ELASTICITY

1
OUTLINE
 The concept of elasticity
 Price elasticity of demand (Own Price elasticity)
 Calculating elasticities of demand
 Elastic, inelastic and unitary elastic
 Relationship between price elasticities of demand
and revenues/expenditures
 Determinants of price elasticity of demand
 Income elasticity and cross elasticity
 Price elasticity of supply
 Determinants of Price Elasticities of supply
 The Concept of Elasticity
Did You Know That...
 Consumers respond to changing prices and
incomes in ways that influence total revenues
that businesses or firms receive?
 Economists have a special name for quantity
responsiveness - elasticity, which is the
subject of this unit.
 The Concept of Elasticity
 Elasticity refers to the responsiveness of one
variable to changes in another

 In the case of demand and supply, elasticity

refers to the responsiveness of quantity
demanded or supplied to changes in one of the
determinants of demand or supply, holding the
other factors constant.
 The Concept of Elasticity
 It measures the percentage change in the quantity
demanded or supplied of a product given a percentage
change in one of the determinants of demand or supply,
ceteris paribus

 When price rises, what happens

to demand?
 Demand falls
 BUT! By how much does demand fall? Elasticity
measures the magnitude by which demand falls
 The Concept of Elasticity
 If price rises by 10% - what happens to demand?

 We know that demand will fall but will it fall

1. By more than 10%? Or
2. By less than 10%? Or
3. By 10%?

 Elasticity measures the extent to which demand

will change
 The Concept of Elasticity
 Generally, elasticity is defined in mathematical
terms as:

 This is the percentage change in the dependent

variable caused by a percentage change in the
independent variable.
 The Concept of Elasticity
4 basic types used:
 Price elasticity of demand
 Income elasticity of demand
 Cross elasticity
 Price elasticity of supply
Price Elasticity of
Demand
 Price Elasticity of Demand
 Also called the “own” price elasticity of
demand, denoted by

 It measures the responsiveness of buyers to

changes in the good’s “own” price OR

 The responsiveness of quantity demanded of

a commodity to changes in its price.
 Price Elasticity of Demand
 It therefore, reflects a movement along a
given demand function

 Price elasticity measures the percentage

change in the quantity demanded “caused” by
a percentage change in the price.

 It is calculated as:
 Arc Price Elasticity of Demand
 A distinction is made between “arc” and “point” price elasticities of
demand.

 Arc price elasticity of demand measures the elasticity of demand over an

interval (between two points) on the demand function.

 Instead of using the price and quantity at a point as in point elasticity,

arc elasticity uses the average of the prices and quantities at the
beginning and end of the stated interval:

12
 Arc Price Elasticity of Demand
Elasticity Formula
Change in Q Change in P
Ep =
Sum of quantities/2 Sum of quantities/2

or

in Q in P
Ep =
(Q1 + Q2)/2 (P1 + P2)/2
 Arc Price Elasticity of Demand

] X 100
 Exhibit 1: Demand Curve for Tacos

For the price

elasticity to be a useful
measure, we should K1.10 a
come up with the same

Price
result between points a K0.90 b
and b as we get
between b and a.
To do this we must
take the average of the
initial price and the
new price (initial
quantity and the new D
quantity) and use that
as the base in
computing the percent 0 95 105
change in price Thousands per day
Price elasticity between a and b =
10% / - 20% = - 0.5 15
 Point Elasticity of Demand
 Given the linear demand function, P=a-bQ, the
formula for point elasticity of demand at any point
(P0,Q0) is

16
 Price Elasticity of Demand
 Price Elasticity of Demand (Ep)

Percentage change in quantity demanded

Ep =
Percentage change in price
 Price Elasticity of Demand
• Example
– Price of oil increases by 10%
– Quantity demanded decreases by 1%

–1%
Ep = = –.1
+10%
 Price Elasticity of Demand
Question
– How would you interpret an elasticity
of –0.1?
Answer
– A 10% increase in the price of oil will lead to a 1%
decrease in quantity demanded.
 Price Elasticity of Demand
Relative quantities only
– Elasticity is measuring the change in quantity
relative to the change in price.
Always negative
– An increase in price decreases the quantity
demanded, ceteris paribus.
– By convention, the minus sign is ignored.
 Price Elasticity of Demand
 Because the average quantity and average price
are used as a base for computing percentage
change, the same elasticity results whether going
from the higher price to the lower price or the
other way around

 Since the focus is on the percentage change, we

need not be concerned with how output or price is
measured (units are not necessary)

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 Price Elasticity of Demand
 Because price and quantity demanded are inversely
related, the price elasticity of demand has a negative sign
 This tends to be cumbersome, thus it is common place to
discuss the price elasticity of demand as an absolute value
 positive number
 For example, absolute value of the elasticity for tacos
computed earlier will be referred to as 0.5 rather than –0.5
 Categories of Price Elasticity
Three general categories
1. Percentage change in quantity demanded is
smaller than the percentage change in price
 The price elasticity has an absolute value
between 0 and 1.0 implying that demand is
inelastic
 This means that the quantity demanded is
relatively unresponsive to changes in the price
 Categories of Price Elasticity
2. Percentage change in quantity demanded is just
equal to percentage change in the price
 The price elasticity with an absolute value of 1
 This is referred to as unitary elastic demand
3. Percentage change in quantity demanded exceeds
percentage change in price
 The price elasticity has an absolute value exceeding
1.0
 This implies that demand is elastic. That is, quantity
is responsive to changes in prices
 Price Elasticity Ranges
Elastic Demand
– Percentage change in quantity demanded is larger
than the percentage change in price
– Total expenditures/revenues and price are
inversely related in the elastic region of the
demand curve
– Ep > 1
 Price Elasticity Ranges
Unit Elasticity of Demand
– Percentage change in quantity demanded is equal
to the percentage change in price
– Total expenditures/revenues are invariant to price
changes in the unit-elastic region of the demand
curve
– Ep = 1
 Price Elasticity Ranges
Inelastic Demand
– Percentage change in quantity
demanded is smaller than the percentage change in
price
– Total expenditures and price are
directly related in the inelastic region
of the demand curve
– Ep < 1
 Price Elasticity Ranges
Elastic demand
– % change in Q > % change in P; Ep > 1
Unit-elastic
– % change in Q = % change in P; Ep = 1
Inelastic demand
– % change in Q < % change in P; Ep < 1
 Price Elasticity Ranges
 Extreme elasticities
– Perfectly Inelastic Demand
 A demand curve that is a vertical line
 It has only one quantity demanded for
each price.
 No matter what the price, quantity demanded does not change.
 A demand that exhibits zero responsiveness to price changes.
Extreme Price Elasticities
 Price Elasticity Ranges
Extreme elasticities
– Perfectly Elastic Demand
 A demand curve that is a horizontal line
 It has only one price for every quantity.
 The slightest increase in price leads to zero quantity
demanded.
Extreme Price Elasticities
 The demand curve
can be a range of
shapes each of

Price (£)
Elasticity which
associated with a
is

different
relationship
between price and
the quantity
demanded.

Quantity Demanded
 Importance of Elasticity
 Relationship between changes
in price and total revenue

 Important in determining
what goods to tax (tax revenue)

 Important in analysing time lags in production

 Influences the behaviour of a firm

Price Elasticity and
Total Revenue
 Price Elasticity and Total Revenue
 The demand function is a relationship between price and
quantity.

 Price elasticity is determined by the slope of the demand

function and the location (price and quantity) on the demand
function.

 Total Revenue (TR) is the product of price and quantity, (TR

= PQ).

 As a consequence, demand, and TR are related.

 Price Elasticity and Total Revenue
Price
Total
The revenue
importance of elasticityis
is the information it
price x quantity
provides on the effect on
sold.
total Inchangesthis
revenue of in
price.
example, TR = K5
K5 x 100,000 =
K500,000.
This value is
represented by the
Total Revenue shaded rectangle.

100 Quantity Demanded (000s)

Price Elasticity and Total Revenue
 What happens to total revenue when price decreases?
Lower price  producers get less for each unit sold
 total revenue declines
Lower price  increases quantity demanded  total
revenue increases
 Overall impact of lower price on total revenue
depends on the net result of these opposite effects
 This is where the responsiveness of quantity
demanded is used to determine the impact of a fall in
the price on total revenue

38
 Price Elasticity and Total
revenue If the firm
decides to
Price
decrease price to
(say) K3, the
degree of price
elasticity of the
K5 demand curve
would determine
the extent of the
K3 increase in
demand and the
change therefore
Total Revenue
in total revenue.
D
100 140 Quantity Demanded (000s)
Price Elasticity and Total Revenue
 When demand is elastic, the percentage increase in quantity demanded
exceeds the percentage decrease in price  total revenue increases

 When demand is unitary elastic, the two (change in quantity

demanded and change in price) are equal  total revenue remains
unchanged

 When demand is inelastic, the percentage increase in quantity

demanded is more than offset by the percentage decrease in price 
total revenue decreases
 Exhibit 2: Demand, Price Elasticity and Total Revenue
(a) Demand and Price Elasticity
$100
Panel (a) shows the 90
80
linear demand curve 70
and panel (b) shows the

Price per unit

60
total revenue generated 50
40
by each price-quantity 30
combination along the 20
demand curve 10
D
Because the demand
0 100 200 500 800 900 1,000
curve is linear, its slope Quantity per period
is constant: a given (b) Total Revenue
decrease in price
TR = p x q
always causes the same $25,000
unit increase in
Total revenue

quantity demanded
However, the price Total
revenue
elasticity of demand is
larger on the high end
of the demand curve
than it is on the low 0 500 1,000
Quantity per period
price end 41
Exhibit 2: Demand, Price Elasticity and Total Revenue
Consider a movement
from point a to point b
on the demand curve.
(a) Demand and Price Elasticity
The 100-unit increase in $100
quantity demanded is a 90
a
percentage change of 80
100/150 = 67% while the 70
b
$10 drop in price is a
60
percent change of 10/85
= 12%  the price 50
c
elasticity of demand here 40
Price per unit

is 5.6 30
Between points d and
20
e, the 100 quantity d
10
increase is a 12% change e D
and the $10 price
decrease is a 67% price 0 100 200 500 800 900 1,000
decrease  price Quantity per period
elasticity of 0.2
42
Exhibit 2: Demand, Price Elasticity and Total Revenue
$100 (a) Demand and Price Elasticity
When demand is 90 a Elastic ED > 1
80
elastic, a decrease in price 70 b
(from a to b) will increase Unit elastic ED = 1

Price per unit

60
total revenue because the 50 c
gain in revenue from 40
30
Inelastic ED < 1
selling more units (blue
20
box) exceeds the loss in 10
d
e D
revenue from selling all
units at a lower price (red 0 100 200 500 800 900 1,000
box) Quantity per period
When demand is
(b) Total Revenue
inelastic, a price decrease
(from d to e) reduces total $25,000
TR = p x q
revenue because the gain
Total revenue

in revenue from selling

more units (blue box) is
Total
less than the loss in revenue
revenue at the lower price
(red box)

0 Quantity per period 500 1,000

43
 Exhibit 3: Constant Elasticity Demand Curves

(a) Perfectly elastic (b) Perfectly inelastic (c) Unit elastic

demand curve demand curve demand curve
D'
Price per unit

Price per unit

Price per unit

E D= 1
E D= ¥ D
p E D= 0
$10 a

6 b
D"

0 Quantity 0 Q Quantity 0 60 100 Quantity

per period per period per period

This demand curve This demand curve This demand curve is

indicates consumers will indicates that quantity unit-elastic everywhere:
demand all that is offered demanded does not vary any percent change in
at the given price, p. If the when the price changes; no price results in an
price rises above p, matter how high the price, identical offsetting
quantity demanded drops consumers will purchase the percent change in
to zero. same quantity. quantity demanded.
44
 Price Elasticity and Total Revenue
When demand is elastic (the upper portion of the
demand curve), a negative relationship exists between
changes in price and changes in total revenues.

 Note that in the upper portion of the demand curve,

the demand curve has a negative slope and TR has a
positive slope.

 This will help you remember that price and TR move

in the opposite directions
Price Elasticity and Total Revenue
 Thus, as price rises, TR will decrease and as
price decreases, TR will increase

When demand is unitary-elastic (mid-point),

changes in price do not change total revenues.

 At this point, the maximum value of TR will

be achieved and the slope of the TR is zero
Price Elasticity and Total Revenue
When demand is inelastic (lower portion of the
demand curve), a positive relationship exists
between changes in price and total revenues.

 In the lower portion of the demand curve, both

the TR and demand curves have negative slopes

 Thus, as price increases, TR will rise and as

price falls, TR will decrease
Price Elasticity and Total Revenue
Price (K)
Producer decides to lower price to attract sales

10 % Δ Price = -50% (use point elastici

% Δ Quantity Demanded = +20%
Ped = -0.4 (Inelastic)
5 Total Revenue would fall
Not a good move!

D
5 6
Quantity Demanded
 Price Elasticity and Total Revenue
Price (K)
Producer decides to reduce price to increase sales
% Δ in Price = - 30%
% Δ in Demand = + 300%
Ped = - 10 (Elastic)
Total Revenue rises
10
Good Move!
7
D

5 Quantity Demanded 20
 Price Elasticity and Total Revenue
• If demand is price • If demand is price
elastic: inelastic:
• Reducing price would • Reducing price would
increase TR (%Δ Qd > decrease TR
% Δ P) (%Δ Qd < % Δ P)
• Increasing price would • increasing price would
reduce TR increase TR (%Δ Qd <
(%Δ Qd > % Δ P) % Δ P)
The Relationship Between Price Elasticity of Demand
and Total Revenues for Cellular Phone Service
The Relationship Between Price Elasticity of Demand
and Total Revenues for Cellular Phone Service
The Relationship Between Price Elasticity of Demand
and Total Revenues for Cellular Phone Service
 Relationship Between
Price Elasticity of Demand and
Total Revenues Example
Determinants of Price Elasticity of Demand

The price elasticity of demand is influenced by the

following factors:

1. Number and Availability of Substitutes: If a product

can be easily substituted, its demand is elastic

 If a product cannot be substituted easily, its demand is

inelastic, like gasoline.
Determinants of Price Elasticity of Demand

 The demand for a class of goods (soft drinks)

is usually more inelastic than the demand for a
specific brand of the good (Pepsi or Coca-
Cola).

 A firm may try to differentiate their product to

make the demand relatively more inelastic.
Determinants of Price Elasticity of Demand

2. Luxury Vs Necessity: Necessity's demand is usually

inelastic because there are usually very few substitutes
for necessities.

 Luxury product, such as leisure sail boats, are not

needed on daily bases.

 There are usually many substitutes for these products.

 So their demand is more elastic.

Determinants of Price Elasticity of Demand

3. The Proportion of Income Taken Up by the Product:

 Because spending on some goods represents a large share of

the consumer’s budget, a change in the price of such a good
has a substantial impact on the amount consumers are able
to purchase

 Generally, the more important the item is as a share of the

consumer’s budget, other things constant, the greater will be
the income effect of a change in price, the more price elastic
will be the demand for the item
Determinants of Price Elasticity of Demand
 In other words, the larger the percentage of income spent on
a good, the more elastic its demand is.

 A change in these products' price will be highly noticeable

as they affect consumers' budget with a bigger magnitude.
 Consumers will respond by cutting back more on these
products when price increases.

 On the other hand, the smaller the percentage of income

spent on a good, the less elastic is its demand (more
inelastic)
Determinants of Price Elasticity of Demand

4. Time lag: The longer the time consumers or buyers

have to make adjustments in their behavior after the
price change, the more elastic the demand is likely
to be

 This is because consumers are given more time to

carry out their actions or adjust to price changes

 A 1-day sale usually generates less sales change per

day as a sale lasted for 2 weeks.
Determinants of Price Elasticity of Demand

 For instance, the absolute value of the short

run price elasticity of demand for gasoline
would be smaller than the absolute value of
the long run price elasticity of demand.

 Thus, price elasticity is greater in the long run

than in the short run.
 Demand Becomes More Elastic over Time

Suppose the price

increases from the initial
price of $1.00 to $1.25. $1.25

Price per unit

Dw shows that one week
1.00
after the price increase, the
quantity demanded has not
changed much, from 100 to Dy
95
After one month, Dm, it
has declined to 75, and Dm
Dw
after one year, Dy, to 50
The longer the time 0 50 75 95 100
period the larger the Quantity per period
response to a given price
change
Determinants of Price Elasticity of Demand

How to Define the Short Run and the Long

Run
– The short run is a time period too short
for consumers to fully adjust to a
price change, other things constant
– The long run is a time period long enough for
consumers to fully adjust to a change in price,
taking into account changes in other factors
Short-Run and Long-Run Price Elasticity of
Demand
With more time for
adjustment the
demand curve
becomes more
elastic and quantity
demanded falls by
a greater amount

In the short run, quantity

demanded falls slightly
Price Elasticities of Demand for Selected
Goods
 How can you interpret the elasticities for each
of the selected goods?????!!!
Income Elasticity
of Demand
 Income Elasticity of Demand
Measures the responsiveness of buyers to
changes in their income, holding the price of a
commodity and other factors constant

In other words, income elasticity of demand

measures the magnitude of change in demand due
to a change in income

It is the percentage change in demand caused by

a percentage change in income.
 Income Elasticity of Demand
 Since income is a shift factor for demand, then
income elasticity of demand measures the shift
in the demand curve caused by a change in the
income

Percentage change in demand

EM=
Percentage change in income
 Income Elasticity of Demand

] X 100
 The income elasticity of demand can be either negative (˂0)or
positive (˃0).
 Remember that in calculating the income
elasticity of demand, the price of the good is assumed to be
constant.
 Income Elasticity of Demand
 Categories
1. Goods with ˂ 0 are called inferior goods: demand declines
with an increase in income or demand rises with a decrease
in income

2. Goods with 0 ˂ ˂ 1 are called normal goods.

 This means that when income increases, then demand also
increases or when income reduces, demand also falls
 In this case, when income elasticity is greater than zero but
less than 1, the good is said to be income inelastic 
demand increases but not as much as does income (demand
increases by less than the increase in demand)
 Income Elasticity of Demand
3. Normal goods for which ˃ 1 are called superior
goods and are income elastic  demand not only
increases when income increases but increases by
more than does income
Example: jewelry
 Income increases by 10%
 Qd jewelry increases by 35%
 Income Elasticity of Demand

Interpretation?!!!
 How Income Affects Quantity of DVDs
Demanded

 Calculate and interpret the income elasticity of

DVDs.

 Based on the income elasticity, what type of

good are DVDs?
 Income Elasticity of Demand
 For example:
 = - 0.6: Good is an inferior good but inelastic – a rise in income of 3%
would lead to demand falling
by 1.8%
 = + 0.4: Good is a normal good but inelastic –
a rise in incomes of 3% would lead to demand rising
by 1.2%
 = + 1.6: Good is a normal good`(Superior good) and elastic –
a rise in incomes of 3% would lead to demand rising
by 4.8%
 = - 2.1: Good is an inferior good and elastic –
a rise in incomes of 3% would lead to a fall in demand of 6.3%
CROSS PRICE ELASTICITY
OF DEMAND
 Cross Price Elasticity of Demand
 Cross price elasticity is used as a measure of the
relationship between two goods (either compliments or
substitutes)

 Since firms often produce an entire line of products, it has

a special interest in how a change in the price of one
product will affect the demand for another

 The responsiveness of the demand for one good to changes

in the price of another good is called the cross-price
elasticity of demand.
 Cross Price Elasticity of Demand
 Defined as the percent change in the demand
for one good (holding its price constant)
divided by the percent change in the price of
another good

 It measures the size of shift in demand curve

when the price of a related good changes
 Cross Price Elasticity of Demand
 Formula for computing cross price elasticity of
demand between good Xand good Y
 Cross Price Elasticity of Demand
 This formula shows how the relationship between the
price of Y and the demand for X can be measured.

 The relationship between the price of X and the demand

for Y can also be measured using the cross price
elasticity of demand as:

Eyx = %Δ Qy/%Δ Px

 The value of Exy is not the same as or equal to Eyx

 Cross Price Elasticity of Demand
Substitutes
– Exy ˃ 0 (positive relationship between X and Y)
 An increase (decrease) in the price of X
would increase decrease) the quantity of Y
demanded at each price.

 An increase (decrease) in the price of Y

would increase (decrease) the quantity of X
demanded at each price
 Cross Price Elasticity of Demand
Complements
– Exy ˂ 0 (Negative relationship between X and
Y)
 An increase (decrease) in the price of X
would decrease (increase) the quantity of Y
demanded at each price.

 An increase (decrease) in the price of Y

would decrease (increase) the quantity of X
demanded at each price
 Cross Price Elasticity of Demand
 If Exy is close to zero, that would be evidence
that the two goods were not related.

 If Exy were positive or negative and significantly

different from zero, it could be used as evidence
that the two goods are related.

 It is possible that Exy might be positive or

negative and the two goods are not related.
 Cross Price Elasticity of Demand
 The price of gasoline has gone up and the
demand for PC’s has also increased.

 This does not mean that gasoline and PC’s are

substitutes.
 Example: Peanut butter
 What happens to Qd of PB,
when the price of jelly rises?
 PB & jelly are complements

Price of jelly = $3 per jar, Qd PB = 2 jars per month

Price of jelly = $4 per jar, Qd PB = 1 jar per month

 % change in Qd PB
1 jar - 2 jars
x 100 = - 66.7%
1.5 jars

% change in P of jelly
$4 - $3
x 100 = 28.6%
$3.5
 Cross Price Elasticity of PB
 With respect to price of jelly

% change in Qd PB
% change in P jelly

- 66.7%
= - 2.33
28.6%
 Example: Peanut butter
 What happens to Qd of PB,
when price of butter rises?
 PB & butter are substitutes

P butter = $1 stick, Qd PB = 2 jars per month

P butter = $3 stick, Qd PB = 2.2 jars per mo.

 % change in Qd PB
2.2 jar - 2 jars
x 100 = 9.5%
2.1 jars

% change in P of butter
$3 - $1
x 100 = 100%
$2
 Cross Price Elasticity of PB
 With respect to price of butter

% change in Qd PB
% change in P butter

9.5%
= .095
100%
 Price Elasticity of Supply

 The price elasticity of supply measures how

responsive producers are to a price change

 The responsiveness of the quantity supplied of a

commodity to a change in
its price

 Equals the percent change in quantity supplied

divided by the percent change in price

91
 Price Elasticity of Supply
 Formula for computing price elasticity
of supply

Percentage change in quantity supplied

ES =
Percentage change in price

 Since the quantity supplied and the price are positively

sloped, the price elasticity of supply is normally a
positive number
Price Elasticity of Supply

93
 Price Elasticity of Supply

 If the price increases from p to p', the

quantity supplied increases from q to q‘

 The price elasticity of Es is

q
Es 
(qq) / 2
p
(pp) / 2

 Where  q is the change in quantity supplied

and  p is the change in price.
94
 Price Elasticity of Supply
Example

• Bunch of roses
• P = $40/bunch, Qs = 6 (million bunches)
• P = $60, Qs = 15 (million bunches)
 % change in Qs

15 - 6
x 100
(6+15)/2

9
x 100 = 86%
10.5
 % change in P

60 - 40
x 100
(60+40)/2

20
x 100 = 40%
50
 Price Elasticity of Supply
% change in Qs
% change in P
86%
= 2.15
40%
Interpretation
 If the price of roses rises by 1%, Qs rises by
2.15%
Categories of Elasticity of Supply
 The terminology for supply elasticity is the same
as for elasticity of demand

1. If Es < 1, supply is inelastic: it will be difficult for

suppliers to react swiftly to changes in price

 It means that the percentage change in the quantity

supplied is less than the percentage change in the price of a
product.

100
Categories of Elasticity of Supply
2. If Es = 1, supply is unitary elastic: The percentage change in
the price is equal to the percentage change in the quantity
supplied

3. If Es > 1, supply is elastic: supply can react quickly to

changes in price

 It implies that the percentage change in quantity supplied is

more than the percentage change in the price of a commodity
 Inelastic Supply
 Steep curve
P
big change in P
small change in Qs

Q
 Elastic Supply
 Flatter curve
P
small change in P
S
big change in Qs

Q
 Perfectly Inelastic Supply
 Vertical line
P
Change in P
No change in Qs

Q
 Perfectly Elastic Supply
 Horizontal line
P
Any change in P
Qs falls to zero
S

Q
 Exhibit 8: Constant-Elasticity Supply Curves

(a) Perfectly elastic (b) Perfectly inelastic (c) Unit elastic

S'
Price per unit

Price per unit

Price per unit
S"
ES= ¥ ES= 1
p S ES= 0 $10

0 Quantity per period 0 Quantity per period 0 10 20 Quantity

Q per period

At one extreme is the The most unresponsive Any supply curve that
horizontal supply curve. relationship is where there is a straight line from
Here producers will is no change in the quantity the origin such as
supply none of the good at supplied regardless of the shown above is a
a price below p, but will price where the supply unitary-elastic supply
supply any amount at a curve is perfectly vertical. curve.
price of p 106
The Extremes in Supply Curves
 Determinants of Price Elasticity of Supply

 The responsiveness of sellers to changes in the price depends on

how easy it is to alter output when price changes

 If the cost of supplying additional units rises sharply as output

expands, then a higher price will elicit little increase in quantity
supplied

 But if the marginal cost rises slowly as output expands, the lure of a
higher price will prompt a large increase in output
 Determinants of Price Elasticity of
Supply
1. Production Possibilities
 Can you make more easily?

If NO : then supply is inelastic

If YES : then supply is elastic
 Example
 Oceanfront property
– can’t make more
– Inelastic supply
 Salt
– almost an infinite amount
– elastic supply
 Determinants of Price Elasticity of
Supply
2. Can you store it easily/cheaply?

– If YES, then supply is elastic

– If NO, then supply is inelastic
 Determinants of Price Elasticity of
Supply
Example
 Bananas
– storage time limited
– supply inelastic
 Determinants of Price Elasticity of
Supply
3. Length of Time
 Supply also becomes more elastic over time as producers
adjust to price changes

 The longer the time period under consideration, the more

able producers are to adjust to changes in relative prices

 The longer the time allowed for adjustment, the more

resources can flow into (out of) an industry through
expansion (contraction) of existing firms.
 Determinants of Price Elasticity of
Supply
 The longer the time allowed for adjustment,
the entry (exit) of firms increases (decreases)
production in an industry.

 It takes time to produce, thus in the short-run,

supply is inelastic whereas it is elastic in the
long-run
Short-Run and Long-Run Price Elasticity
of Supply
As time passes the supply
curve rotates from S1 to S2 and
quantity supplied rises to Q1

As more time passes the

supply curve rotates from S2
to S3 and quantity supplied
rises from Q1 to Q2
 Supply Becomes More Elastic over Time

Sw is the supply

Sw Sm
curve when the period
of adjustment is a Sy
week.
Sm is the supply $1.25
Price
curve when the 1.00
adjustment period is
one month; supply
more elastic and
quantity supplied
increases to 140
After one year the
supply curve becomes
Sy and the quantity 0
supplied increases to 100 140 200 Quantity per period
200 110

116
 Example
 Hotel Rooms
– takes time to build
– Supply is inelastic in short-run
and elastic in long-run
Estimated Price Elasticities of Demand for
Selected Illicit Drugs
 Summary of Discussion
 Expressing and calculating the price elasticity
of demand
– Percentage change in quantity demanded divided
by the percentage change in price
 Summary of Discussion
 The relationship between the price elasticity of
demand and total revenues
– When demand is elastic, price and total revenue
are inversely related.
– When demand is inelastic, price and total revenue
are positively related.
– When demand is unitary-elastic, total revenue
does not change when price changes.
 Summary of Discussion
 Factors that determine price elasticity
of demand
– Availability of substitutes
– Percentage of a person’s budget spent on the good
– The length of time allowed for adjustment to a
price change
– Type of good: luxury or necessity
 Summary of Discussion
 The cross price elasticity of demand and using it to
determine whether two goods are substitutes or
complements
– Percentage change in the demand for one good divided by
the percentage change in the price of a related good
– If cross elasticity is positive, the goods are substitutes.
– If cross elasticity is negative, the goods are complements.
 Summary of Discussion
 Income elasticity of demand
– Responsiveness of the demand for the good to a
change in income
– Percentage change in the demand for a good
divided by the percentage change in income.
 Summary of Discussion
 Classifying supply elasticities and how the length of time for
adjustment affects price elasticity of supply
– Elastic supply: price elasticity of supply is greater than 1
– Inelastic supply: price elasticity of supply is less than 1
– Unit-elastic supply: price elasticity of supply is equal to 1
– The longer the time period for adjustment, the more elastic
is supply.
~END~