1. CChhaapptteerr 55
ELASTICITY OF
DEMAND AND SUPPLY

2. Price Elasticity of Demand
Price elasticity of demand allows us to measure the
relative size of changes in the price and the quantity
demanded
The price elasticity of demand formula is used to
measure the degree of consumer responsiveness, or
sensitivity to a change in price.
 The idea is to take a closer look at how sensitive quantity is to
the changes.

3. Price Elasticity of Demand
Question: “Is the response a little or a lot?”
What does it measure?
 The price elasticity of demand measures HOW RESPONSIVE
CONSUMERS ARE TO A CHANGE IN PRICE!!!!

4. The elasticity formula
percentage change in quantity demanded
percentage change in price
Ed
=

5. Price Elasticity of Demand
LO1
E = %
D
q
%
p
¸ D
p p
p
D
D
E = D
q
q q
+
+
( ') / 2 ( ') / 2
D
 Law of demand
 ED negative
 Absolute value of ED positive

6. The elasticity formula
So, what does the percentage change in quantity
demanded and the percentage change in price
mean??
percentage change in Q = newQ -old Q
d d
d old Q
d
new P old P
old P
percentage change in P
-
=

7. LO1 Demand Curve for Tacos
D
$1.10
0.90
0 95 105 Thousands per day
Price per taco
b
a
If the price of tacos drops from
$1.10 to $0.90, the quantity
demanded increases from
95,000 to 105,000.
Exhibit 1

8. Categories of ED
LO1
 If %Δq < %Δp
– ED between 0 and 1
– Inelastic D
 If %Δq > %Δp
– ED greater than 1
– Elastic D
 If %Δq = %Δp
– ED = 1
– Unit elastic D

9. Elasticity and Total Revenue
LO1
 Total revenue = price *
quantity demanded at this
price
 TR= p * q
 As p decreases
 If D elastic, TR
increases
 If D inelastic, TR
decreases
 If D unit elastic, TR
unchanged

10. Price Elasticity and the Linear D
Curve
LO1
 Linear D curve
– Constant slope
– Different elasticity
– D becomes less elastic as we move
downward
 D upper half: elastic
 D lower half: inelastic
 D midpoint: unit elastic

11. LO1
Demand, Price
Elasticity, and
Total Revenue
Where D is elastic, a
lower P increases TR
Where D is inelastic, a
lower P decreases TR
TR reaches a
maximum at the rate
of output where D is
unit elastic
Exhibit 2
(a) Demand and price elasticity
Elastic, ED >1
Unit elastic, ED =1
Inelastic, ED c <1
D
$100
90
80
Price per unit
70
60
50
40
30
20
10
b
a
d
e
0 100 200 500 800 900 1,000 Quantity per period
25,000
Total revenue
(b) Total revenue
Total
revenue
0 500 1,000 Quantity per period

12. Constant-Elasticity Demand
Curves
LO1
 Perfectly elastic D curve
– Horizontal; ED = ∞
– Consumers don’t tolerate P increases
 Perfectly inelastic D curve
– Vertical; ED = 0
– ‘Price is no object’
 Unit-elastic D curve
– %Δp causes an exact opposite %Δq

13. LO1
Constant-Elasticity Demand Curves
(a) Perfectly elastic
Price per unit
0 Quantity per period
p
ED = ∞
D
(b) Perfectly inelastic
Price per unit ED’’ = 0
(c) Unit elastic
ED ’’ = 1
D’
0 Quantity
per period
Q
Price per unit
$10
6
b
0 Quantity
per period
60 100
D’’
a
Consumers demand all quantity
offered for sale at p, but demand
nothing at a price above p
Consumers demand Q
regardless of price
Total revenue is the same
for each p-q combination
Exhibit 3

14. LO1
Exhibit 4
Summary of Price Elasticity of Demand
Effects of a 10 Percent Increase in Price

15. Determinants of Price
Elasticity of D
 ED is greater:
– The greater the availability of substitutes,
and the more similar the substitutes
– The more important the good as a share of
the consumer’s budget
– The longer the period of adjustment (time)
LO2

16. LO2
Demand Becomes More Elastic over Time
Dw: one week after the price increase
Dm: one month after the price increase
Dy: one year after the price increase
Dw
Price per unit
$1.25
1.00
Dm
Dy
Exhibit 5
e
0 50 75 95 100 Quantity per day
Dy is more elastic than Dm , which is more elastic than Dw

17. Elasticity Estimates
 Short run
– Consumers have little time to adjust
 Long run
– Consumers can fully adjust to a price change
 Demand is more elastic in the long run
LO2

18. LO2 Selected Price Elasticities of
Demand (Absolute Values)
Exhibit 6

19. Price Elasticity of Supply
 Elasticity
– Responsiveness
 Price elasticity of supply
– Producers’ responsiveness to a change
in price
– Percentage change in quantity supplied
divided by percentage change in price
LO3

20. Price Elasticity of Supply
E = %
D
q
%
p
S
D
E = D
q
q q
 Law of supply
 ES positive
LO3
p
¸ D
p p
( ') / 2 ( ') / 2
S
+
+

21. LO3
Exhibit 7
Price Elasticity of Supply
S
Price per unit
p’
p
If the price increases from p
to p’, the quantity supplied
increases from q to q’.
Price and quantity supplied
move in the same direction,
so the price elasticity of
supply is a positive number.
0 q q’ Quantity per period

22. Categories of ES
LO3
 If %Δq < %Δp
– ES between 0 and 1
– Inelastic S
 If %Δq > %Δp
– ES greater than 1
– Elastic S
 If %Δq = %Δp
– ES = 1
– Unit elastic S

23. Constant-Elasticity Supply Curves
 Perfectly elastic S curve
LO3
– Horizontal; ES = ∞
– Producers supply 0 at a price below P
 Perfectly inelastic S curve
– Vertical; ES = 0
– Goods in fixed supply
 Unit-elastic S curve
– %Δp causes an exact opposite %Δq
– S curve is a ray from the origin

24. LO3
Constant-Elasticity Supply Curves
(a) Perfectly elastic
0 Quantity
per period
Price per unit
p
ES = ∞
S
(b) Perfectly inelastic
Price per unit ES’ = 0
(c) Unit elastic
ES’’ = 1
S’
0 Quantity
per period
Q
Price per unit
$10
5
0 Quantity
per period
10 20
S’’
Firms supply any amount of
output demanded at p, but
supply 0 at prices below p.
Quantity supplied is
independent of the price
Any %Δp results in the
same %Δq supplied.
Exhibit 8

25. Determinants of Supply Elasticity
 ES is greater:
LO3
– If the marginal cost
rises slowly as
output expands
– The longer the
period of
adjustment (time)

26. LO3
Exhibit 9
Supply Becomes More Elastic over Time
Sw
Price per unit
$1.25
1.00
Sm
Sy
Sw: one week after the
price increase
Sm: one month after the
price increase
Sy: one year after the
price increase
0 100 110 140 200 Quantity per day
Sw is less elastic than Sm, which is less elastic than Sy

27. Income Elasticity
of Demand
 Demand responsiveness to a change in
consumer income
 Percentage change in demand divided by the
percentage change in income that caused it
 Inferior goods
LO4
– Negative income elasticity
 Normal goods
– Positive income elasticity

28. Other Elasticity Measures
Income Elasticity Measure:
 Def: Income elasticity of demand is the ratio of the percentage
change in quantity demanded of a good or service to a given
percentage change in income.
E Q Q I +
I I
2 1
1 2
= -
2 1
1 2
I I
Q Q
¸ -
+

29. Income Elasticity
of Demand
 Normal goods
LO4
– Income inelastic
• Elasticity between 0 and 1
• Necessities
– Income elastic
• Elasticity > 1
• Luxuries

30. LO4
Exhibit 10
Selected Income Elasticities of Demand

31. Cross-Price Elasticity
of Demand
 Responsiveness of D for one good to
changes in P of another good
 %Δ in demand for one good divided by
%Δ in price of another good
LO4
– If positive: substitutes
– If negative: complements
– If zero: unrelated

32. Cross-Price Elasticity of Demand
Def: The ratio of the percentage change in the
quantity demanded of a good or service to a given
percentage change in the price of another good or
service
-
y y
2 1
E = Q -
Q
c P P
1 2
x x
2 1
1 2
y y
x x
P P
Q Q
+
¸
+