a 1 percent

increase in dollar payments for workouts induced
about 0.15 additional gym workouts per week.

• Price elasticity of supply and length of time for

adjustment:
– The longer the time allowed for adjustment,
the more resources can flow into (out of) an industry
through expansion (contraction) of existing firms.
– The longer the time allowed for adjustment, the more
entry (exit) of firms increases (decreases) production in
an industry.

Figure 6-6 Short-Run and Long-Run Price Elasticity
of Supply
Consider a situation in which the price is Pe and the quantity supplied is Qe. In the immediate
run, we hypothesize a vertical supply curve, S1. With the price increase to P1, therefore, there will
be no change in the short run in quantity supplied, which will remain at Qe. Given some time for
adjustment, the supply curve will rotate to S2. The new amount supplied will increase to Q1. The
long-run supply curve is shown by S3. The amount supplied again increases to Q2.

Economics in Your Life: Imposing a British
Columbia Carbonated Beverage Tax Reveals
Information about the Price Elasticity of Demand
• The imposition of the 7 percent tax on carbonated
drinks is an effort to decrease obesity and the
negative health impacts of being overweight. The
government is assuming carbonated drinks are elastic
and the tax will discourage consumption.
• The tax will generate an additional $27 million in
provincial revenue in its first year. The government
claims they will use the additional revenue to address
the health and economic costs of these beverages.

Issues & Applications: Vaping Products: Should
They Be Taxed Similarly to Cigarettes? (1 of 2)
• Researchers concluded that for every 10 percent
increase in vape product price, vape product sales
dropped 26 percent. The quantity of vape products
demanded was relatively responsive to an increase in
the price created by the tax. Thus, the study
concluded the price of vape products is elastic (2.6).
• The tax should reduce the use of vape products,
especially among young adults who are more price
sensitive.

Issues & Applications: Vaping Products: Should
They Be Taxed Similarly to Cigarettes? (2 of 2)
• Researchers also concluded that a 10 percent
increase in the price of vape products caused an
increase of 11 percent in traditional cigarette sales. As
governments increase taxes on vape products,
traditional cigarette consumption will increase.
• The reverse is also true: An increase in taxes on
cigarettes will increase the consumption of vape
products.

Summary Discussion of Learning
Objectives (1 of 6)
6.1 Calculate price elasticity of demand
– Percentage change in quantity demanded divided by
the percentage change in price

Objectives (2 of 6)
6.2 Explain the relationship between price elasticity of
demand and total revenues
– When demand is elastic, price and total revenue are
inversely related.
– When demand is inelastic, price and total revenue are
positively related.
– When demand is unit-elastic, total revenue does not
change when price changes.

Objectives (3 of 6)
6.3 Describe the factors that determine the price
elasticity of demand
– Availability of substitutes
– Percentage of a person’s budget spent on the good
– The length of time allowed for adjustment to a price
change

Objectives (4 of 6)
– The cross price elasticity of demand is the percentage
change in the demand for one good divided by the
percentage change in the price of a related good
– If cross elasticity is positive, the goods are
substitutes.
– If cross elasticity is negative, the goods are
complements.

Objectives (5 of 6)
– Income elasticity of demand is the responsiveness of
the demand for the good to a change in income.
– Income elasticity of demand is measured by the
percentage change in the demand for a good divided
by the percentage change in income.

Objectives (6 of 6)
6.5 Classify supply elasticities and explain how the
length of time for adjustment affects the price
elasticity of supply
– Elastic supply: Price elasticity of supply is greater
than 1.
– Inelastic supply: Price elasticity of supply is less
than 1.
– Unit-elastic supply: Price elasticity of supply is equal
to 1.
– The longer the time period for adjustment, the more
elastic the supply.

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Economics Today

A Canadian Perspective Microeconomics, First Edition

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Percentage change in quantity demanded

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500  30 $130,000  $75,000

• The price elasticity of 3.3 means that a 1 percent

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• When demand is elastic, a negative relationship exists

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• What happens to the product of price times quantity

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Price Elasticity of Blank Effect of Price Change Blank

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% change in amount of good X demanded

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• Formula for computing income elasticity of

Percentage change in amount of a good demanded

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Change in quantity Change in income

– The income elasticity of demand can be either negative

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• Price elasticity of supply (Es)

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• Formula for computing price elasticity of supply:

Percentage change in quantity supplied

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• Classifying supply elasticities: