Discussion of elasticity (price-elasticity of demand and supply, income elasticity of demand, and cross-price elasticity of demand) for my Principles of Microeconomics students.

1. Elasticity
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2. Price Elasticity of Demand
• Measures buyers’ responsiveness to price
changes
• Elastic demand
• Sensitive to price changes
• Large change in quantity when price
changes
• Inelastic demand
• Insensitive to price changes
• Small change in quantity when price
changes
LO1

3. Price Elasticity of Demand Formula
Percent change in Quantity
Ed = Demanded of Product X
Percent change in Price
of Product X

4. Price Elasticity of Demand Formula


5. Price Elasticity of Demand Formula
• It is in percentages
• Unit free measure
• Compares responsiveness across
products
• Eliminates the minus sign
• Easier to compare elasticities
LO1 4-5

6. Interpretation of Elasticity of Demand
• Ed > 1 demand is elastic
• Ed = 1 demand is unit elastic
• Ed < 1 demand is inelastic
• Extreme cases
• Perfectly inelastic
• Perfectly elastic

7. Extreme Cases
P D1
Perfectly
inelastic
demand
(Ed = 0)
0
Perfectly inelastic demand

8. Extreme Cases
P
D2
Perfectly
elastic
demand
(Ed = ∞)
0
Perfectly elastic demand

9. Total Revenue Test


10. Total Revenue Test
• Increase price with elastic demand: orange gain is less than blue
loss
•Decrease price with elastic demand: orange loss is less than blue
gain
•Elastic demand forces sellers to lower prices
P
$3
a
2
b
1
D1
0 10 20 30 40 Q

11. Total Revenue Test
• Increase price with inelastic demand: orange gain is more than blue loss
• Decrease price with inelastic demand: orange loss exceeds blue gain
• With inelastic demand, sellers can increase prices and gain
P
$4
c
3
2
d
1
D2
0 10 20 Q

12. Total Revenue Test
• With unit elastic demand: increasing or
decreasing price leaves R unchanged
P
$3 e
2
f
1
D3
0 10 20 30 Q

13. Total Revenue Test
Price Elasticity of Demand for Movie Tickets as Measured by the Elasticity
Coefficient and the Total-Revenue Test
(1) (3) (4) (5)
Total Quantity of Elasticity Total Total
Tickets Demanded per (2) Coefficient Revenue Revenue
Week, Thousands Price per Ticket (Ed) (1) X (2) Test
1 $8 $8,000
2 7 5.00 14,000 Elastic
3 6 2.60 18,000 Elastic
4 5 1.57 20,000 Elastic
5 4 1.00 20,000 Unit Elastic
6 3 0.64 18,000 Inelastic
7 2 0.38 14,000 Inelastic
8 1 0.20 8,000 Inelastic

14. Elasticity and Total Revenue
$8 Elastic
7 a Ed > 1
6 b
5 c Unit Elastic
Price 4 d Ed = 1
3 e Inelastic
2 f Ed < 1
1 g
h D
0 1 2 3 4 5 6 7 8
Quantity Demanded
(Thousands of Dollars)
$20
18
Total Revenue
16
14
12
10
8
6 TR
4
2
0 1 2 3 4Demanded
Quantity 5 6 7 8

15. Summary of Price Elasticity of Demand
Price Elasticity of Demand: A Summary
Absolute Value Impact on Total Revenue of a:
of Elasticity
Coefficient Demand Is: Description Price Increase Price Decrease
Greater than 1 Elastic or Qd changes by a Total Revenue Total Revenue
(Ed > 1) relatively larger decreases increases
elastic percentage than
does price
Equal to 1 Unit or unitary Qd changes by Total revenue Total revenue
(Ed = 1) elastic the same is unchanged is unchanged
percentage as
does price
Less than 1 Inelastic or Qd changes by a Total revenue Total revenue
(Ed < 1) relatively smaller increases decreases
inelastic percentage than
does price

16. Determinants of Elasticity of Demand
• Substitutability
• More substitutes, demand is more elastic
• Proportion of Income
• Higher proportion of income, demand is more elastic
• Luxuries vs. Necessities
• Luxury goods, demand is more elastic
• Time
• More time available, demand is more elastic

17. Price Elasticity of Demand
Selected Price Elasticities of Demand
Price Elasticity Price Elasticity
Product or Service of Demand (Ed) Product or Service of Demand (Ed)
Newspapers .10 Milk .63
Electricity (household) .13 Household appliances .63
Bread .15 Liquor .70
MLB Tickets .23 Movies .87
Telephone Service .26 Beer .90
Cigarettes .25 Shoes .91
Sugar .30 Motor vehicles 1.14
Medical Care .31 Beef 1.27
Eggs .32 China, glassware 1.54
Legal Services .37 Residential land 1.60
Automobile repair .40 Restaurant meals 2.27
Clothing .49 Lamb and mutton 2.65
Gasoline .60 Fresh peas 2.83

18. Applications of Ed
• Large Crop Yields
• Inelastic demand, lower total revenue
• Excise Taxes
• Inelastic demand, more total revenue
• Decriminalization of Illegal Drugs
• Inelastic demand, more total revenue

19. Price Elasticity of Supply
Measures sellers’ responsiveness
to price changes
• Elastic supply, producers are
responsive to price changes
• Inelastic supply, producers are
not responsive to price changes

20. Price Elasticity of Supply
• Formula to compute elasticity
• Es > 1 supply is elastic
• Es < 1 supply is inelastic
Percentage Change in Quantity
Supplied of Product X
Es =
Percentage Change in Price
of Product X

21. Price Elasticity of Supply
• Time is primary determinant of
elasticity of supply
• Time periods considered
• Market period
• Short Run
• Long Run

22. Elasticity of Supply: The Market Period
• Perfectly inelastic supply
P
Sm
Pm
P0
D2
D1
Q0 Q

23. Elasticity of Supply: The Short Run
• Supply is more elastic than in market
period
P
Ss
Ps
P0
D2
D1
Q0 Qs Q

24. Elasticity of Supply: The Long Run
• Supply is even more elastic than in
the short run
P
Sl
Pl
P0
D2
D1
Q0 Ql Q

25. Applications of Elasticity of Supply
Antiques
• Inelastic supply
Reproductions
• More elastic supply
Volatile gold prices
• Inelastic supply

26. Cross Elasticity of Demand
• Measures responsiveness of sales
to change in the price of another
good
• Substitutes – positive sign
• Complements – negative sign
• Independent goods - zero
Percentage change in quantity demanded of
product X
Ex,y = Percentage change in price of product Y

27. Cross Elasticity of Demand
• Application
• Change the price?
• Allow a merger?

28. Income Elasticity of Demand
• Measures responsiveness of buyers
to changes in income
• Normal goods – positive sign
• Inferior goods – negative sign
Percentage change
in quantity demanded
Ei =
Percentage change in income

29. Income Elasticity Insights
• High income elasticities
• Most affected by a recession
• Low or negative income
• Least affected by a recession

30. Ex,y and Ei
Cross and Income Elasticities of Demand
Value of
Coefficient Description Type of Good(s)
Cross elasticity: Quantity demanded of W changes in same Substitutes
Positive (Ewz > 0) direction as change in price of Z
Negative (Exy < 0) Quantity demanded of X changes in Complements
opposite direction from change in price of Y
Income elasticity: Quantity demanded of the product changes Normal or superior
Positive (Ei >0) in same direction as change in income
Negative (Ei<0) Quantity demanded of the product changes Inferior
in opposite direction from change in income

31. Elasticity and Pricing Power
• Charge different prices based on
price elasticities
• Examples:
• Business air travelers
• Adult vs. child

32. Summary
• Price elasticity of demand
• Income elasticity of demand
• Cross-price elasticity of demand
• Price elasticity of supply