3. 1. Price Elasticity of Demand
Elasticity
– Responsiveness
Price elasticity of demand
– Consumers’ responsiveness to a change in price
– Percentage change in quantity demanded divided
by percentage change in price
3
4. Price Elasticity of Demand
2
/
)
'
(
2
/
)
'
(
%
%
p
p
p
q
q
q
E
p
q
E
D
D
Law of demand
ED negative
Absolute value of ED positive
2
/
)
'
(
2
/
)
'
(
%
%
p
p
p
q
q
q
E
p
q
E
D
D
4
5. Categories of ED
If %∆q < %∆p
– ED between 0 and 1
– Inelastic D
If %∆q > %∆p
– ED greater than 1
– Elastic D
If %∆q = %∆p
– ED = 1
– Unit elastic D 5
6. Elasticity and Total Revenue
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
6
7. Price Elasticity and the Linear D
Curve
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
7
8. 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
D
90
60
10
70
Price
per
unit
$100
80
50
40
30
20
b
a
d
e
800
500
200
100 Quantity per period
1,000
0 900
Total
revenue
$25,000
500 Quantity per period
1,000
0
(a) Demand and price elasticity
(b) Total revenue
Total
revenue
Unit elastic, ED =1
Elastic, ED >1
Inelastic, ED <1
c
8
9. Constant-Elasticity
Demand Curves
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
– %∆p causes an exact opposite %∆q
9
11. Constant-Elasticity Demand Curves
0 Quantity per period
Price
per
unit
p
ED = ∞
(a) Perfectly elastic
D
Price
per
unit
ED’’ = 0
(b) Perfectly inelastic
ED ’’ = 1
(c) Unit elastic
D’
0 Quantity
per period
Q
Price
per
unit
$10
6
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
b
11
12. Summary of Price Elasticity of Demand
Effects of a 10 Percent Increase in Price
12
13. 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)
13
14. Demand Becomes More Elastic over Time
Dw
Price
per
unit
$1.25
1.00
Dm
Quantity per day
95 100
75
50
0
Dy
e
Dy is more elastic than Dm , which is more elastic than Dw
Dw: one week after the price increase
Dm: one month after the price increase
Dy: one year after the price increase
14
15. 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
15
17. 2. 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
17
18. Price Elasticity of Supply
Law of supply
ES positive
2
/
)
'
(
2
/
)
'
(
%
%
p
p
p
q
q
q
E
p
q
E
S
S
19. Categories of ES
If %∆q < %∆p
– ES between 0 and 1
– Inelastic S
If %∆q > %∆p
– ES greater than 1
– Elastic S
If %∆q = %∆p
– ES = 1
– Unit elastic S
20. Constant-Elasticity Supply Curves
Perfectly elastic S curve
– 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
– %∆p causes an exact same %∆q
– S curve is a ray from the origin
21. Constant-Elasticity Supply Curves
0 Quantity
per period
Price
per
unit
p
ES = ∞
(a) Perfectly elastic
S
Price
per
unit
ES’ = 0
(b) Perfectly inelastic
ES’’ = 1
(c) Unit elastic
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 %∆p results in the
same %∆q supplied. 21
22. Determinants of Supply Elasticity
ES is greater:
– If the marginal cost rises slowly as output
expands
– The longer the period of adjustment (time)
23. Supply Becomes More Elastic over Time
Sw
Price
per
unit
1.00
$1.25
Quantity per day
110 200
0 100 140
Sm
Sy
Sw: one week after the
price increase
Sm: one month after the
price increase
Sy: one year after the
price increase
Sw is less elastic than Sm, which is less elastic than Sy 23
24. 3. 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
– Negative income elasticity
Normal goods
– Positive income elasticity
24
25. Income Elasticity of Demand
Normal goods
– Income inelastic
• Elasticity between 0 and 1
• Necessities
– Income elastic
• Elasticity > 1
• Luxuries
25
27. The Market for Food and ‘The Farm Problem’
Demand
Price inelastic
Total revenue falls when P falls
Income inelastic
D increases
Technological improvements
S increases
27
28. The Demand for Grain
D
5 10 11 Billions of bushels per year
0
Price
per
bushel
$5
4
3
2
1
The D for grain tends to be inelastic.
As the market P falls, so does TR.
28
29. The Effect on Increases in Demand and Supply on Farm Revenue
S’
D’
D
5 10 14
Billions of bushels per year
0
Price
per
bushel
$8
4
S
Technological advance
- sharp increase in S
Increase in consumer income
- small increase in D
Drop in P
Drop in total revenue
29
30. 4. Cross-Price Elasticity of Demand
Responsiveness of D for one good to changes in P
of another good
%∆ in demand for one good divided by %∆ in price
of another good
– If positive: substitutes
– If negative: complements
– If zero: unrelated
30
31. Price Elasticity and Tax Incidence
Tax
– Decrease in S by the amount of tax
Tax incidence
– Consumers: high P
– Producers: net-of-tax receipt
31
32. Price Elasticity and Tax Incidence
The more price elastic the D:
– The more tax producers pay
– The less tax consumers pay
The more elastic the S:
– The less tax producers pay
– The more tax consumers pay
32
33. Effects of Price Elasticity of D on Tax Incidence
St
S
D’
St
S
D
$0.20 Tax
Price
per
ounce
$1.15
1.00
0.95
Millions of ounces per day
10
9
0
$0.20 Tax
10
7
Price
per
ounce
$1.05
1.00
0.85
(a) Less elastic demand (b) More elastic demand
The more elastic the D curve, the more tax is paid by producers (lower net-of-tax receipt) 33
34. Effects of Price Elasticity of Supply on Tax Incidence
St’
S’
D’’
$0.20 Tax
Price
per
ounce
$1.15
1.00
0.95
(a) More elastic supply
St”
S”
D’’
$0.20 Tax
10
9
Price
per
ounce
$1.05
1.00
0.85
(b) Less elastic supply
Millions of ounces per day
10
8
0
The more elastic the S curve, the more tax is paid by consumers as a higher price.
34
