CHAPTER 4 ELASTICITY

I. Price Elasticity of demand

An understanding of demand and supply gives us the fundamentals of how markets
operate - the determination of prices and quantity in the market for a good or
service. However, responses of output to a change in the price of the good are not
the same for all goods.
In analyzing the consumer's demand curve for a good, we have seen that as the
price of the good rises, quantity demanded for that good decreases the law of
demand!. How much, if at all, quantity demanded of a good falls when the good's
price rises, depends on the nature of the good. "here are some goods that we do
not want or we cannot sacrifice consumption when the price rises. #ther goods have
many close su$stitutes and we can easily shift our consumption towards them when
the price of the good rises. "he responsiveness of quantity demanded to a change in
a good's price is known as the elasticity %&'()*+,)-)'! of demand. In this section
we will e.plore the concept of elasticity as it relates to the demand and supply
curves, to incomes and to the prices of related goods.
"he price elasticity of demand %&'()*+,)-)' )*/01! measures how strongly the
quantity demanded responds to a change in the price of a product. 2sing the slope
of the demand curve as a measure of responsiveness has a pro$lem3 "he slope of
the demand curve depends on the unit of measurement /4567' /8)9-(-1!. As a
result, the slope changes with a change in the units of measurement for e.ample,
instead of using pounds we use cents, or instead of using kilometers we use meters!
so comparing the responsiveness of demand for different products is very difficult.
"he price elasticity of demand is defined as the percentage change in quantity
demanded divided $y the percentage change in price, that is
Price elasticity of demand (E
d
) =
:ake sure to recognize that when we speak of the price elasticity of
demand for a good, we are referring to the change in the qantity
demanded of the good when the price of the same good changes. ;ater we
will look at the cross-price elasticity of demand which e.amines the
change in the demand for a good when the price of another good changes.
Also, notice that the price elasticity of demand will always $e e.pressed as a
positi!e nm"er since the a$solute value of a negative num$er is always positive!.
<hen the price elasticity of demand $etween two points on a demand curve is $eing
measured, the percentage change in the quantity demanded equals the change in
quantity divided $y the average quantity= the percentage change in the price equals
the change in the price divided $y the average price. >or e.ample, suppose that we
wish to measure the elasticity of demand in the interval $etween a price of ?@ and a
price of ?A. In this case, if we start at ?@ and increase to ?A, price has increased
$y BAC. If we start at ?A and move to ?@, however, price has fallen $y BDC. <hich
percentage change should $e used to represent a change $etween ?@ and ?AE "o
avoid am$iguity '(6F%*'!, the most common measure is to use a concept known as
arc elasticity in which the midpoint of the interval is used as the $ase value in
computing elasticity. 2nder this approach, the price elasticity formula $ecomes3
where3
;et's consider an e.ample. Guppose that quantity demanded falls from HD to @D
when the price rises from ?I to ?A. "he elasticity measure is given $y3
"he elasticity of demand can $e elastic, unit elastic or inelastic.
A good is considered to $e relatively elastic when the price elasticity of demand
e.ceeds an a$solute value of J. "his indicates that if the price of the good
changes $y JC, the response in the quantity demand is greater than JC. "he
demand curves for elastic goods are relatively flat in slope. >or e.ample, if the
percentage increase in price is JDC and the percentage decrease in quantity
demanded is JAC, calculating the price elasticity of demand C change in
quantity demanded K C change in price L JACKJDC! yields a price elasticity of
J.A. "he price elasticity of demand of J.A calculated here, implies that for every
JC change in the price of the good, quantity demand changes $y J.AC - clearly a
relatively elastic good.
A good is considered to $e relatively inelastic when the price elasticity of
demand is $elow an a$solute value of J. "his indicates that if the price of the
good changes $y JC, the response in the quantity demand is less than JC. "he
demand curves for inelastic goods are relatively steep in slope. >or e.ample, if
the percentage increase in price is JDC and the percentage decrease in quantity
demanded is AC, calculating the price elasticity of demand C change in quantity
demanded K C change in price L ACKJDC! yields a price elasticity of D.A. "he
price elasticity of demand of D.A calculated here, implies that for every JC
change in the price of the good, quantity demand changes $y D.AC - clearly a
relatively inelastic good.
A good has unitary elasticity when the price elasticity of demand e.actly equals
J. "his indicates that if the price of the good changes $y JC, the response in
the quantity demand is also JC. >or e.ample, if the percentage increase in price
is JDC and the percentage decrease in quantity demanded is also JDC,
calculating the price elasticity of demand C change in quantity demanded K C
change in price L JDCKJDC! yields a price elasticity of J. "he price elasticity of
demand of J calculated here, implies that for every JC change in the price of
the good, quantity demand changes also changes $y JC.
"here are two e.tremes3
"he demand for a good is considered perfectly elastic M&09N1 %&'()*+0! when the
price elasticity of demand approaches infinity. "his implies that the demand for the
product is unlimited at the market price - the demand curve is horizontal. "he
elasticity measure in this case is infinite notice that the denominator of the
elasticity measure equals zero!. "he closest we get to a perfectly elastic demand
curve is the demand curve facing a firm that produces a very small share of the
total quantity produced in a market. In this case, the firm is such a small share of
the market that it must take the market price as given. An individual farmer, for
e.ample, has no control over the price that it receives when it $rings its product to
market. <hether he supplies JDD or BD,DDD tons of cotton, the price that it
received per ton is that day's market price.
"he demand for a good is considered perfectly inelastic M&09N1 '5%&'()*+0! when
the price elasticity of demand equals zero. "his implies that changes in price have
no effect on the quantity demand of a good - the demand curve is vertical. Oote
that the price elasticity of demand equals zero for a perfectly inelastic demand
curve since the C change in quantity demanded equals zero. In practice, we do not
e.pect to see demand curves that are perfectly inelastic. >or some range of prices,
the demand for insulin, dialysis, and other such medical treatments, is likely to $e
close to $eing perfectly inelastic. As the price for these commodities rises,
however, we would eventually e.pect to see the quantity demanded fall $ecause
individuals have limited $udgets.
Plasticity is not the same as slope. Along a downward sloping straight-line demand
curve, elasticity varies. :oving downward and to the right along downward sloping
straight-line demand curves, the price elasticity of demand $ecomes smaller. "o see
why this occurs, it is necessary to consider the distinction $etween a change in the
level of a varia$le and the percentage change in the same varia$le. Guppose we
consider the distinction $y discussing the percentage change that results from a ?J
increase in the price of a good.
a price increase from #J to #B represents a JDDC increase in price,
a price increase from #B to #I represents a ADC increase in price,
a price increase from #I to #@ represents a IIC increase in price, and
a price increase from #JD to #JJ represents a JDC increase in price.
Ootice that, even though the price increases $y #J in each case, the percentage
change in price $ecomes smaller when the starting value is larger. ;et's use this
concept to e.plain why the price elasticity of demand varies along a linear demand
curve.
Qonsider the change in price and quantity
demanded that are illustrated in the
diagram on the right. At the top of the
curve, the percentage change in quantity
is large since the level of quantity is
relatively low! while the percentage
change in price is small since the level of
price is relatively high!. "hus, demand will
$e relatively elastic at the top of the
demand curve. At the $ottom of the
curve, the same change in quantity
demanded is a small percentage change
since the level of quantity is large! while
the change in price is now a relatively
large percentage change since the level of price is low!. "hus, demand is relatively
inelastic at the $ottom of the demand curve.
:ore generally, we can note that elasticity
decreases continuously along a linear
demand curve. "he top part of the demand
curve will $e highly elastic and the $ottom
is highly inelastic. In $etween, elasticity
gradually $ecomes smaller as price declines
and quantity rises. At some point, demand
changes from $eing elastic to inelastic.
"he point at which that happens, of
course, is the point at which demand is unit
elastic. "his relationship is illustrated in
the diagram to the right.
"he size of elasticity of demand for a good depends on three factors3
J. Availa$ility of su$stitutes. "he more other goods can $e su$stituted for the
product under study, the larger is the productRs elasticity of demand.
Oecessities generally have fewer su$stitutes and have an inelastic demand=
lu.uries often have many su$stitutes, so their demand is often elastic.
B. "he proportion of income spent on the good. "he greater the proportion of
income M4(4(), %*(470/')41! spent on a good, the larger is the elasticity of
demand.
I. "he time passed since a price change. In general, the more time that has
passed since a price change, the larger is the elasticity of demand.
Sistinguishing $etween two time frames, the short-run demand and the
long-run demand is useful. "he first shows the initial response of $uyers to
a change in price and is often inelastic. "he second descri$es the response
of $uyers to a price change after all adTustments have $een made and
generally is more elastic than the short-term demand.
"he concept of price elasticity of demand is e.tensively used $y firms that are
investigating the effects of a change in the prices of their products. Total re!ene
(U54&*+6 8(47'! is defined as3
"otal Vevenue L Wrice . Xuantity
"V L W . X
Guppose that a firm is facing a downward sloping demand curve for its product. How
will its revenue change if it changes its priceE
<hen, for e.ample, price falls, quantity demanded $y consumers rises. "he lower
price received for each unit of quantity demanded lowers total revenue while the
increase in the num$er of units sold raises total revenue. "otal revenue will rise
when price falls if quantity rises $y a large enough percentage to offset
'5)*()'Y/Z(%*! the reduction in price per unit. In particular, we can note that total
revenue will increase if quantity demanded rises $y more than one percent when the
price falls $y one percent. Alternatively, total revenue will decline if quantity
demanded rises $y less than one percent when the price declines $y one percent. If
the price falls $y JC and quantity demanded falls $y JC, total revenue will remain
unchanged since the changes will offset each other!.
2sing the logic discussed a$ove, we can note that a reduction in price will lead to3
an increase in total revenue when demand is elastic,
no change in total revenue when demand is unit elastic, and
a decrease in total revenue when demand is inelastic.
In a similar manner, an increase in price will lead to3
a reduction in total revenue when demand is elastic,
no change in total revenue when demand is unit elastic, and
an increase in total revenue when demand is inelastic.
"he diagram to the right illustrates the
relationship that e.ists $etween total revenue
and demand elasticity along a linear demand
curve. As this diagram shows, total revenue
increases as quantity increases and price
decreases! in the region in which demand is
unit elastic. "otal revenue falls as quantity
increases and price decreases! in the
inelastic portion of the demand curve. "otal
revenue is ma.imized at the point at which
demand is unit elastic.
Soes this mean that firms will choose to
produce at the point at which demand is unit
elasticE "his would only $e the case if they
had no production costs. >irms are assumed to
$e concerned with ma.imizing their profits,
not their revenue. "he optimal level
production can $e determined only when we
consider $oth revenue and costs. "his topic
will $e studied at later chapters.
>or an e.ample of the change in revenue with different values of the
elasticity consider a firm that raises it price $y JC.
Assume3
W
D
L #JDD, X
D
L J,DDD units and "V L #JDD,DDD W
D
. X
D
!
Also assume that the price elasticity of demand is equal to D.A. <ith a
JC increase in price we have.
W
J
L #JDJ, X
J
L [[A units and "V L #JDD,@[A W
J
. X
J
!
If the elasticity is equal to D.A, then a JC increase in price will lead to
a D.AC decrease in quantity demanded. In this e.ample, we can see if
the good has an inelastic demand, total revenue will increase in
response to a price rise.
;et us change our e.ample to show what happens when price is
increased $y JC, $ut the demand for the good is elastic. >or e.ample,
assume the price elasticity of demand is equal to B.D.
Assume3
W
D
L #JDD, X
D
L J,DDD units and "V L #JDD,DDD W
D
. X
D
!
Also assume that the price elasticity of demand is B. <ith a JC
increase in price we have.
W
J
L #JDJ, X
J
L [\D units and "V L #[\,[\D W
J
. X
J
!
If the elasticity equals B.D, then a JC increase in price will lead to a
BC decrease in quantity demanded. In this e.ample, we can see if the
good has an elastic demand, total revenue will decrease in response to a
price rise.
Smmary of Price Elasticity of $emand
Elasticity $escription
C%an&e in '
d
(it% a )*
Increase in
Price
C%an&e in
Re!ene (it%
an Increase
in Price
C%an&e in '
d
(it% a )*
$ecrease in
Price
C%an&e in
Re!ene (it%
a $ecrease in
Price
+ero
Werfectly
inelastic -
vertical demand
curve
]ero
Increased $y
JC
]ero
Secreased $y
JC
,et(een -
and )
Inelastic
Secreased $y
less than JC
Increased
Increased $y
less than JC
Secreased
)
2nitary
elasticity
Secreased $y
JC
Oo change
Increased $y
JC
Oo change
.reater
t%an )
Plastic
Secreased $y
more than JC
Secreased
Increased $y
more than JC
Increased
Infinite
Werfectly elastic
- horizontal
demand curve
Secreased to
zero
Secreased to
zero
Oo change
Increased $y
JC
II. /ore Elasticities of $emand
"he cross elasticity of demand ()'U94%*701 %&'()*+,)-)'! shows how the demand
for a good reacts to a change in the price of another product. "he cross-price
elasticity of demand $etween the goods T and k can $e e.pressed as3
In other words, the cross-price elasticity of the goods T and k, measures the
percentage change in the quantity demanded of good T, when the price of good k
changes $y JC. Qross-price elasticities are given two categories3 complements and
su$stitutes.
Complements - "wo goods that have a ne&ati!e !ale for t%eir cross0price
elasticity are considered complementary goods such as compact disc QS!
players and compact discs. If the price of QS players increases then our
consumption of QS's decreases, leading to a negative relationship $etween the
two. Qonversely, if the price of QS players falls a negative coefficient!, our
consumption of QS's rises a positive coefficient!.
S"stittes - "wo goods that have a positi!e !ale for t%eir cross0price
elasticity are considered su$stitutes such as gasoline prices and the demand for
pu$lic transportation. If the price of gasoline rises, so does consumer demand
for less e.pensive transportation alternatives such as pu$lic transportation
$uses, su$ways!.
Qross-price elasticity can $e used $y firms in making pricing and output decisions.
:cSonald's, for e.ample, might want to know the cross-price elasticity of demand
$etween its chicken sandwiches and its ^ig :acs if it is considering the effect of a
BDC decrease in the price of its ^ig :acs. If the cross-price elasticity of demand
is D.A, then a BDC decrease in the price of its ^ig :ac would result in a JDC
decrease in the num$er of chicken sandwiches sold. A -D.[ cross-price elasticity of
demand $etween ^ig :acs and chips, though, would indicate that a BDC decrease in
the price of ^ig :ac would result in an J\C increase in the sale of chips. "his sort
of information would $e useful in determining what prices to charge and in planning
for the impact of such a price change.
Also, take the e.ample of the airline industry and consider goods that are close
su$stitutes. >or e.ample one good is the price of seat on Qyprus Airways, the other
good is the demand for seat on #lympic Airways, each on an identical flight route -
say ;arnaca to Athens. In the case of the airline industry, the cross-price elasticity
of demand for airline tickets is very high, and firms respond immediately to fare
changes. If one airline such as Qyprus Airways starts a price war, competitors such
as #lympic Airways quickly follow in reducing prices to prevent a loss of market
share. Gince there is a high cross-price elasticity, if Qyprus Airways lowers its fare
from ;arnaca to Athens, and #lympic Airways keeps its fares constant, consumers
quickly shift consumption towards the lower priced Qyprus Airways tickets. "he
resulting decrease in the demand for #lympic Airways tickets is large.
Go far, we have studied the effect of a change in the price of a good on the same
good's quantity demanded. Oow we turn our attention to the impact on the demand
for a good when consumer incomes change, holding prices constant. "he $usiness
cycle descri$es alternating periods of economic growth 4*+454/*+0 '56+'/_-!, when
incomes generally increase, and recession `F%(-! which lead to a decrease in
consumer incomes. A firm needs to understand income elasticity to see how changes
in the economy affect the demand for the good or service produced $y the firm.
#ur consumption of some goods, such as lu.uries, is very sensitive to changes in
economic growth and consumer incomes. In contrast, necessities such as food and
housing tend to $e less affected $y economic swings and the corresponding changes
in consumer incomes.
"he income elasticity of demand %*(47-/')*+0 %&'()*+,)-)'! measures how the
demand for a good responds to a change in income. "he income elasticity of demand
is defined as the percentage change in the quantity demanded divided $y the
percentage change in income3
"here are three possi$ilities for a good's income elasticity3
A good is income elastic if the income elasticity of demand is greater than J. "his
implies that for a JC change in income, demand for the good changes $y more than
JC.
A good is income inelastic if the income elasticity of demand is greater than D $ut
less than J. "his implies that for a JC change in income, demand for the good
changes $y less than JC.
A good is considered inferior if the associated income elasticity of demand is a
negative num$er. In this case, if income increases, consumers actually $uy less of
the good.
"he first two categories a$ove, income elastic and income inelastic, $oth
correspond to a normal good, where the income elasticity of demand is greater than
zero. A normal good is one that we $uy more of when our income increases. If the
income elasticity of demand is greater than J, the good is often considered a lu.ury
such as a computer, mo$ile telephone, car or many types of entertainment. A
necessity is a good that we $uy more of when our income increases, such as health
care or gasoline, $ut our consumption is not su$stantially affected= income elasticity
for necessities is generally $etween D and J. >inally, inferior goods are
characterized $y consumption that actually decreases with improvements in income.
>or many consumers, inferior goods include items such as canned food, frozen meat
or fish, cheap seats at the foot$all game or a concert.
III. Elasticity of Spply
"he elasticity of spply measures the responsiveness of the quantity supplied of a
good to a change in its price. "he elasticity of supply is defined as the percentage
change in the quantity supplied divided $y the percentage change in price3
"he elasticity of supply is perfectly inelastic if the supply curve is vertical. In this
case, the elasticity of supply is D zero!. If, on the other hand, the supply curve is
horizontal, the elasticity of supply is perfectly elastic and is infinite.
"he size of the elasticity of supply depends on two general factors3
J. Vesource su$stitution possi$ilities3 "he more common, readily availa$le
resources are used to produce a product, the greater is the elasticity of
supply.
B. "he time passed since the price change3 "he more time that passes after a
price change, the greater is the elasticity of supply.
a! If quantity supplied does not react immediately following a price change,
the supply curve is very steep, almost vertical. "his is called the
momentary supply curve and it is very inelastic and pro$a$ly perfectly
inelastic.
$! If quantity supplied responds to a change in price after some of the
technological possi$le adTustments to production have $een made, the
supply curve is somewhat steep $ut not as steep as the momentary
supply curve. It is called the short-run supply curve and it is less
inelastic.
c! If quantity supplied reacts to a change in price after all possi$le ways of
adTusting supply have $een utilized, the supply curve is rather flat. It is
called the long-run supply curve and it is elastic and, perhaps, perfectly
elastic.
In general, it is e.pected that supply will $e more elastic in the long run than in the
short run since firms can increase or decrease their capital in the long run. In the
short run, an increase in the price of personal computers, for e.ample, may result in
increased employment, more overtime, and additional shifts in computer factories.
In the long run, though, higher prices will lead to a larger e.pansion in output as new
factories are $uilt.
'1ESTI23S
Tre45alse
J. "he price elasticity of demand is the same as the slope of the demand curve.
B. "he price elasticity of demand ranges from D to a.
I. "he more consumers respond to a price change, the larger the price elasticity
of demand.
@. If the price elasticity of demand is positive, then demand is elastic.
A. bP# $eer is likely to have an elastic demand.
H. :oving along a linear demand curve to lower prices and larger quantities, the
price elasticity of demand does not change.
c. Weople spend more on food than on chocolates, so the price elasticity of
demand for food is likely to $e larger than the price elasticity of demand for
chocolates.
\. "he price elasticity of demand for food is largest in poor nations.
[. As more time passes after a price change, the price elasticity of demand
$ecomes smaller.
JD. Wizza Hut estimates that the price elasticity of demand for its pizzas is @,DD,
so if it increases the price it charges for its pizza, its total revenue will
increase.
JJ. "he cross elasticity of demand $etween tennis rackets and tennis $alls is
negative.
JB. A product has an elastic demand if its income elasticity of demand is greater
than J,D.
JI. An inferior good has a negative income elasticity while a normal good has a
positive income elasticity.
J@. "he elasticity of supply equals the change in the quantity supplied divided $y
the change in price.
JA. If a good has a vertical supply curve, its elasticity of supply equals D.
/ltiple c%oice
J. Guppose that a JDC increase in the price of movie tickets decreases the
quantity demanded $y BC. "hen the price elasticity of demand for movies is
a. D.B.
$. B.D.
c. A.D.
d. JD.D.
TA,LE 4.)
Price4$6$ 7#8 'antity demanded
I\ JJD
@B [D
B. "wo points on the demand curve for SdSs are shown in "a$le @.J. <hat is the
price elasticity of demand $etween these two pointsE
a. B.A.
$. B.D.
c. D.A.
d. D.@.
I. "he quantity of new cars increases $y AC. If the price elasticity of demand
for new cars is J.BA, the price of a new car will
a. fall $y @C.
$. fall $y AC.
c. fall $y H.BAC.
d. fall $y J.BAC.
@. Along a perfectly inelastic demand curve, the price elasticity of demand
a. equals D.
$. is greater than D $ut less than J.D.
c. equals J.D.
d. is negative.
A. A Werfectly elastic demand is represented $y a demand curve that
a. is vertical.
$. is horizontal.
c. has a @Ae slope.
d. none of the a$ove.
J
H. "he demand for a good is more price inelastic if
a. its price is higher.
$. the percentage of income spent on it is larger.
c. it is a lu.ury good.
d. it has no close su$stitutes.
J
c. <hich of the following is likely to have the largest price elasticity of demandE
a. A car
$. A new car
c. A new GAA^ car
d. A new GAA^ "ur$o converti$le
\. :oving upward along a linear demand curve, as the price rises and the quantity
demanded decreases, the price elasticity of demand
a. falls.
$. does not change.
c. rises.
d. first rises and then falls.
[. If the price elasticity of demand equals J,D, then as price falls the
a. quantity demanded decreases.
$. total revenue falls.
c. quantity demanded does not change.
d. total revenue does not change.
JD. A rise in the price of a product increases total revenue from the product if
a. income elasticity of demand is greater than J.
$. the good is an inferior product.
c. the product has an inelastic demand.
d. the product has an elastic demand.
JJ. ^y looking at its sales records, "#GHI^A discovered that when it lowers the
price of its laptop computers, the total revenue from the sale of its laptop
computers increases. Go we can conclude that
a. supply of "#GHI^A laptop computers is elastic.
$. demand for "#GHI^A laptop computers is elastic.
c. supply of "#GHI^A laptop computers is inelastic.
d. demand for "#GHI^A laptop computers is inelastic.
JB. If a @C rise in the price of honey causes total revenue from sales of honey to
fall $y \C, then honey has an!
a. elastic demand.
$. inelastic demand.
c. unit elastic demand.
d. "here is not enough information given to determine whether the demand for
honey is elastic, unit elastic, or inelastic.
JI. <hen the price of a ham$urger rises JDC, your e.penditure on ham$urgers
increases. Go, it is certain that
a. ham$urgers are a normal good for you.
$. ham$urgers are an inferior good for you.
c. your demand for ham$urgers is elastic.
d. your demand for ham$urgers is inelastic.
J@. >or which of the following pairs of goods is the cross elasticity of demand
positiveE
a. QSs and QS players
$. dideotapes and toothpaste
c. Airline trips and te.t$ooks
d. ^eef and chicken
JA. A JDC increase in the price of a Wepsi increases the demand for a Qoca Qola $y
ADC. Go, the cross elasticity of demand $etween Wepsi and Qoca Qola is
a. AD.D.
$. JD.D.
c. A.D.
d. D.B.
JH. A fall in the price of a $ook from ?H to ?@ causes a decrease in the quantity of
magazines demanded from J.JDD to [DD. <hat is the cross elasticity of
demand $etween $ooks and magazinesE
a. D.A
$. fD.A
c. B.D
d. not possi$le to calculate the cross elasticity of demand.
Jc. Guppose that the income elasticity of demand for apartments is fD.B. "his
value shows that
a. the demand for apartments is price inelastic.
$. the demand for apartments is unit elastic.
c. a rise in the rent for apartments lowers the total revenue from renting
apartments.
d. apartments are an inferior good.
J\. >rozen meat is an inferior good= fresh $eef is a normal good. <hen peopleRs
incomes rise, the demand for frozen meat ggg and the demand for fresh $eef
ggg
a. increases= increases
$. increases= decreases
c. decreases= increases
d. decreases= decreases
J[. A JDC increase in income increases the demand for coffee $y IC. "hen the
income elasticity of demand for coffee is
a. fD.I.
$. I.I.
c. D.I.
d. JD.D
BD. All normal goods have
a. income elasticities of demand greater than J.D.
$. price elasticities of demand greater than J.D.
c. negative price elasticities of demand.
d. positive income elasticities of demand.
BJ. Guppose that the price elasticity of supply for oil is D.J. "hen, if the price of
oil rises $y BDC, the quantity of oil supplied will increase
a. $y BDDC.
$. $y BDC.
c. $y BC.
d. $y D.BC.
BB. <hen the price of a QS is ?JI per QS, I[,DDD,DDD QSs per year are supplied.
<hen the price is ?JA per QS, @J,DDD,DDD QSs per year are supplied. <hat is
the elasticity of supply for QSsE
a. B.\H
$. D.IA
c. D.J@
d. D.DA
BI. If the long-run supply of rice is perfectly elastic, then
a. as peopleRs incomes rise, the quantity of rice supplied decreases.
$. as the price of corn falls, the quantity of rice demanded decreases.
c. in the long run, a large rise in the price of rice causes no change in the
quantity of rice supplied.
d. in the long run, an increase in the demand for rice leaves the price of rice
unchanged.
B@. "he elasticity of supply does O#" depend on
a. resource su$stitution possi$ilities.
$. the proportion of income spent on the product.
c. the time passed since the price change.
d. none of the a$ove
S%ort ans(ers
J. Assume that the price elasticity of
demand for oil is D.B in the short run
and D.\ in the long run. "o raise the
price of oil $y JDC in the short run,
what must $e the decrease in the
quantity of oilE In the long run, to have
a JDC rise in the price of oil, what must
$e the decreaseE
B. In the graph on the right, which
demand is more elastic $etween prices
hJD and h\E
I. <hy is the price elasticity of demand for food larger in poor nations than in
rich nationsE
@. P.plain what perfectly elastic demand means. Sescri$e an e.ample of a
demand curve for a good with
perfectly elastic demand. <hen will
perfectly elastic demand occurE
A. "he supply curve for tapes is
illustrated in the diagram on the
right. Werhaps $ecause of a rise in
wages, the supply of tapes decreases
so that for every possi$le quantity,
the new supply curve lies a$ove the
old supply curve $y hJ.
a. Guppose the demand for tapes is
perfectly elastic and is such that the initial equili$rium price is hB for a
tape. After the decrease in supply, $y
how much does the price of a tape riseE Sraw a diagram to illustrate your
answer.
$. Guppose the demand for tapes is perfectly inelastic and is such that the
initial equili$rium price of a tape is hB. In this case, $y how much does
the price of a tape riseE Sraw a diagram to illustrate this situation.
c. ^ased on your answers to parts a! and $!, when will an increase in costs
raise the price of a product the most3 <hen demand is elastic or when it is
inelasticE <hen will it decrease the quantity the mostE <hen demand
is elastic or inelasticE Is there any situation under which the price does not
changeE
H. "a$le @.B gives eight points on a demand curve for ham$urgers.
a. Qalculate the price elasticity of demand $etween ?J and ?B= ?B and ?I= ?I
and ?@= ?@ and ?A= ?A and ?H= ?H and ?c= and ?c and ?\.
$. In "a$le @.B, complete the last column.
c. ^ased on your answer
to part a!, how does the price elasticity of demand
change for a movement downward along this demand curveE How does this
change relate to your answers in part $! for total revenue at the different
pricesE
Ta"le 4.9 T%e demand for pi::a
Price
7;4slice of pi::a8
'antity demanded
7slices of pi::a4(ee<8
Total re!ene
7; per (ee<8
\ JB.A
c J@.I
Ta"le 4.= T%e demand for %am"r&ers
Price
7#4%am"r&er8
'antity demanded
7%am"r&ers4(ee<8
Total re!ene
7per (ee<8
\ ID
c @D
H AD
A HD
@ cD
I \D
B [D
J JDD
H JH.c
A BD
@ BA
I II.I
B AD
J JDD
c. "a$le @.I gives eight points on a demand curve for slices of pizza.
a. iraph the demand curve.
$. Qalculate the price elasticity of demand $etween ?J and ?B= ?B and ?I= ?I
and ?@= ?@ and ?A= ?A and ?H= ?H and ?c= and ?c and ?\.
c. Qomplete the last column in "a$le @.I.
d. ^ased on your answers to parts $! and c!, how does the total revenue per
week relate to the price elasticity of demand at the different pricesE
\. jou are the manager of a local restaurant. jou notice that when you lower the
price of your meals, your total revenue rises. <hat conclusion can you draw
a$out the demand for your restaurantRs mealsE
[. >or cars, why does the elasticity of supply generally increase as more time
passes after a price changeE
JD. "he demand for a product permanently increases. Guppose that the long-run
supply is more elastic than the short-run supply. <hen will the price of the
product rise the mostE Immediately after the demand change or in the long
runE <hen will the quantity increase the mostE Sraw a graph to illustrate your
answers.
A3S>ERS
Tre45alse
J. 5 "he slope of the demand curve equals kWKkX, whereas the price elasticity
of demand equals kXK kX
ave
K kWK kW
ave
2. T "he smallest value for the price elasticity of demand, D, shows a perfectly
inelastic demand= the largest, , indicates perfectly elastic demand.
I. T "he stronger the response to a price change, the larger is the elasticity.
@. 5 Semand is elastic when the price elasticity of demand e.ceeds J.D.
A. T #ther $eers, such as Qarls$erg or Heineken, are close su$stitutes for bP#,
so the demand for bP# is likely to $e elastic.
H. 5 As we move downward along a linear demand curve, the price elasticity of
demand falls.
c. T ienerally, the larger the proportion of total income spent on a product, the
greater is the price elasticity of demand.
\. T In poor nations food takes a larger portion of consumer spending, so the
price elasticity of demand is larger.
[. 5 As more time passes, more changes in demand can take place, so demand
$ecomes more elastic.
JD. 5 "he demand for Wizza Hut is elastic, so rising the price decreases the
quantity $y so much that total revenue declines.
JJ. T "ennis rackets and tennis $alls are complements, so the cross elasticity of
demand is negative.
JB. 5 "o $e elastic, the price elasticity of demand must $e greater than J.D.
JI. T An increase in income decreases the demand for inferior goods and
increases it for normal goods.
J@. 5 "he price elasticity of supply equals the percentage change in the quantity
supplied divided $y the percentage change in price.
JA. T <hen the elasticity of supply equals zero, the supply is perfectly inelastic.
/ltiple c%oice
J. a "he price elasticity of demand is equal to BC!KJDC! L D.B.
B. " "he price elasticity of demand $etween two points equals kXK kX
ave
K kWK
kW
ave.
In this case we get JDKAD!K?BK?BD! L B.
I. a Vearranging the formula for the price elasticity of demand gives
percentage change in price! L percentage change in quantity demanded!K
elasticity of demand!. Go, the percentage change in price equals AC!KJ.BA! L
@C.
@. a <hen a product has a perfectly inelastic demand, the price elasticity of
demand equals zero and the demand curve is vertical.
A. " lWerfectly elasticm means that a very small rise in the price will decrease
quantity demanded to D, which is the situation with a horizontal demand curve.
H. d If there are no close su$stitutes, consumers continue to $uy the product
even if its price is increased su$stantially, which means that the demand is
inelastic.
c. d "here are many more su$stitutes for a new GAA^ "ur$o converti$le than
for the other goods. "his answer is an e.ample of the proposition that the
more narrow the definition of a good is, the larger is its price elasticity of
demand.
\. c :oving upward along a linear demand curve, the price elasticity of demand
increases in value.
[. d If demand is unit price elastic, a change in the price of the product creates
an offsetting change in the quantity demanded so that total revenue does not
change.
JD. c If demand is inelastic, the percentage increase in price is greater than the
percentage decrease in quantity demanded, so total revenue from sales of the
good increases.
JJ. " <hen demand is elastic, the percentage increase in the quantity demanded
is greater than the percentage fall in the price, so total revenue rises.
JB. a <hen demand is elastic, a rise in the price of the product decreases the
quantity demanded $y proportionally more, so that total revenue falls when
price increases.
JI. d <hen an increase in the price of a product increases your e.penditure on
the product for e.ample, cigarettes, if you are a smoker! your demand for the
product is inelastic.
J@. d "he cross elasticity of demand is positive for su$stitutes. ^eef and chicken
are su$stitutes, so their cross elasticity of demand is positive.
JA. c "he cross elasticity of demand equals the percentage change in the quantity
of Qoca Qola divided $y the percentage change in the price of a Wepsi. Go, the
cross elasticity of demand equals ADC!KJDC! L A.D.
JH. a "he cross elasticity of demand is calculated kXK kX
ave
K kWK kW
ave
in which
lquantitym refers to magazines and the lpricem to $ooks. 2sing the formula for
the cross elasticity gives fBDDKJ,DDD!Kf ?BK?A! L D.A.
Jc. d If income elasticity is negative, the product is an inferior good.
J\. c >or an inferior good an increase in income decreases demand= for a normal
good an increase in income increases demand.
J[. c Income elasticity of demand equals in this case equals IC!KJDC! or D.I.
BD. d An increase in income increases the demand for a normal good.
BJ. c Vearranging the formula for the price elasticity of supply gives percentage
change in quantity supplied! L price elasticity of supply! n percentage change
in price! L D.J! n BDC! L B percent.
BB. " Analogous to the price elasticity of demand, the elasticity of supply is kXK
kX
ave
KkWKkW
ave
or
B,DDD,DDDK@D,DDD,DDD!K ?BK?J@!L
D.IA.
BI. d <hen the supply is perfectly
elastic, an increase in demand has no
effect on the equili$rium price. "his
result is in the graph on the right
where the increase in demand from S
D
to S
J
leaves the price constant at hAD
a ton.
B@. " "he proportion of income spent on
the product affects the price
elasticity of demand, not the price
elasticity of supply.
S%ort ans(ers
J. Vearranging the formula for the price elasticity of demand gives price
elasticity of demand! n percentage change in price! L percentage change in
quantity!. "he price rise is JDC, so the amount $y which the quantity must $e
restricted in the short run is D.B! n JDC! L BC. In the long run, the price
elasticity of demand is D.\, so the decrease in the quantity is D.\!JDC! L \
percent. "o raise the price $y JDC, the long-run decrease in the quantity must
$e four times the short-run decrease.
B. "he demand represented $y S
A
is
more elastic than the demand given
$y S
^
. "o see why, recall the formula
for the price elasticity of demand
percentage change in quantity
demanded K percentage change in
price!. Along $oth demand curves, the
percentage change in the price from
hJD to h\ is the same. ^ut the graph
on the right shows that the
percentage change in the quantity
demanded is greater along S
A
where the quantity demanded increases from ID
to AD, a ADC increase, whereas along S
^
the quantity demanded increases to
@D, only a B[C increase. ^ecause the percentage increase in the quantity
demanded is greater along S
A
the price elasticity of demand over this price
range is higher for S
^
.
I. "he larger the percentage of their income that consumers spend on a product,
the greater the price elasticity of demand. Weople in poor nations spend a
larger proportion of their income on food than do people in wealthy nations, so
the price elasticity of demand for food is larger in poor nations.
@. A perfectly elastic demand is shown in the graph on the right. Semand is
perfectly elastic when consumers can
find perfect su$stitutes )8&%*'
UM4+')6()')'! for a product. >or
e.ample, consider corn grown $y one
farmer. Qorn that other farmers grow
is a perfect su$stitute for the first
farmerRs corn. If there are perfect
su$stitutes for the product, even the
smallest rise in the price of the
product leads the quantity demanded
to decrease to D. "he horizontal
demand curve indicates that any rise
in the price a$ove h@ a $ushel will
decrease the quantity demanded to D.

A. "he answers are3
a. In >igure @.H the rise in costs shifts the supply curve from G
A
to G
^
. "he
arrow indicates hJ, the amount $y which the new supply curve lies a$ove
the old supply curve. "he price stays at hB= in other words, the price
does not rise. Xuantity, however, decreases from @D million to BD million
per year.
$. In >igure @.c, the supply curve again shifts from G
A
to G
^
and the length
of the arrow again indicates hJ. In this case, when demand is perfectly
inelastic, the price rises $y the full amount indicated $y the arrow= that
is, the price clim$s from hB to hI a tape, which is a rise of e.actly hJ.
"he quantity, however, remains constant at @D million tapes.
c. As >igures @.H and @.c show, the rise in costs increases the price the
most when demand is inelastic. <hen demand is perfectly inelastic, the
price goes up $y the full amount of the rise in costs. "hen, as demand
$ecomes more elastic, the price rises $y less. At the other e.treme,
when demand is perfectly elastic, the price does not change. "he quantity
decreases most when demand is perfectly elastic. As demand $ecomes
less elastic, the change in the quantity $ecomes smaller.

H. "he answers are3
a. "a$le @.@ contains the price elasticities of demand. "o see how these
elasticities are calculated, take the elasticity $etween ?J and ?B as an
e.ample. "he elasticity of demand is defined as kXKkX
ave
KkWKkW
ave
which in this case gives JDK[A!K?JK?J.AD! L D.JH.
$. "he total revenues are given in "a$le @.A. "otal revenue equals W ! . X !,
so at a price of ?H, ?H!AD! L ?IDD.
Ta"le 4.4
Prices 7#8 Elasticity
c to\ B.J@
H to c J.@@
A to H J.DD
@ to A D.H[
I to @ D.@c
B to I D.B[
J to B D.JH
Ta"le 4.?
Prices 7#8 Total re!ene 7#8
\ B@D
c B\D
H IDD
A IDD
@ B\D
I B@D
B J\D
J JDD
c. :oving along the demand curve from ?\ to ?J results in the elasticity
falling, from B.J@ when the price is $etween ?\ and ?c, to D.JH when the
price is $etween ?B and ?J. <hen demand is elastic, $etween ?\ and ?H, a
fall in price with its corresponding increase in sales! raises total revenue.
<hen demand is unit elastic, $etween ?H and ?A, total revenue is at its
ma.imum and a drop in price with the increase in sales! does not change
the total revenue. >inally, over the range when demand is inelastic, from a
price of ?A to a price of ?J, even though a fall in price raises the quantity
sold, it does so $y a smaller percentage so that in this range the fall in
price lowers total revenue.
c. "he answers are3
a. "he graph on the right illustrates
the demand curve.
$. "a$le @.H contains the price
elasticities of demand. >or
e.ample, at a price $etween h@
and hA, the price elasticity of
demand equals
kXKkX
ave
KkWKkW
ave
L AKBB.A!K
hJKh@.AD! L J.DD.
c. "otal revenues are in "a$le @.c.
"otal revenue equals W! . X!. Go,
to calculate the total revenue at a
price of, say, hB, multiply the price times the quantity, or hB!AD! L
hJDD.
d. "he price elasticity of demand along this demand curve always equals
J.DD. In other words, this demand is always unit elastic. <ith unit
elasticity, changes in price do not change total revenue, which is precisely
what "a$le @.c illustrates.
Ta"le 4.@
Prices 7#8 Elasticity
c to\ J.DD
H to c J.DD
A to H J.DD
@ to A J.DD
I to @ J.DD
B to I J.DD
J to B J.DD
Ta"le 4.A
Prices 7#8 Total re!ene 7;8
\ JDD
c JDD
H JDD
A JDD
@ JDD
I JDD
B JDD
J JDD

\. "he demand for restaurant meals is elastic. <hyE <hen demand is elastic, a
fall in price raises total revenue, which is e.actly what you have o$served.
[. "he elasticity of supply increases as time passes after a price change $ecause
it is easier to make in the production process M'9'oNo*+0 7*'7*+'(Z'!. >or
e.ample, to meet a permanent increase in the demand for cars, car industries
may at the $eginning only $e a$le to add an additional shift %M*M9,(Y%)-
p697*'! of workers at e.isting factories. ^ut as time passes, the companies can
make larger changes, such as $uilding more factories. As more capacity
7U5'/*+,)-)'! is added, more cars will $e made, increasing the elasticity of
supply.
JD. "he price of the product rises the
most immediately after the increase in
demand, and the quantity increases the
most in the long run. "hese results are
illustrated in the graph on the right.
Here, the short-run supply curve is G
GV
and the long-run supply curve is G
;V
.
Semand increases from S
J
to S
B
.
Immediately after the increase, the
price rises from W to W
J
and the
quantity increases from X to X
J
. In the
long run, supply $ecomes more elastic
and so the long run supply curve, G
;V
$ecomes relevant. Hence the price rises ultimately only to W
B
while the quantity
increases all the way to X
B
.