SESSION 8-10:

ELASTICITY
 LEARNING OBJECTIVES

• Define, calculate, and explain the factors that influence the price elasticity of
demand
• Define, calculate, and explain the factors that influence the cross elasticity of
demand and the income elasticity of demand
• Define, calculate, and explain the factors that influence the elasticity of
supply
 Price Elasticity of Demand
•When supply increases, the equilibrium price falls and the equilibrium quantity increases
•But does the price fall by a large amount and the quantity increase by a little? Or does the price
barely fall and the quantity increase by a large amount?
•The answer depends on the responsiveness of the quantity demanded to a change in price
•Figure 4.1 illustrates the principle
 Price Elasticity of Demand
Price elasticity of demand: Measuring responsiveness (sensitivity) of consumers to price changes
• When a modest/ small changes in Price cause a very large changes in Qd Relatively elastic
• When a substantial changes in Price cause small changes in Qd Relatively inelastic
The contrast between the two graphs highlights the need for a measure of the responsiveness of
the quantity demanded to a price change.
•Figure 4.1 illustrates the principle
 Price Elasticity of Demand
Calculating Price Elasticity of Demand
The price elasticity of demand is equal to the
absolute value of:
Percentage change in quantity demanded
___________________________________________________________________________________________________________________________________

Percentage change in price

price elasticity = %Q

of demand %P
•Negative due to law of demand
(absolute value)

•To calculate the price elasticity of

demand, we express the change in price
as a percentage of the average price and
the change in the quantity demanded as
a percentage of the average quantity
 Price
Using averages
Elasticity of Demand
• Midpoint formula: it averages the two prices and the two quantities as the
reference points to compute percentages:

(Q1- Q0)
x 100
(Q0+Q1)/2
Ed =
(P1- P0)
x 100
(P0+P1)/2
 Price Elasticity of Demand
Average Price and Quantity
• We use the average price and average quantity because it gives the most precise
measurement of elasticity
Percentages and Proportions
• Elasticity is the ratio of two percentage changes, so when we divide one percentage
change by another, the 100s cancel
A Units-Free Measure
• Elasticity is a units-free measure because the percentage change in each variable is
independent of the units in which the variable is measured
Minus Sign and Elasticity
• When the price of a good rises, the quantity demanded decreases
• Because a positive change in price brings a negative change in the quantity demanded,
the price elasticity of demand is a negative number
• So to compare price elasticities of demand, we use the magnitude of the elasticity and
ignore the minus sign
 Price Elasticity of Demand
Inelastic and Elastic Demand
Demand can be inelastic, unit elastic, or elastic, and can range from zero to infinity.

1.Perfectly inelastic demand

It is when the quantity demanded doesn’t change when the price changes (price elasticity
of demand = Zero)

2.Unit elastic demand

It is when the percentage change in the quantity demanded equals the percentage change
in price (%ΔQd = %ΔP), (price elasticity of demand = 1)

3.Perfectly elastic demand.

It is when the percentage change in the quantity demanded is infinitely large when the
price barely changes (price elasticity of demand = infinite)

 the price elasticity of demand is less than 1 and the good has inelastic demand.
 the price elasticity of demand is greater than 1 and the good has elastic demand.
 Price Elasticity of Demand

Inelastic and Elastic Demand

 Price Elasticity of Demand
Elasticity Along a Linear Demand Curve
• Elasticity and slope are not the same. A linear demand curve has a constant slope but
a varying elasticity

•On a linear demand curve,

demand is unit elastic at the
midpoint (elasticity is 1),
elastic above the midpoint,
and inelastic below the
midpoint
 Price Elasticity of Demand
Total Revenue and Elasticity
• The total revenue from the sale of a good equals the price of the good multiplied by the quantity
sold (TR = P x Q)
• When a price changes, total revenue also changes
• But a rise in price doesn’t always increase total revenue (when all other factors remain the same,
ceteris paribus).

The change in total revenue due to a change in price depends on price elasticity of demand:

o If demand is elastic (>1), total revenue moves in opposite direction from price. A 1% P ↓ , ↑Q
sold by more than 1%, therefore total revenue increases.
o If demand is inelastic (< 1), total revenue moves in same direction as price. A 1% P ↓ , ↑Q
sold by less than 1% and total revenues decreases.
o If demand is unit elastic (= 1), total revenue remains the same as price changes. A 1% P ↓ ,
↑Q sold by 1% and total revenue remains unchanged.
 Price Elasticity of Demand
Your Expenditure and Your Elasticity
• When a price changes, the change in your expenditure on the good depends on your elasticity of
demand
The Factors That Influence the Elasticity of Demand
• The closeness of substitutes
• The closer the substitutes for a good or service, the more elastic is the demand for it
• The proportion of income spent on the good
• The greater the proportion of income spent on a good, the more elastic (or less inelastic) is the
demand for it
• The time elapsed since the price change
• The longer the time that has elapsed since a price change, the more elastic is demand
 More Elasticities of Demand

Cross Elasticity of Demand

Cross Elasticity of Demand
The cross elasticity of demand is a measure
of the responsiveness of demand for a
good to a change in the price of a
substitute or a complement, other things
remaining the same.

The cross elasticity equals:

Percentage change in quantity demanded
Percentage change in price of substitute or
complement

%ΔQddA
%ΔPB
 More Elasticities of Demand
Income Elasticity of Demand
Income elasticity of demand =
Percentage change in quantity demanded
Percentage change in income

• Income elasticities of demand can be positive or negative and they fall into
three interesting ranges:

• Greater than 1 (normal good, income elastic)

• Positive and less than 1 (normal good, income inelastic)

• Negative (inferior good)

 Elasticity of Supply

Calculating the Elasticity of Supply

The elasticity of supply measures the responsiveness of the quantity supplied to
a change in the price of a good, ceteris paribus.
The Elasticity of Supply
Percentage change in quantity supplied
Percentage change in price

The Factors That Influence the Elasticity of Supply

• Resource substitution possibilities
• Time frame for the supply decision
Elasticity of Supply
Elasticity of Supply
 Elasticity of Supply

• Each supply curve illustrated on Figure 4.8 has a constant elasticity

• The supply curve in part (a) illustrates the supply of a good that has a zero elasticity
of supply.
• The supply curve in part (b) illustrates the supply of a good with a unit elasticity of
supply
• All linear supply curves that pass through the origin illustrate supplies that are unit
elastic
• The supply curve in part (c) illustrates the supply of a good with an infinite elasticity
of supply
END OF SESSIONS 8-10