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1. Elasticity and its Application
Economics
P R I N C I P L E S O F
N. Gregory Mankiw
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2. ELASTICITY AND ITS
APPLICATION
2
Calculating Percentage Changes
• So, we instead use the midpoint method:
end value – start value
midpoint
x 100%
 The midpoint is the number halfway between the
start & end values, the average of those values.
 It doesn’t matter which value you use as the
“start” and which as the “end” – you get the same
answer either way!

3. ELASTICITY AND ITS
APPLICATION
3
Calculating Percentage Changes
• Using the midpoint method, the % change
in P equals
$250 – $200
$225
x 100% = 22.2%
 The % change in Q equals
12 – 8
10
x 100% = 40.0%
 The price elasticity of demand equals
40/22.2 = 1.8

4. A C T I V E L E A R N I N G 1
Calculate an elasticity
4
Use the following
information to
calculate the
price elasticity
of demand
for hotel rooms:
if P = $70, Qd = 5000
if P = $90, Qd = 3000

5. A C T I V E L E A R N I N G 1
Answers
5
Use midpoint method to calculate
% change in Qd
(5000 – 3000)/4000 = 50%
% change in P
($90 – $70)/$80 = 25%
The price elasticity of demand equals
50%
25%
= 2.0

6. ELASTICITY AND ITS
APPLICATION
6
Price Elasticity and Total Revenue
• If demand is elastic, then
price elast. of demand > 1
% change in Q > % change in P
• The fall in revenue from lower Q is greater
than the increase in revenue from higher P,
so revenue falls.
Revenue = P x Q
Price elasticity
of demand
=
Percentage change in Q
Percentage change in P

7. ELASTICITY AND ITS
APPLICATION
7
Price Elasticity and Total Revenue
Elastic demand
(elasticity = 1.8) P
Q
D
$200
12
If P = $200,
Q = 12 and revenue
= $2400.
When D is elastic,
a price increase
causes revenue to fall.
$250
8
If P = $250,
Q = 8 and
revenue = $2000.
lost
revenue
due to
lower Q
increased
revenue due
to higher P
Demand for
your websites

8. ELASTICITY AND ITS
APPLICATION
8
Price Elasticity and Total Revenue
Now, demand is
inelastic:
elasticity = 0.82 P
Q
D
$200
12
If P = $200,
Q = 12 and revenue
= $2400. $250
10
If P = $250,
Q = 10 and
revenue = $2500.
When D is inelastic,
a price increase
causes revenue to rise.
lost
revenue
due to
lower Q
increased
revenue due
to higher P
Demand for
your websites

9. Supply, Demand, and
Government Policies
Economics
P R I N C I P L E S O F
N. Gregory Mankiw
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10. A C T I V E L E A R N I N G 1
Price controls
40
50
60
70
80
90
100
110
120
130
140
50 60 70 80 90 100 110 120 130
Q
P
S
0
The market for
hotel rooms
D
Determine
effects of:
A. $90 price
ceiling
B. $90 price
floor
C. $120 price
floor
10

11. A C T I V E L E A R N I N G 1
A. $90 price ceiling
40
50
60
70
80
90
100
110
120
130
140
50 60 70 80 90 100 110 120 130
Q
P
S
0
The market for
hotel rooms
D
The price falls
to $90.
Buyers
demand
120 rooms,
sellers supply
90, leaving a
shortage.
shortage = 30
Price ceiling
11

12. A C T I V E L E A R N I N G 1
B. $90 price floor
40
50
60
70
80
90
100
110
120
130
140
50 60 70 80 90 100 110 120 130
Q
P
S
0
The market for
hotel rooms
D
Eq’m price is
above the floor,
so floor is not
binding.
P = $100,
Q = 100 rooms. Price floor
12

13. A C T I V E L E A R N I N G 1
C. $120 price floor
40
50
60
70
80
90
100
110
120
130
140
50 60 70 80 90 100 110 120 130
Q
P
S
0
The market for
hotel rooms
D
The price
rises to $120.
Buyers
demand
60 rooms,
sellers supply
120, causing a
surplus.
surplus = 60
Price floor
13

14. A C T I V E L E A R N I N G 2
Effects of a tax
40
50
60
70
80
90
100
110
120
130
140
50 60 70 80 90 100 110 120 130
Q
P
S
0
The market for
hotel rooms
D
Suppose govt
imposes a tax on
buyers of $30
per room.
Find new
Q, PB, PS,
and incidence of
tax.

15. A C T I V E L E A R N I N G 2
Answers
40
50
60
70
80
90
100
110
120
130
140
50 60 70 80 90 100 110 120 130
Q
P
S
0
The market for
hotel rooms
D
Q = 80
PB = $110
PS = $80
Incidence
buyers: $10
sellers: $20
Tax
PB =
PS =

16. Consumers, Producers,
and the Efficiency of Markets
Economics
P R I N C I P L E S O F
N. Gregory Mankiw
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17. 17
0
5
10
15
20
25
30
35
40
45
50
0 5 10 15 20 25
P
Q
demand curve
A. Find marginal
buyer’s WTP at
Q = 10.
B. Find CS for
P = $30.
Suppose P falls to $20.
How much will CS increase
due to…
C. buyers entering
the market
D. existing buyers paying
lower price
$
A C T I V E L E A R N I N G 1
Consumer surplus

18. A C T I V E L E A R N I N G 1
Answers
18
0
5
10
15
20
25
30
35
40
45
50
0 5 10 15 20 25
P
$
Q
demand curve
A. At Q = 10, marginal
buyer’s WTP is $30.
B. CS = ½ x 10 x $10
= $50
P falls to $20.
C. CS for the
additional buyers
= ½ x 10 x $10 = $50
D. Increase in CS
on initial 10 units
= 10 x $10 = $100

19. 0
5
10
15
20
25
30
35
40
45
50
0 5 10 15 20 25
P
Q
supply curve
A. Find marginal
seller’s cost
at Q = 10.
B. Find total PS for
P = $20.
Suppose P rises to $30.
Find the increase
in PS due to…
C. selling 5
additional units
D. getting a higher price
on the initial 10 units 19
A C T I V E L E A R N I N G 2
Producer surplus

20. A C T I V E L E A R N I N G 2
Answers
0
5
10
15
20
25
30
35
40
45
50
0 5 10 15 20 25
P
Q
supply curve
A. At Q = 10,
marginal cost = $20
B. PS = ½ x 10 x $20
= $100
P rises to $30.
C. PS on
additional units
= ½ x 5 x $10 = $25
D. Increase in PS
on initial 10 units
= 10 x $10 = $100
20

21. Application:
The Costs of Taxation
Economics
P R I N C I P L E S O F
N. Gregory Mankiw
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22. A C T I V E L E A R N I N G 1
Answers to A
22
D
S
CS
= ½ x $200 x 100
= $10,000
0
50
100
150
200
250
300
350
400
0 25 50 75 100 125
P
Q
$
Total surplus
= $10,000 + $10,000
= $20,000
PS
= ½ x $200 x 100
= $10,000
P =
The market for
airplane tickets

23. A C T I V E L E A R N I N G 1
Answers to B
23
D
S
CS
= ½ x $150 x 75
= $5,625
0
50
100
150
200
250
300
350
400
0 25 50 75 100 125
P
Q
$
Total surplus
= $18,750
PS = $5,625
Tax revenue
= $100 x 75
= $7,500
DWL = $1,250
PS =
PB =
A $100 tax on
airplane tickets

24. Application:
International Trade
Economics
P R I N C I P L E S O F
N. Gregory Mankiw
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25. A C T I V E L E A R N I N G 1
Analysis of trade
25
Without trade,
PD = $3000, Q = 400
In world markets,
PW = $1500
Under free trade,
how many TVs
will the country
import or export?
Identify CS, PS, and
total surplus without trade,
and with trade.
P
Q
D
S
$1500
200
$3000
400 600
Plasma TVs

26. A C T I V E L E A R N I N G 1
Answers
26
Under free trade,
 domestic
consumers
demand 600
 domestic
producers
supply 200
 imports = 400
P
Q
D
S
$1500
200
$3000
600
Plasma TVs
imports

27. A C T I V E L E A R N I N G 1
Answers
27
Without trade,
CS = A
PS = B + C
Total surplus
= A + B + C
With trade,
CS = A + B + D
PS = C
Total surplus
= A + B + C + D
P
Q
D
S
$1500
$3000
Plasma TVs
A
B D
C
gains from
trade
imports