Ch.

18: Elasticity

Del Mar College

John Daly
©2003 South-Western Publishing, A Division of Thomson Learning
 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 Straight Line 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.
• Necessities Versus Luxuries: The more that a good
is considered a luxury rather than a necessity, the
higher the price elasticity of demand.
 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: Compaq 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
• A tax placed on the
sellers of VCR tapes Who Pays the Tax?
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.
• Tax revenues are
maximized by placing the
tax on the seller who
faces the more inelastic
demand curve.
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?