PowerPoint Lectures for

Principles of Economics,
9e
; ; By
Karl E. Case,
Ray C. Fair &
Sharon M. Oster
CHAPTER 5 Elasticity

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 PART I INTRODUCTION TO ECONOMICS

Elasticity
5
Olivia Tanaya S.E., MBA
CHAPTER OUTLINE
Price Elasticity of Demand
Slope and Elasticity
Types of Elasticity
Calculating Elasticities
Calculating Percentage Changes
Elasticity Is a Ratio of Percentages
The Midpoint Formula
Elasticity Changes Along a Straight-Line
Demand Curve
Elasticity and Total Revenue
The Determinants of Demand Elasticity
CHAPTER 5 Elasticity

Availability of Substitutes
The Importance of Being Unimportant
The Time Dimension
Other Important Elasticities
Income Elasticity of Demand
Cross-Price Elasticity of Demand
Elasticity of Supply
Looking Ahead
Appendix: Point Elasticity

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 Outline
Price elasticity of
demand

Calculating
elasticity

The determinants
of demand
elasticity
CHAPTER 5 Elasticity

Other important
elasticities

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 1.
Elasticity

elasticity A general concept used to quantify the response

in one variable when another variable changes.

%A
elasticity of A with respect to B =
%B
CHAPTER 5 Elasticity

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 1.
Price Elasticity of Demand

Slope and Elasticity

1 pound = 16 ounces
CHAPTER 5 Elasticity

 FIGURE 5.1 Slope Is Not a Useful Measure of Responsiveness

Changing the unit of measure from pounds to ounces changes the numerical value of the
demand slope dramatically, but the behavior of buyers in the two diagrams is identical.
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 1.
The slope of a demand curve is:
a. The best way of measuring the responsiveness in quantity
demanded to changes in price.
b. Equivalent to elasticity as a measure of responsiveness.
c. A poor measure of the responsiveness compared to elasticity.
d. A measure of the proportional change in quantity demanded,
given a proportional change in price.
e. A negative value, while demand elasticity is always a positive
value.
CHAPTER 5 Elasticity

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 1.
The slope of a demand curve is:
a. The best way of measuring the responsiveness in quantity
demanded to changes in price.
b. Equivalent to elasticity as a measure of responsiveness.
c. A poor measure of the responsiveness compared to
elasticity.
d. A measure of the proportional change in quantity demanded,
given a proportional change in price.
e. A negative value, while demand elasticity is always a positive
value.
CHAPTER 5 Elasticity

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 1.

The numerical value of slope depends on the units used to measure the
variables on the axes.

To correct this problem, we convert the changes in price and quantity to

percentages. By looking at by how much the percent quantity demanded
changes for a given percent price change, we have a measure of
responsiveness that does not change with the unit of measurement.
CHAPTER 5 Elasticity

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 1.
Price Elasticity of Demand

Slope and Elasticity

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
CHAPTER 5 Elasticity

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 1.
Price Elasticity of Demand

Types of Elasticity

Price
elasticity of
demand

Perfectly Perfectly
Elastic Inelastic
elastic Unitary inelastic
demand demand
demand demand

Less Responsive
CHAPTER 5 Elasticity

perfectly inelastic demand Demand in which quantity demanded

does not respond at all to a change in price.

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 1.
Price Elasticity of Demand

Types of Elasticity
CHAPTER 5 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 higher price.
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 1.
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. (When an elasticity is less
than 1 in absolute value)

A warning: You must be vey 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.
CHAPTER 5 Elasticity

Absolute value or absolute size means ignoring the sign.

The absolute value of -4 is 4

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 1.
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).
CHAPTER 5 Elasticity

perfectly elastic demand Demand in which quantity drops to

zero at the slightest increase in price.

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 1.
CHAPTER 5 Elasticity

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 1.
Price Elasticity of Demand

Types of Elasticity

A good way to remember the difference between the two

“perfect” elasticities is:
CHAPTER 5 Elasticity

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 2.
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%
Q 1

Q -Q
= 2
x 100%1
CHAPTER 5 Elasticity

Q 1

Step 1

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 2.
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
CHAPTER 5 Elasticity

P -P
= x 100%
2 1

P 1

Step 2

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 2.
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
CHAPTER 5 Elasticity

Step 3

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 2.
Calculating Elasticities

Calculating Percentage Changes

We will use the data introduced in Figure 5.1(a) to do our elasticity calculations. In
the figure we see that the quantity of steak demanded increases from 5 pounds (Q1)
to 10 pounds (Q2) when price drops from $3 to $2 per pound. Thus, the change in
quantity demanded is equal to Q2 - Q1, or 5 pounds.

How much is % change in quantity demanded? % change in price? Can we

categorize steak as inelastic?
CHAPTER 5 Elasticity

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 2.
Calculating Elasticities

Calculating Percentage Changes

We will use the data introduced in Figure 5.1(a) to do our elasticity calculations. In the
figure we see that the quantity of steak demanded increases from 5 pounds (Q1) to 10
pounds (Q2) when price drops from $3 to $2 per pound. Thus, the change in
quantity demanded is equal to Q2 - Q1, or 5 pounds.

How much is % change in quantity demanded? % change in price? Can we categorize

steak as inelastic?

change in quantity demanded

% change in quantity demanded = x 100%
Q 1

Q -Q
= 2
x 100%
1
CHAPTER 5 Elasticity

Q 1

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 2.
Calculating Elasticities

Calculating Percentage Changes

We will use the data introduced in Figure 5.1(a) to do our elasticity calculations. In
the figure we see that the quantity of steak demanded decreases from 10 pounds
(Q1) to 5 pounds (Q2) when price rises from $2 to $3 per pound. Thus, the change
in quantity demanded is equal to Q2 - Q1, or -5 pounds.

How much is % change in quantity demanded?

CHAPTER 5 Elasticity

Changing the “direction” of the calculation should not change the

elasticity.

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 2.
Calculating Elasticities

The Midpoint Formula

midpoint formula A more precise way of calculating percentages using

the value halfway between P1 and P2 for the base in calculating the
percentage change in price, and the value halfway between Q1 and Q2 as
the base for calculating the percentage change in quantity demanded.

change in quantity demanded

% change in quantity demanded = x 100%
(Q + Q ) / 2
1 2

Q -Q
CHAPTER 5 Elasticity

= 2
x 100%
1

(Q + Q ) / 2
1 2

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 2.
Calculating Elasticities

The Midpoint Formula

Using the point halfway between P1 and P2 as the base

for calculating the percentage change in price, we get

change in price
% change in price = x 100%
(P + P ) / 2
1 2

P -P
= x 100%
CHAPTER 5 Elasticity

2 1

(P + P ) / 2
1 2

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 2.
Calculating Elasticities

The Midpoint Formula

CHAPTER 5 Elasticity

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 2.
Calculating Elasticities

Elasticity and Total Revenue

In any market, P x Q is total revenue (TR) received by producers:

TR = P x Q
total revenue = price x quantity

When price (P) declines, quantity demanded (QD) increases. The

two factors, P and QD move in opposite directions:
CHAPTER 5 Elasticity

Effects of price changes P → QD 

on quantity demanded: and
P → QD 

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 2.
Calculating Elasticities

Elasticity and Total Revenue

Because total revenue is the product of P and Q, whether TR rises

or falls in response to a price increase depends on which is
bigger: the percentage increase in price or the percentage
decrease in quantity demanded.

Effects of price increase on

a product with inelastic demand:  P x QD  = TR 

If the percentage decrease in quantity demanded is smaller

CHAPTER 5 Elasticity

than the percentage increase in price, total revenue will rise.

This occurs when demand is inelastic.

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 2.
Calculating Elasticities

Elasticity and Total Revenue

The opposite is true for a price cut. When demand is elastic, a cut in
price increases total revenues:

effect of price cut on a product

with elastic demand:  P x QD  = TR 

When demand is inelastic, a cut in price reduces total revenues:

effect of price cut on a product

with inelastic demand:  P x QD  = TR 
CHAPTER 5 Elasticity

Having a responsive (or elastic) market is good when we are lowering prices because it
means that we are dramatically increasing our units sold. But that same responsiveness
is unattractive as we contemplate raising prices because now it means that we are
losing customers

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 3.
The Determinants of Demand Elasticity

Availability of Substitutes

Perhaps the most obvious factor affecting demand elasticity

is the availability of substitutes.

The Importance of Being Unimportant

When an item represents a relatively small part of our total budget,
we tend to pay little attention to its price. We are not likely to
respond much to changes in price, and demand is likely to be
inelastic.
Luxuries versus Necessities

Luxury goods, like yachts or Armani suits, tend to have relatively

CHAPTER 5 Elasticity

elastic demand, while necessities, like food, have inelastic

demand. It is easy to give up owning a yacht (at least for most
people) when the price rises, but few of us can give up food.
Although there may be no product that is exactly like a yacht,
there are many things that give us pleasures that act as
substitutes for that yacht.
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 3.
The Determinants of Demand Elasticity

The Time Dimension

The elasticity of demand in the short run may be very different from
the elasticity of demand in the long run. In the longer run, demand
is likely to become more elastic, or responsive, simply because
households make adjustments over time and producers develop
substitute goods.
CHAPTER 5 Elasticity

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 The Determinants of Demand Elasticity 3.
CHAPTER 5 Elasticity

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 4.
Other Important Elasticities
CHAPTER 5 Elasticity

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 4.
Other Important Elasticities

Income Elasticity of Demand

income elasticity of demand A measure of the responsiveness of

demand to changes in income.

% change in quantity demanded

income elasticity of demand =
% change in income
CHAPTER 5 Elasticity

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 4.
Other Important Elasticities

Income Elasticity of Demand

Income elasticities can be positive or negative. During periods of

rising income, people increase their spending on some goods
(positive income elasticity) but reduce their spending on other goods
(negative income elasticity).

The income elasticity of demand for jewelry is positive, whereas the

income elasticity of demand for inferior good is negative.

As incomes rise in most countries, the demand for education and

CHAPTER 5 Elasticity

health care rises, a positive income elasticity.

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 4.
Other Important Elasticities

Income Elasticity of Demand

According to a survey of 1,200 ultra-high-net-worth investors released by
the financial information site Millionaire Corner, a third of people with a net
worth of more than $5 million say they shop at Walmart, while half shop at
Costco and more than 40 percent head to Target. It makes sense when you
think about it—they’re wealthy for a reason, and one of those reasons
may be that they’re smart shoppers.
CHAPTER 5 Elasticity

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 4.
Other Important Elasticities

Cross-Price Elasticity Of Demand

cross-price elasticity of demand A measure of the

response of the quantity of one good demanded to a
change in the price of another good.

% change in quantity of Y demanded

cross - price elasticity of demand =
% change in price of X
CHAPTER 5 Elasticity

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 4.
Other Important Elasticities

Cross-Price Elasticity Of Demand

A positive cross-
price elasticity
indicates that an
increase in the
price of X causes
the demand for Y to
rise. This implies
that the goods are
CHAPTER 5 Elasticity

substitutes.

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 4.
Other Important Elasticities

Cross-Price Elasticity Of Demand

Like income elasticity, cross-price elasticity can be either positive or negative.

A positive cross-price elasticity indicates that an increase in the price of X
causes the demand for Y to rise. This implies that the goods are substitutes.

For McDonald’s, Big Macs and Chicken McNuggets are substitutes with a
positive cross-price elasticity. For example, as McDonald’s lowered the price of
Big Macs, it saw a decline in the quantity of McNuggets sold as consumers
substituted between the two meals.

If cross-price elasticity turns out to be negative, an increase in the price of X

CHAPTER 5 Elasticity

causes a decrease in the demand for Y. This implies that the goods are
complements. Hot dogs and soda are complements with a negative
cross-price elasticity.

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 4.
Other Important Elasticities

Elasticity Of Supply

elasticity of supply A measure of the response of quantity of a good

supplied to a change in price of that good. Likely to be positive in
output markets.

% change in quantity supplied

elasticity of supply =
% change in price
CHAPTER 5 Elasticity

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 4.
Other Important Elasticities

Elasticity Of Supply

elasticity of labor supply A measure of the

response of labor supplied to a change in the price of labor.

% change in quantity of labor supplied

elasticity of labor supply =
% change in the wage rate
CHAPTER 5 Elasticity

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 REVIEW TERMS AND CONCEPTS

cross-price elasticity of demand inelastic demand

elastic demand midpoint formula
elasticity perfectly elastic demand
elasticity of labor supply perfectly inelastic demand
elasticity of supply price elasticity of demand
income elasticity of demand unitary elasticity
CHAPTER 5 Elasticity

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 APPENDIX
POINT ELASTICITY (OPTIONAL)

 FIGURE 5A.1 Elasticity at a Point

Along a Demand Curve

Consider the straight-line

demand curve in Figure 5A.1.
We can write an expression for
elasticity at point C as follows:
CHAPTER 5 Elasticity

Q Q
 100
%Q Q Q Q P1
elasticity = = = 1 = 
%P P  100 P P Q1
P P1

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 APPENDIX
POINT ELASTICITY (OPTIONAL)

∆Q/∆P is the reciprocal of the slope of the curve.

Slope in the diagram is constant along the curve,
and it is negative. To calculate the reciprocal of
the slope to plug into the previous electricity
equation, we take Q1B, or M1, and divide by minus
the length of line segment CQ1. Thus,
Q M 1
=
P CQ1
Since the length of CQ1 is equal to P1, we can
write:
Q M 1
=
CHAPTER 5 Elasticity

P P1
By substituting we get:

M 1 P1 M 1 P1 M1
elasticity =  =  =
P1 Q1 P1 M 2 M 2
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 APPENDIX
POINT ELASTICITY (OPTIONAL)

 FIGURE 5A.2 Point

Elasticity Changes Along
a Demand Curve
CHAPTER 5 Elasticity

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