Elasticity

Price Elasticity of Demand

• A measure of the responsiveness of quantity
demanded to changes in price.
• Measured by dividing the percentage change in the
quantity demanded of a good by the percentage
change in its price.
• Economists compute price elasticity of demand
using midpoints as the base values of changes in
prices and quantities demanded.
Computing Elasticity of Demand
We divide the change
in quantity demanded
by the average quantity
demanded, all of which
is then divided by the
change in price divided
by the average price.
 Perfectly Elastic and Perfectly Inelastic
Demand
Percentage change in quantity demanded
Ed = -------------------------------------------
Percentage change in price

• Elastic Demand (Ed > 1): the numerator is

greater than the denominator, the coefficient
is greater than 1 and demand is elastic.
• Inelastic Demand (Ed < 1): the numerator is
less than the denominator , the coefficient is
less than 1, and demand is inelastic.
 Perfectly Elastic and Perfectly Inelastic
Demand
• Unit Elastic Demand (Ed = 1): If the numerator and
denominator are the same, the coefficient is equal to one.
The quantity demanded changes proportionally to a change
in price.
 Elastic and Inelastic Demand
• Perfectly Elastic Demand (Ed = ) If the
quantity demanded is extremely responsive
to a change in price.
• Perfectly Inelastic Demand (Ed = 0) If
quantity demanded is completely
unresponsive to changes in price, demand is
perfectly inelastic. A change in price causes
no change in quantity demanded.
Price Elasticity of Demand
 Price Elasticity of Demand and Total
Revenue
• Total Revenue (TR) of a seller equals the price of a good
times the quantity of the good sold.
• Total revenue may increase, decrease or remain constant.
• If demand is elastic, a price rise decreases total revenue.
• If demand is elastic, a price fall increases total revenue.
• If demand is inelastic, a price fall decreases total revenue.
• If demand is unit elastic, a price fall will sell more goods
while total revenue remains constant.
 Elasticities,
Price Changes
and Total
Revenue
 Q&A
• On Tuesday, price and quantity demanded are $7 and 120
units, respectively. Ten days later, price and quantity are $6
and 150 units, respectively. What is the price elasticity of
demand between the price of $6 and $7?
• What does a price elasticity of demand of 0.39 mean?
• Identify what happens to total revenue as a result of each of
the following: price rises and demand is elastic; price falls
and demand is inelastic; price rises and demand is unit
elastic; price rises and demand is inelastic; price falls and
demand is elastic.
• Alexi says, “When a seller raises his price, his total revenue
rises.” What is Alexi implicitly saying?
Price Elasticity of Demand Along a
Demand Curve
 Determinants of Price Elasticity on
Demand
• Number of Substitutes: The more
substitutes for a good, the higher the price
elasticity of demand; the fewer substitutes
for a good, the lower the price elasticity of
demand.
• The more broadly defined the good, the
fewer the substitutes; the more narrowly
defined the good, the greater the substitutes.
 Determinants of Price Elasticity on
Demand
• Percentage of One’s Budget Spent on the Good:
The greater the percentage of one’s budget that
goes to purchase a good, the higher the price
elasticity of demand; the smaller the percentage of
one’s budget that goes to purchase a good, the
lower the elasticity of demand.
• Time: The more time that passes, the higher the
price elasticity of demand for the good; the less
time that passes, the lower the price elasticity of
demand for the good.
 Q&A
• If there are 7 substitutes for good X and demand is
inelastic, does it follow that if there are 9
substitutes for good X demand will be elastic?
Explain your answer.
• Price elasticity of demand is predicted to be higher
for which good of the following combinations of
goods: Compac computers or computers; Heinz
ketchup or ketchup; Perrier water or water?
Explain your answers.
 Cross Elasticity of Demand
• Measures the responsiveness in the quantity
demanded of one good to changes in the price of
another good.
• Defined as the percentage change in the quantity
demanded of one good divided by the percentage
change in the price of another good.
• This concept is often used to determine whether
two goods are substitutes or complements and the
degree to which one good is a complement to or
substitute for another.
 Income Elasticity of Demand
• Measures the responsiveness of quantity demanded
to changes in income.
• Define as the percentage change in quantity
demanded of a good divided by the percentage
change in income.
• Income elasticity of demand is positive (Ey > 0) for
a normal good.
• The demand for an inferior good decreases as
income increases.
Income Elasticity of Demand
• If Ey >1, demand is
considered to be
income elastic.
• If Ey <1, demand is
considered to be
income inelastic.
• If Ey =1, demand is
considered to be unit
elastic.
 Price Elasticity of Supply
• Measures the responsiveness of quantity
supplied to changes in price.
• Defined as the percentage change in quantity
supplied of a good divided by the percentage
change in the price of the good.
• Supply can be classified as elastic, inelastic,
unit elastic, perfectly elastic, or perfectly
inelastic.
Price Elasticity of Supply
Price Elasticity of Supply and Time
• The longer the period
of adjustment to a
change in price, the
higher the price
elasticity of supply.
• Additional production
takes time.
• Reducing production
takes time.
Summary of the Four Elasticity Concepts
 Who Pays the Tax?
A tax placed on the
sellers of VCR tapes
shifts the supply curve
from S1 to S2 and
raises the equilibrium
price from $8 to
$8.50. Part of the tax
is paid by buyers
through a higher price
paid, and part of the
tax is paid by sellers
through a lower price
kept.
Different Elasticities and Who Pays the Tax
 Q&A
• What does an income elasticity of demand of 1.33
mean?
• If supply is perfectly inelastic, what does this
signify?
• Why will government raise more tax revenue if it
applies a tax to a good with inelastic demand than
if it applies the tax to a good with elastic demand?
• Under what condition would a per-unit tax placed
on the sellers of computers be fully paid by the
buyers of computers?