1/13/2025

N. GREGORY MANKIW NINTH EDITION

IN THIS CHAPTER
PRINCIPLES OF • What is elasticity?
• What kinds of issues can elasticity help us
ECONOMICS understand?
• What is the price elasticity of demand?
How is it related to the demand curve?
CHAPTER How is it related to revenue and expenditure?
Elasticity and • What is the price elasticity of supply?
5 Its Application How is it related to the supply curve?
• What are the income and cross-price elasticities
Interactive PowerPoint Slides by: of demand?
V. Andreea Chiritescu
Eastern Illinois University
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Our scenario The Elasticity of Demand

• You maintain the social media accounts for local
businesses • Elasticity
– You charge $2,000 per business, and currently – Measure of the responsiveness of Qd or Qs
maintain the social media accounts for 12 to a change in one of its determinants
businesses per year.
• Your costs are rising (including the opportunity cost • Price elasticity of demand
of your time). – How much the quantity demanded of a
– You consider raising the price to $2,500. good responds to a change in the price of
• The law of demand: if you raise your price, you will that good
not have as many accounts to maintain.
• Loosely speaking, it measures the price-
– How many fewer accounts?
sensitivity of buyers’ demand
– How much will your revenue fall, or might it
increase?
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The Price Elasticity of Demand Calculating percentage changes

Price elasticity of demand is Demand for maintaining Standard method of
P percentage change in Q d social media accounts computing the percentage (%)
Cotang 𝜶  P
percentage change in P change:
B
P rises P2 15% $2500 end value  start value
  1.5
by 10% P1 10% $2000
A  100%
start value
D D
Going from A to B:
Q Along a D curve, P and Q Q
Q2 Q 1 move in opposite 8 12 • the % change in P = 25%
Q falls directions, which would • the % change in Q = - 33%
Going from B to A: Price elasticity = 33/25 = 1.33
by 15% make price elasticity
• % change in P = - 20%
negative. We get different values!
• % change in Q = 50%
We will drop the minus sign and report all price elasticities as
positive numbers (absolute values).  |Lấy trị tuyệt đối | Price elasticity =50/20 = 2.5 (2.5 + 1.3)/ 2  ???
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The Price Elasticity of Demand Our scenario: calculating percentage changes

• Midpoint method: trung điểm/ theo đoạn Demand for maintaining

Using the midpoint method
social media accounts
The midpoint is the number halfway between the P of computing % changes:
start and end values B
$2500
• The average of those values: 𝑄 = (Q1 + Q2)/2 A
$2000 40%
Type equation here.
Price elasticity =  1.8
∆ D 22.2%
𝐸 = %∆ = ∆ =
∆
×
%∆ ∆ Q
12 8
end value  start value $2500  $2000
percentage change   100% % change in P =  100%  22.2%
midpoint $2250
(Q  Q1 ) / [(Q2  Q1 ) / 2 ] 12  8
Price elasticity of demand  2 % change in Q =  100%  40%
(P2  P1 ) / [(P2  P1 ) / 2 ] 10
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Active Learning 1: Calculate an elasticity Active Learning 1: Answers

Use the following information to calculate the Using the midpoint method to calculate
price elasticity of demand for iPhones: percentage changes:
• if P = $400, Qd = 10,600 A. % change in P =
• if P = $600, Qd = 8,400 [($600 - $400)/$500] ×100 = 40%
A. Use the midpoint method to calculate B. % change in Qd =
percentage change in price [(10,600 – 8,400)/9,500] ×100 = 23.16%
B. Use the midpoint method to calculate C. Price elasticity of demand =
percentage change in quantity = % change in Qd / % change in P
C. Calculate the price elasticity of demand = 23.16/40 = 0.58
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Determinants of price elasticity of demand EXAMPLE 1: Cheerios vs. airfare

We look at a series of examples comparing • Prices of both of these goods rise by 20%.
two common goods. For which good does Qd drop the most?
• In each example: Why?
– Suppose prices of both goods rise by 20% • Cheerios has many close substitutes, so
– Which good has the highest price elasticity of buyers can easily switch if the price rises
demand? Why? • Traveling by airplanes has no close
– What lesson we learn about the determinants of substitutes, so a price increase would not
price elasticity of demand? affect demand very much
Price elasticity is higher when close
substitutes are available.
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EXAMPLE 2: Mountain Dew vs. soda (pop) EXAMPLE 3: Insulin vs. Rolex watches
• Prices of both of these goods rise by 20%. • Prices of both of these goods rise by 20%.
For which good does Qd drop the most? For which good does Qd drop the most?
Why? Why?
• For a narrowly defined good, Mountain Dew, • Insulin is a necessity to diabetics. A rise in
there are many substitutes price would cause little or no decrease in
quantity demanded
• There are fewer substitutes available for
broadly defined goods (soda / pop) • A Rolex watch is a luxury. If the price rises,
some people will forego it.
Price elasticity is higher for narrowly defined
goods than for broadly defined ones. Price elasticity is higher for luxuries than for
necessities.
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EXAMPLE 4: Gasoline, short run vs. long run The Variety of Demand Curves – 1
• The price of gasoline rises 20%. Does Qd • Demand is elastic
drop more in the short run or the long run?
– Price elasticity of demand > 1
Why?
• Demand is inelastic
• There’s not much people can do in the – Price elasticity of demand < 1
short run, other than ride the bus or carpool.
• Demand has unit elasticity
• In the long run, people can buy smaller cars or
live closer to work. – Price elasticity of demand = 1
Price elasticity is higher in the long run.

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The Variety of Demand Curves – 2 Perfectly inelastic demand

Price elasticity % change in Q 0%
• Demand is perfectly inelastic of demand
= = =0
% change in P 10%
– Price elasticity of demand = 0
P
• D curve:
– Demand curve is vertical D
Vertical
• Demand is perfectly elastic P1 • Consumers’
– Price elasticity of demand = infinity P2 price sensitivity:
– Demand curve is horizontal None
• The flatter the demand curve P falls
Q1 Q
• Elasticity:
by 10%
– The greater the price elasticity of demand Q changes 0
by 0%
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Inelastic demand Unit elastic demand

Price elasticity % change in Q <10% Price elasticity % change in Q 10%
= = <1 = = =1
of demand % change in P 10% of demand % change in P 10%
P
• D curve P • D curve
relatively steep intermediate
P1
P1 slope
P2
• Consumers’ price
sensitivity: P2 • Consumers’ price
D D
sensitivity:
P falls relatively low P falls
by 10% Q1 Q2 Q intermediate
• Elasticity: by 10% Q1 Q2 Q
Q rises less Q rises • Elasticity:
than 10%
<1 by 10% =1
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Elastic demand Perfectly elastic demand

Price elasticity % change in Q >10% Price elasticity % change in Q any %
= = >1 = = = infinity
of demand % change in P 10% of demand % change in P 0%
P • D curve P • D curve
relatively flat D horizontal
P1 P 2 = P1
• Consumers’ price P changes
• Consumers’
P2 D sensitivity: by 0% price sensitivity:
P falls
relatively high extreme
by 10% Q1 Q2 Q • Elasticity: Q1 Q2 Q • Elasticity:
Q rises more >1 Q changes infinity
than 10% by any %
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A few elasticities from the real world Elasticity along a linear demand curve
The slope of a
P linear demand
200% curve is constant,
$30 E = = 5.0
40% but its elasticity
67% is not.
20 E = = 1.0
67%
40%
10 E = = 0.2
200%

$0 Q
0 20 40 60

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Our scenario: total revenue Our scenario: elastic demand

Continuing our scenario, if you raise your price Demand for maintaining Price elasticity of
social media accounts demand = 1.8
from $2,000 to $2,500, would your revenue
increased • If P = $2,000,
rise or fall? P revenue due to Q = 12, and TR =
higher P
Total Revenue (TR) = P x Q $24,000
lost revenue • If P = $2,500,
• A price increase has two effects on revenue: $2500 due to lower Q
Q = 8, and TR =
– Higher revenue: because of the higher P $2000 $20,000
– Lower revenue: you maintain fewer accounts D
(lower Q) When D is elastic,
a price increase
• Which of these two effects is bigger? Q causes revenue to
8 12 fall.
– It depends on the price elasticity of demand
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Our scenario: inelastic demand Price Elasticity and Total Revenue

Demand for maintaining Price elasticity of
social media accounts demand = 0.82 • For a price increase, if demand is elastic
P
increased • If P = $2,000,  E > 1: % change in Q > % change in P
revenue due to
higher P
Q = 12, and TR =  TR decreases: the fall in revenue from lower
$24,000
Q > the increase in revenue from higher P
$2500 lost revenue • If P = $2,500,
due to lower Q
Q = 10, and TR= • For a price increase, if demand is inelastic
$2000 $25,000
 E < 1: % change in Q < % change in P
D
When D is inelastic,  TR increases: the fall in revenue from lower
a price increase Q < the increase in revenue from higher P
Q causes revenue to
10 12
rise.
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Active Learning 2: Elasticity and total revenue Active Learning 2: Answers, A

A. Pharmacies raise the price of insulin by A. Pharmacies raise the price of insulin by
10%. 10%.
– Does total expenditure on insulin rises or – Does total expenditure on insulin rises or
falls? falls?
B. As a result of a fare war, the price of a • Expenditure = total revenue = P x Q
luxury cruise falls 20%.
• Since demand for insulin is inelastic, Q will
– Does luxury cruise companies’ total fall less than 10%, so expenditure rises.
revenue rises or falls?

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Active Learning 2: Answers, B Does Drug Interdiction Increase

or Decrease Drug-related Crime?
B. As a result of a fare war, the price of a 1. Increase the number of federal agents
luxury cruise falls 20%. devoted to the war on drugs
– Does luxury cruise companies’ total – Illegal drugs: supply curve shifts left
revenue rises or falls?
• Higher price and lower quantity
• Revenue = P x Q – Amount of drug-related crimes
• The fall in P reduces revenue, but Q increases, • Inelastic demand for drugs
which increases revenue. Which effect is • Higher drugs price: higher total revenue
bigger? • Increase drug-related crime
• Since demand is elastic, Q will increase more
than 20%, so revenue rises.
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Policy 1: Interdiction Does Drug Interdiction Increase

or Decrease Drug-related Crime?
Price of
Interdiction reduces Drugs new value of drug- 2. Policy of drug education
the supply of drugs. related crime
D1 S2
– Reduce demand for illegal drugs
• Demand for drugs S1 – Left shift of demand curve
is inelastic: P rises P2
proportionally – Lower quantity
more than Q falls.
P1 initial value – Lower price
Result: an increase of drug-
related
– Reduce drug-related crime
in total spending on
crime
drugs, and in drug-
related crime. Q2 Q 1 Quantity
of Drugs
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Policy 2: Education Income Elasticity of Demand

new value of drug-
Price of related crime • Income elasticity of demand
Drugs
D2 D1 – How much the quantity demanded of a
Education reduces
S good responds to a change in consumers’
the demand for
drugs. income
• P and Q fall. P1 initial value – Percentage change in quantity demanded
of drug-
Result: P2 related • Divided by the percentage change in income
A decrease in total crime – Normal goods: income elasticity > 0
spending on drugs,
Q2 Q 1 Quantity – Inferior goods: income elasticity < 0
and in drug-related
of Drugs
crime.
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Cross-Price Elasticity of Demand The Price Elasticity of Supply

• Cross-price elasticity of demand • Price elasticity of supply
– How much the Qd of one good responds – How much the quantity supplied of a good
to a change in the price of another good responds to a change in the price of that
– Percentage change in Qd of the first good good
• Divided by the percentage change in price of – Percentage change in quantity supplied
the second good • Divided by the percentage change in price
– Substitutes: cross-price elasticity > 0 – Loosely speaking, it measures sellers’
– Complements: cross-price elasticity < 0 price-sensitivity

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Calculating Price Elasticity of Supply The Variety of Supply Curves – 1

Price elasticity percentage change in Q s 16% • Supply is unit elastic
of supply   2
percentage change in P 8% – Price elasticity of supply = 1
P • Supply is elastic
S
Again, we use the – Price elasticity of supply > 1
midpoint method to P rises P2
compute the by 8% P
1
• Supply is inelastic
percentage – Price elasticity of supply < 1
changes.
Q
Q1 Q2
Q rises
by 16%
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The Variety of Supply Curves – 2 Perfectly inelastic supply

Price elasticity % change in Q 0%
• Supply is perfectly inelastic of supply
= = =0
% change in P 10%
– Price elasticity of supply = 0
• S curve: P
– Supply curve is vertical S
vertical
• Supply is perfectly elastic P
• Sellers’ price P rises 2
– Price elasticity of supply = infinity sensitivity: by 10% P
1
– Supply curve is horizontal none
• The flatter the supply curve • Elasticity: Q1
Q
– The greater the price elasticity of supply 0 Q changes
by 0%
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Inelastic supply Unit elastic supply

Price elasticity % change in Q < 10% Price elasticity % change in Q 10%
= = <1 = = =1
of supply % change in P 10% of supply % change in P 10%
• S curve: P
• S curve: P
S intermediate slope S
relatively steep
• Sellers’ price P rises P2 • Sellers’ price P2

sensitivity: by 10% P1 sensitivity: P1

relatively low intermediate P rises
Q • Elasticity: by 10% Q
• Elasticity: Q 1 Q2 Q1 Q2
<1 Q rises less =1 Q rises
than 10% by 10%
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Elastic supply Perfectly elastic supply

Price elasticity % change in Q > 10% Price elasticity % change in Q any %
= = >1 = = = infinity
of supply % change in P 10% of supply % change in P 0%
• S curve: • S curve:
P P
relatively flat S horizontal
• Sellers’ price P rises P2 • Sellers’ price P2 = P1 S
sensitivity: by 10%
P1 sensitivity: P changes
relatively high extreme by 0%

• Elasticity: Q • Elasticity: Q
Q1 Q2 Q1 Q2
>1 Q rises more infinity Q changes
than 10% by any %
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The Determinants of Supply Elasticity Active Learning 3: Elasticity and changes in equilibrium
Assume the supply of parking spots is inelastic
• Greater price elasticity of supply
and the supply of wheat is elastic. Suppose
– The more easily sellers can change the population growth causes demand for both goods
quantity they produce to double (at each price, Qd doubles).
• Price elasticity of supply is greater in the • For which product will P change the most?
long run than in the short run • For which product will Q change the most?
– In the long run: firms can build new factories, A. Draw a graph with the new equilibrium in the
or new firms may be able to enter the market market for parking
B. Draw a graph with the new equilibrium in the
market for wheat

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Active Learning 3A. Parking spots Active Learning 3B. Wheat

Parking spots Wheat
When supply is (inelastic supply): When supply (elastic supply):
P
inelastic, an P S is elastic,
increase in D1 D2 an increase in D1 D2
demand has a demand has a
P2 B
bigger impact on bigger impact on B S
price than on quantity than on P2
A
P1 A P1
quantity. price.
Q Q
Q1 Q 2 Q1 Q2

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How the price elasticity of supply can vary More Applications – 1

Price Supply
1. Can Good News for Farming Be Bad
Elasticity is small
$15 (less than 1).
News for Farmers?
12 – New hybrid of wheat: 20% increased
Elasticity is large production per acre
(greater than 1). • Supply curve shifts to the right
4
3 • Higher quantity and lower price

0 100 200 500 525 Quantity

• Demand is inelastic: total revenue falls
– Paradox of public policy: induce farmers
• Supply often becomes less elastic as Q rises, due not to plant crops
to capacity limits.
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An increase in supply in the market for wheat More Applications – 2

1. When demand is inelastic, 2. Why Did OPEC Fail to Keep the Price of
Price of an increase in supply . . .
Wheat Oil High?
S1
– Increase in prices 1973-1974, 1971-1981
S2
2. … leads
$3
– Short-run: supply and demand are
to a large
fall in 2
3. … and a proportionately
smaller increase in quantity
inelastic
price. . . sold. As a result, revenue • Decrease in supply: large increase in price
falls from $300 to $220.
Demand
– Long-run: supply and demand are elastic
0 100 110 Quantity of Wheat • Decrease in supply: small increase in price

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A reduction in supply in the world market for oil THINK-PAIR-SHARE

(a) The Oil Market in the Short Run (b) The Oil Market in the Long Run In order to reduce teen smoking, the
government places a $2 per pack tax on cigarettes.
1. In the short run, when supply and 1. In the long run, when
demand are inelastic, a shift in supply and demand are After one month, the quantity demanded of cigarettes
supply. . . elastic, a shift in supply. . . has been reduced only slightly. Discuss the following:
Price
Price A. What conclusion can you draw about the one-
S2 2. … leads to a
S1
small increase S2 S1
month demand for cigarettes?
P2 in price B. Caleb suggests that the cigarette industry should
P1
P2 get together and raise the price of cigarettes
P1
further to increase total revenue .
2. … leads to a
large increase in Demand
C. Keisha suggests that only your firm should raise
price Demand the price of your cigarettes to increase total
0 Quantity 0 Quantity revenue.
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CHAPTER IN A NUTSHELL CHAPTER IN A NUTSHELL

• The price elasticity of demand • Demand tends to be more elastic if
– Measures how much the quantity demanded – Close substitutes are available
responds to changes in the price. – The good is a luxury rather than a necessity
– Is the percentage change in quantity demanded – The market is narrowly defined
divided by the percentage change in price. – If buyers have substantial time to react to a price
– If < 1, inelastic demand: quantity demanded change.
moves proportionately less than the price • Total revenue (PxQ), total amount paid for a good
– If > 1, elastic demand: quantity demanded – Moves in the same direction as P (inelastic D)
moves proportionately more than the price
– Moves in the opposite direction as P (elastic D)

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CHAPTER IN A NUTSHELL CHAPTER IN A NUTSHELL

• The income elasticity of demand • The price elasticity of supply
– Measures how much the quantity demanded – Measures how much the quantity supplied responds
responds to changes in consumers’ income to changes in the price.
• The cross-price elasticity of demand – Is the percentage change in quantity supplied
divided by the percentage change in price
– Measures how much the quantity demanded of
– If < 1, inelastic supply: quantity supplied moves
one good responds to changes in the price of
proportionately less than the price
another good
– If > 1, elastic supply: quantity supplied moves
• The tools of supply and demand can be applied to proportionately more than the price
many different kinds of markets. This chapter uses
– Depends on the time horizon under consideration.
them to analyze the market for wheat, the market
In most markets, supply is more elastic in the long
for oil, and the market for illegal drugs. run than in the short run.
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