1. Price Elasticity of Demand and Supply
Tutor2u Economics
March 2001
Price Elasticity of Demand and Supply

2. Definition of Price Elasticity
Price elasticity (Ped) measures responsiveness of
demand to change in price of good itself
Ped = % change in Qdx / % change in Px
When price falls we expect to see an expansion of
demand
When price rises we expect to see a contraction of
demand
Therefore an inverse relationship between price and
demand (negative value for Ped)
Price Elasticity of Demand and Supply

3. Price elasticity of demand
% change in quantity demanded
Ped =
% change in price
Ped > 1 elastic demand
Ped = 1 unit-elastic demand
Ped < 1 inelastic demand
Price Elasticity of Demand and Supply

4. Straight-line demand curve
Price
ED > 1
El
ast i
c
ED = 1 Unit elastic
In
ela ED < 1
st i
c
0
Quantity demanded
Price Elasticity of Demand and Supply

5. Extreme values for elasticity
Price D Price
D
Insulin
Perfectly inelastic demand Perfectly elastic demand
ED = 0 ED = o o
Price Elasticity of Demand and Supply

6. Range and Meaning of Ped
Type Value of ε Meaning
Perfectly 0 No change in quantity when
Inelastic price changes
Inelastic <1 Quantity changes by less
than price
Unit Elasticity 1 Quantity & price change by
same %
Elastic >1 Quantity changes by more
than price
Perfectly ∞ Demand only exists at one
Elastic price
Price Elasticity of Demand and Supply

7. Factors that determine Ped
The closer the substitutes for a good, the more elastic is demand
The more substitutes for a good, the more elastic is demand
The lower the cost of substitution the more elastic is demand
The higher the proportion of income spent on a good, the more
elastic is demand
The greater the time elapsed since a price change, the more
elastic is demand
Necessities have an inelastic demand. Luxuries have more elastic
demand. Habit forming goods tend to have an inelastic demand
Price Elasticity of Demand and Supply

8. Elastic or inelastic demand?
Gateway cuts the price of their desktop PCs by 10%
A fall in the price of Euro-star tickets
An increase in the price of the Financial Times
A taxi home from a night-club on a Friday night
A rise in average car insurance premiums
A two week foreign holiday for a student to Greece
Motorway petrol prices rise by 5% after the budget
Vodafone cuts their mobile phone charges
Price Elasticity of Demand and Supply

9. Time Frame and Elasticity
Longer time frame => more elastic demand
Two World oil price shocks of the 1970s
 Response to higher oil prices was modest in the immediate
period after price increases,
 As time passed, people found ways to consume less
petroleum and other oil products
better mileage from their cars
higher spending on insulation in homes
car pooling for commuters
 Car manufacturers invested enormous sums in more fuel
efficient vehicles
Price Elasticity of Demand and Supply

10. Using price elasticity of demand
How much tax revenue will higher “sin taxes” on cigarettes and
alcohol provide?
Why do airlines often give discounts for advance bookings?
What happens to our demand for foreign holidays when the
exchange rate appreciates?
Why do hotels lower rates at weekends?
Will a business always pass on higher costs to consumers?
Will the introduction of road tolls cut road congestion?
Price Elasticity of Demand and Supply

11. Elasticity and total revenue
Price
A 0 What happens to total revenue as
8 price falls?
B £30
6
C £40
4
D £30
2
E
0
0
5 10 15 20
Quantity demanded
Price Elasticity of Demand and Supply

12. Price Elasticity of Supply
Elasticity of supply - responsiveness of the quantity
supplied of a good to a change in its price
Elasticity of supply (Pes) is the
 % change in quantity supplied divided by the % change in
price
 Normally as price rises - so does supply
Price Elasticity of Demand and Supply

13. Price elasticity of supply
% change in quantity supplied
ES =
% change in price
ES > 1 price-elastic supply
ES = 1 unit-elastic supply
ES < 1 price-inelastic supply
Price Elasticity of Demand and Supply

14. What Determines Supply Elasticity?
Factor substitution possibilities
 Can labour/capital be switched easily
 When substitution is possible, supply is elastic
Spare production capacity available
Stocks (inventories) available to meet changes in
demand
Time frame for the supply to the market
 Momentary period (fixed supply)
 Short run (inelastic supply)
 Long run (elastic supply)
Price Elasticity of Demand and Supply

15. Applying concept of Pes
Seats in a football stadium
 Short run capacity is fixed
 Long run – expansion of stadium capacity
Supply of seat-belts when the government made them
compulsory
 Substitutability of factors of production?
An increase in demand for fresh salmon
 Time lags in the production process
World supply of oil following a large rise in world demand
 Amount of spare capacity of major oil producers
 Can stocks be put onto the market to meet the rise in demand?
Price Elasticity of Demand and Supply

16. Elasticity of Supply and Time Frame
Momentary Supply
Price
Short Run Supply
Long Run Supply
Quantity supplied per time period
Price Elasticity of Demand and Supply

17. Short Run Elasticity of Supply
Short Run Supply
Price
of
kitchens
D2
D1
Quantity supplied per time period
Price Elasticity of Demand and Supply

18. Long-run elasticity of supply
Short Run Supply
Price
of
kitchens
Long Run Supply
D3
D2
D1
Quantity supplied per time period
Price Elasticity of Demand and Supply

19. Extreme values for Pes
ES = 0
Price ES = 1 Unit elastic
Perfectly elastic ES = o o
Perfectly
inelastic
Quantity supplied
Price Elasticity of Demand and Supply