Parkin Elasticity Ch04

ELASTICITY
CHAPTER
Predicting Prices
The Organization of Oil Exporting Countries (OPEC) is a big enough
player in the global oil market to influence the price of oil. To raise the
price, OPEC must cut production. If it does so, by how much will the
price rise? Will non-OPEC producers also cut production? Or will they
produce more to take advantage of the higher price achieved by OPECs
actions? To answer questions like these, we need to know the quantitative relationship between price and the quantities demanded and supplied. All firms are interested in the factors that influence prices and
in predicting prices. A pizza producer wants to know if the arrival of a
new competitor will lower the price of pizza, whether as peoples
incomes rise they will spend more or less on pizza. A labor union wants
to know whether, if it goes for a large wage rise the number of people
employed will fall by a lot or a little.
In this chapter, you will learn about a tool that helps us to answer
questions like the ones weve just considered. You will learn about the
elasticity of demand and supply. At the end of the chapter, well return
to the questions the OPEC needs to answer and see how the concept of
elasticity helps us to understand the effects of OPECs actions on the
price of crude oil, a price that has a big impact on the price that you end
up paying for gasoline.
After studying this chapter,

you will be able to
Define, calculate, and explain the
factors that influence the price
elasticity of demand
factors that influence the cross
elasticity of demand and the income
elasticity of demand
factors that influence the elasticity
of supply
81
ELASTICITY
Price Elasticity of Demand

Y ,
equilibrium price falls and the equilibrium quantity
increases. But does the price fall by a large amount and
the quantity increase by a little? Or does the price
barely fall and the quantity increase by a large amount?
The answer depends on the responsiveness of the
quantity demanded to a change in price. You can see
why by studying Fig. 4.1, which shows two possible
scenarios in a local pizza market. Figure 4.1(a) shows
one scenario, and Fig. 4.1(b) shows the other.
In both cases, supply is initially S0. In part (a),
the demand for pizza is shown by the demand curve
DA. In part (b), the demand for pizza is shown by the
demand curve DB. Initially, in both cases, the price is
$20 a pizza and the quantity of pizza produced and
consumed is 10 pizzas an hour.
Now a large pizza franchise opens up, and the
supply of pizza increases. The supply curve shifts
rightward to S1. In case (a), the price falls by an enormous $15 to $5 a pizza, and the quantity increases by
only 3 to 13 pizzas an hour. In contrast, in case (b),
the price falls by only $5 to $15 a pizza and the
quantity increases by 7 to 17 pizzas an hour.
The different outcomes arise from differing degrees
of responsiveness of the quantity demanded to a change
in price. But what do we mean by responsiveness? One
possible answer is slope. The slope of demand curve DA
is steeper than the slope of demand curve DB.
In this example, we can compare the slopes of
the two demand curves. But we cant always do so.
The reason is that the slope of a demand curve
depends on the units in which we measure the price
and quantity. And we often must compare the
demand curves for different goods and services that
are measured in unrelated units. For example, a pizza
producer might want to compare the demand for
pizza with the demand for soft drinks. Which quantity demanded is more responsive to a price change?
This question cant be answered by comparing the
slopes of two demand curves. The units of measurement of pizza and soft drinks are unrelated. The
question can be answered with a measure of responsiveness that is independent of units of measurement.
Elasticity is such a measure.
The price elasticity of demand is a units-free measure of the responsiveness of the quantity demanded of
a good to a change in its price when all other influences on buyers plans remain the same.
How a Change in Supply

Changes Price and Quantity
FIGURE 4.1
Price (dollars per pizza)
C HAPTER 4
40.00
S0
An increase
in supply
brings ...
S1
30.00
... a large
fall in price ...
20.00
10.00
... and a small

increase in quantity
5.00
DA
0
10
13 15
20
25
Quantity (pizzas per hour)
(a) Large price change and small quantity change
82
40.00
An increase
S0 in supply
brings ...
S1
30.00
20.00
15.00
10.00
DB
... a small
fall in
price ...
... and a
large increase
in quantity
10
15 17
20
25
(b) Small price change and large quantity change
Initially the price is $20 a pizza and the quantity sold is 10

pizzas an hour. Then supply increases from S0 to S1. In part
(a), the price falls by $15 to $5 a pizza, and the quantity
increases by only 3 to 13 pizzas an hour. In part (b), the
price falls by only $5 to $15 a pizza, and the quantity
increases by 7 to 17 pizzas an hour. This price change is
smaller and the quantity change is larger than in case (a).
The quantity demanded is more responsive to price in case
(b) than in case (a).
PRICE ELASTICITY
Price elasticity of

demand
Percentage change
in quantity demanded
.
Percentage change in price
To use this formula, we need to know the quantities

demanded at different prices when all other influences on buyers plans remain the same. Suppose we
have the data on prices and quantities demanded of
pizza and we calculate the price elasticity of demand
for pizza.
Figure 4.2 zooms in on the demand curve for
pizza and shows how the quantity demanded
responds to a small change in price. Initially, the
price is $20.50 a pizza and 9 pizzas an hour are sold
the original point in the figure. The price then
falls to $19.50 a pizza, and the quantity demanded
increases to 11 pizzas an hour the new point in
the figure. When the price falls by $1 a pizza, the
quantity demanded increases by 2 pizzas an hour.
To calculate the price elasticity of demand, we
express the changes in price and quantity demanded as
percentages of the average price and the average quantity. By using the average price and average quantity,
we calculate the elasticity at a point on the demand
curve midway between the original point and the new
point. The original price is $20.50 and the new price is
$19.50, so the average price is $20. The $1 price
decrease is 5 percent of the average price. That is,
P>Pave 1$1>$202 100 5%.
The original quantity demanded is 9 pizzas and
the new quantity demanded is 11 pizzas, so the average quantity demanded is 10 pizzas. The 2 pizza
increase in the quantity demanded is 20 percent of
the average quantity. That is,
Q>Qave 12>102 100 20%.
So the price elasticity of demand, which is the
percentage change in the quantity demanded (20 percent) divided by the percentage change in price (5
percent) is 4. That is,
%Q
Price elasticity of demand
%P
20%

4.
5%
FIGURE 4.2
We calculate the price elasticity of demand by using

the formula:
83
DEMAND
Calculating the Elasticity

of Demand
Original
point
20.50
Calculating Elasticity
OF
P = $1
Elasticity = 4
20.00
Pave = $20
New
point
19.50
D
Q = 2
Qave = 10
0
10
11
The elasticity of demand is calculated by using the

formula:*
Price elasticity of demand

Percentage change
% Q
% P
Q>Qave
P>Pave
2>10
1>20
4.
This calculation measures the elasticity at an average price

of $20 a pizza and an average quantity of 10 pizzas an hour.
* In the formula, the Greek letter delta () stands for change in and %
stands for percentage change in.
Average Price and Quantity Notice that we use
the average price and average quantity. We do this

because it gives the most precise measurement of elasticity at the midpoint between the original price
and the new price. If the price falls from $20.50 to
$19.50, the $1 price change is 4.8 percent of $20.50.
The 2 pizza change in quantity is 22.2 percent of 9,
the original quantity. So if we use these numbers, the
elasticity of demand is 22.2 divided by 4.8, which
equals 4.5. If the price rises from $19.50 to $20.50,
84
C HAPTER 4
ELASTICITY
demand curve. Because a positive change in price

brings a negative change in the quantity demanded,
the price elasticity of demand is a negative number.
But it is the magnitude, or absolute value, of the price
elasticity of demand that tells us how responsive
how elastic demand is. To compare elasticities, we
use the magnitude of the price elasticity of demand
and ignore the minus sign.
the $1 price change is 5.1 percent of $19.50. The 2

pizza change in quantity is 18.2 percent of 11, the
original quantity. So if we use these numbers, the
elasticity of demand is 18.2 divided by 5.1, which
equals 3.6.
By using percentages of the average price and
average quantity, we get the same value for the elasticity regardless of whether the price falls from $20.50
to $19.50 or rises from $19.50 to $20.50.
Inelastic and Elastic Demand
Percentages and Proportions Elasticity is the ratio
Figure 4.3 shows three demand curves that cover

the entire range of possible elasticities of demand.
In Fig. 4.3(a), the quantity demanded is constant
regardless of the price. If the quantity demanded
remains constant when the price changes, then the
price elasticity of demand is zero and the good is said
to have perfectly inelastic demand. One good that has
a very low price elasticity of demand (perhaps zero
over some price range) is insulin. Insulin is of such
importance to some diabetics that if the price rises or
falls, they do not change the quantity they buy.
If the percentage change in the quantity demanded
equals the percentage change in price, then the price
elasticity equals 1 and the good is said to have unit
elastic demand. The demand in Fig. 4.3(b) is an
example of unit elastic demand.
Between the cases shown in Fig. 4.3(a) and Fig.
4.3(b) is the general case in which the percentage
change in the quantity demanded is less than the
of two percentage changes. So when we divide one

percentage change by another, the 100s cancel. A percentage change is a proportionate change multiplied
by 100. The proportionate change in price is P/Pave,
and the proportionate change in quantity demanded
is Q/Qave. So if we divide Q/Qave by P/Pave we
get the same answer as we get by using percentage
changes.
A Units-Free Measure Now that youve calculated
a price elasticity of demand, you can see why it is a

units-free measure. Elasticity is a units-free measure
because the percentage change in each variable is
independent of the units in which the variable is
measured. And the ratio of the two percentages is a
number without units.
Minus Sign and Elasticity When the price of a
good rises, the quantity demanded decreases along the
D1
Price
Price
Price
Inelastic and Elastic Demand
FIGURE 4.3
Elasticity = 0
Elasticity =
Elasticity = 1
12
12
12
D2
0
(a) Perfectly inelastic demand
Quantity
(b) Unit elastic demand
Each demand illustrated here has a constant elasticity. The

demand curve in part (a) illustrates the demand for a good
that has a zero elasticity of demand. The demand curve in
Quantity
Quantity
(c) Perfectly elastic demand
part (b) illustrates the demand for a good with a unit elasticity of demand. And the demand curve in part (c) illustrates
the demand for a good with an infinite elasticity of demand.
PRICE ELASTICITY
Elasticity Along a Straight-Line

Demand Curve
Along a straight-line demand curve, like the one
shown in Fig. 4.4, the elasticity varies. At high prices
and small quantities, the elasticity is large; and at low
prices and large quantities, the elasticity is small. To
convince yourself of this fact, calculate the elasticity
at three different average prices.
First, suppose the price falls from $25 to $15 a
pizza. The quantity demanded increases from zero to
20 pizzas an hour. The average price is $20, so the
percentage change in price is $10 divided by $20
multiplied by 100, which equals 50. The average
quantity is 10 pizzas, so the percentage change in
quantity is 20 pizzas divided by 10 pizzas, multiplied
by 100, which equals 200. So dividing the percentage change in the quantity demanded (200) by the
percentage change in price (50), you see that the
elasticity of demand at an average price of $20 is 4.
Next, suppose that the price falls from $15 to
$10 a pizza. The quantity demanded increases from
20 to 30 pizzas an hour. The average price is now
$12.50, so the percentage change in price is $5
DEMAND
85
divided by $12.50 multiplied by 100, which equals

40 percent. The average quantity is 25 pizzas an hour,
so the percentage change in the quantity demanded is
10 pizzas divided by 25 pizzas multiplied by 100,
which also equals 40 percent. So dividing the percentage change in the quantity demanded (40) by the
percentage change in price (40), you see that the elasticity of demand at an average price of $12.50 is 1.
The elasticity of demand is always equal to 1 at the
midpoint of a straight-line demand curve.
Finally, suppose that the price falls from $10 to
zero. The quantity demanded increases from 30 to 50
pizzas an hour. The average price is now $5, so the
percentage change in price is $10 divided by $5 multiplied by 100, which equals 200 percent. The average quantity is 40 pizzas an hour, so the percentage
change in the quantity demanded is 20 pizzas divided
by 40 pizzas multiplied by 100, which also equals 50
percent. So dividing the percentage change in the
quantity demanded (50) by the percentage change in
price (200), you see that the elasticity of demand at
an average price of $5 is 14.
Elasticity Along a StraightLine Demand Curve
FIGURE 4.4
percentage change in price. In this case, the price

elasticity of demand is between zero and 1 and the
good is said to have inelastic demand. Food and
housing are examples of goods with inelastic demand.
If the quantity demanded changes by an infinitely large percentage in response to a tiny price
change, then the price elasticity of demand is infinity and the good is said to have perfectly elastic
demand. Figure 4.3(c) shows perfectly elastic
demand. An example of a good that has a very
high elasticity of demand (almost infinite) is a soft
drink from two campus machines located side by
side. If the two machines offer the same soft drinks
for the same price, some people buy from one
machine and some from the other. But if one
machines price is higher than the others, by even
a small amount, no one will buy from the machine
with the higher price. Soft drinks from the two
machines are perfect substitutes.
Between the cases in Fig. 4.3(b) and Fig. 4.3(c)
is the general case in which the percentage change in
the quantity demanded exceeds the percentage change
in price. In this case, the price elasticity is greater
than 1 and the good is said to have elastic demand.
Automobiles and furniture are examples of goods that
have elastic demand.
OF
25.00
Elasticity = 4
20.00
Elastic
15.00
Elasticity = 1
12.50
Inelastic
10.00
Elasticity = 1/4
5.00
10
20 25
30
40
50
On a straight-line demand curve, elasticity decreases as the

price falls and the quantity demanded increases. Demand is
unit elastic at the midpoint of the demand curve (elasticity
is 1). Above the midpoint, demand is elastic; below the midpoint, demand is inelastic.
C HAPTER 4
ELASTICITY
Total Revenue and Elasticity

The total revenue from the sale of a good equals the
price of the good multiplied by the quantity sold.
When a price changes, total revenue also changes.
But a rise in price does not always increase total revenue. The change in total revenue depends on the
elasticity of demand in the following way:
If demand is elastic, a 1 percent price cut increases

the quantity sold by more than 1 percent and total
revenue increases.
Elasticity and Total Revenue
FIGURE 4.5
86
25.00
Elastic
demand
20.00
Unit
elastic
15.00
12.50
If demand is inelastic, a 1 percent price cut

increases the quantity sold by less than 1 percent
and total revenue decreases.
If demand is unit elastic, a 1 percent price cut
increases the quantity sold by 1 percent and so
total revenue does not change.
10.00
Inelastic
demand
5.00
25
If a price cut increases total revenue, demand is

elastic.
If a price cut decreases total revenue, demand is
inelastic.
If a price cut leaves total revenue unchanged,
demand is unit elastic.
350.00
Maximum
total revenue
312.50
250.00
200.00
150.00
100.00
In Fig. 4.5(a), over the price range from $25 to

$12.50, demand is elastic. Over the price range from
$12.50 to zero, demand is inelastic. At a price of
$12.50, demand is unit elastic.
Figure 4.5(b) shows total revenue. At a price of
$25, the quantity sold is zero, so total revenue is
also zero. At a price of zero, the quantity demanded
is 50 pizzas an hour but total revenue is again zero.
A price cut in the elastic range brings an increase in
total revenue the percentage increase in the quantity demanded is greater than the percentage decrease
in price. A price cut in the inelastic range brings a
decrease in total revenue the percentage increase
in the quantity demanded is less than the percentage
decrease in price. At unit elasticity, total revenue is
at a maximum.
50
(a) Demand
Total revenue (dollars)
Figure 4.5 shows how we can use this relationship between elasticity and total revenue to estimate elasticity using the total revenue test. The
total revenue test is a method of estimating the
price elasticity of demand by observing the change
in total revenue that results from a change in the
price, when all other influences on the quantity
sold remain the same.
50.00
When demand
is elastic, a
price cut
increases
total revenue
When demand
is inelastic, a
price cut
decreases
total revenue
25
50
(b) Total revenue
When demand is elastic, in the price range from $25 to

$12.50, a decrease in price (part a) brings an increase in
total revenue (part b).When demand is inelastic, in the
price range from $12.50 to zero, a decrease in price (part
a) brings a decrease in total revenue (part b).When
demand is unit elastic, at a price of $12.50 (part a), total
revenue is at a maximum (part b).
PRICE ELASTICITY
Your Expenditure and Your Elasticity

When a price changes, the change in your expenditure
on the good depends on your elasticity of demand.
If your demand is elastic, a 1 percent price cut

increases the quantity you buy by more than 1 percent and your expenditure on the item increases.
If your demand is inelastic, a 1 percent price cut
increases the quantity you buy by less than 1 percent and your expenditure on the item decreases.
If your demand is unit elastic, a 1 percent price
cut increases the quantity you buy by 1 percent
and your expenditure on the item does not change.
So if when the price of an item falls, you spend

more on it, your demand for that item is elastic; if you
spend the same amount, your demand is unit elastic;
and if you spend less, your demand is inelastic.
The Factors That Influence the
Elasticity of Demand
Table 4.1 lists some estimates of actual elasticities in
the real world. You can see that these real-world elasticities of demand range from 1.52 for metals, the
item with the most elastic demand in the table, to
0.05 for oil, the item with the most inelastic demand
in the table. What makes the demand for some goods
elastic and the demand for others inelastic?
Elasticity depends on three main factors:
The closeness of substitutes

The proportion of income spent on the good
The time elapsed since a price change
Closeness of Substitutes The closer the substitutes
for a good or service, the more elastic is the demand for

it. For example, oil from which we make gasoline has
substitutes but none that are currently very close (imagine a steam-driven, coal-fueled car). So the demand for
oil is inelastic. Plastics are close substitutes for metals,
so the demand for metal is an elastic demand.
The degree of substitutability between two goods
also depends on how narrowly (or broadly) we define
them. For example, the elasticity of demand for meat
is low, but the elasticity of demand for beef or pork is
high. The elasticity of demand for personal computers is low, but the elasticity of demand for a Compaq,
Dell, or IBM is high.
In everyday language we call some goods, such
as food and housing, necessities and other goods, such
as exotic vacations, luxuries. A necessity is a good
TABLE 4.1
OF
87
DEMAND
Some Real-World Price

Elasticities of Demand
Good or Service
Elasticity
Elastic Demand
Metals
1.52
Electrical engineering products
1.39
Mechanical engineering products
1.30
Furniture
1.26
Motor vehicles
1.14
Instrument engineering products
1.10
Professional services
1.09
Transportation services
1.03
Inelastic Demand
Gas, electricity, and water
0.92
Chemicals
0.89
Drinks (all types)
0.78
Clothing
0.64
Tobacco
0.61
Banking and insurance services
0.56
Housing services
0.55
Agricultural and fish products
0.42
Books, magazines, and newspapers
0.34
Food
0.12
Oil
0.05
Sources: Ahsan Mansur and John Whalley,Numerical Specification of Applied

General Equilibrium Models: Estimation, Calibration, and Data, in Applied
General Equilibrium Analysis, eds. Herbert E. Scarf and John B. Shoven (New
York: Cambridge University Press, 1984), 109, and Henri Theil, Ching-Fan
Chung, and James L. Seale, Jr., Advances in Econometrics, Supplement I, 1989,
International Evidence on Consumption Patterns (Greenwich, Conn.: JAI Press
Inc., 1989), and Geoffrey Heal, Columbia University,Web site.
that has poor substitutes and that is crucial for our

well-being. So generally, a necessity has an inelastic
demand. In Table 4.1, food and oil might be classified
as necessities that have inelastic demand.
A luxury is a good that usually has many substitutes, one of which is not buying it. So a luxury generally has an elastic demand. In Table 4.1, furniture
and motor vehicles might be classified as luxuries that
have elastic demand.
88
C HAPTER 4
ELASTICITY
Proportion of Income Spent on the Good Other
things remaining the same, the greater the proportion

of income spent on a good, the more elastic is the
demand for it.
Think about your own elasticity of demand for
chewing gum and housing. If the price of chewing
gum doubles, you consume almost as much gum as
before. Your demand for gum is inelastic. If apartment
rents double, you shriek and look for more students
to share accommodation with you. Your demand for
housing is more elastic than your demand for gum.
Why the difference? Housing takes a large proportion
of your budget, and gum takes only a tiny proportion.
You dont like either price increase, but you hardly
notice the higher price of gum, while the higher rent
puts your budget under severe strain.
Figure 4.6 shows the proportion of income spent
on food and the price elasticity of demand for food in
10 countries. This figure confirms the general tendency we have just described. The larger the proportion of income spent on food, the larger is the price
elasticity of demand for food. For example, in Tanzania,
FIGURE 4.6
Price Elasticities in
10 Countries
Country
Food budget
(percentage of income)
Tanzania
62
India
56
Korea
40
35
Brazil
Greece
31
Spain
28
17
France
Germany
15
Canada
14
United States
12
0
0.2
0.4
0.6
0.8
1.0
Price elasticity
As income increases and the proportion of income spent on

food decreases, the demand for food becomes less elastic.
Source: Henri Theil, Ching-Fan Chung, and James L. Seale, Jr., Advances in
Econometrics, Supplement 1, 1989, International Evidence on Consumption Patterns (Greenwich, Conn.: JAI Press, Inc., 1989).
a nation where average incomes are 3.3 percent of

incomes in the United States and where 62 percent
of income is spent on food, the price elasticity of
demand for food is 0.77. In contrast, in the United
States, where 12 percent of income is spent on food,
the price elasticity of demand for food is 0.12.
Time Elapsed Since Price Change The longer the
time that has elapsed since a price change, the more

elastic is demand. When the price of oil increased by
400 percent during the 1970s, people barely changed
the quantity of oil and gasoline they consumed. But
gradually, as more efficient auto and airplane engines
were developed, the quantity consumed decreased.
The demand for oil has become more elastic as more
time has elapsed since the huge price hike. Similarly,
when the price of a PC fell, the quantity of PCs
demanded increased only slightly at first. But as more
people have become better informed about the variety of ways of using a PC, the quantity of PCs
bought has increased sharply. The demand for PCs
has become more elastic.
1 Why do we need a units-free measure of the

responsiveness of the quantity demanded of a
good or service to a change in its price?
2 Can you define and calculate the price elasticity
of demand?
3 Why, when we calculate the price elasticity of
demand, do we express the change in price as a
percentage of the average price and the change in
quantity as a percentage of the average quantity?
4 What is the total revenue test and why does it
work?
5 What are the main influences on the elasticity
of demand that make the demand for some
goods elastic and the demand for other goods
inelastic?
6 Why is the demand for a luxury generally more
elastic than the demand for a necessity?
Youve now completed your study of the price

elasticity of demand. Two other elasticity concepts tell
us about the effects of other influences on demand.
Lets look at these other elasticities of demand.
MORE ELASTICITIES
B ,
out how a price cut by the burger shop next door will
affect the demand for your pizza. You know that pizzas and burgers are substitutes. And you know that
when the price of a substitute for pizza falls, the
demand for pizza decreases. But by how much?
You also know that pizza and soft drinks are complements. And you know that if the price of a complement of pizza falls, the demand for pizza increases. So
you wonder whether you might keep your customers
by cutting the price you charge for soft drinks. But
again by how much?
To answer these questions, you need to calculate
the cross elasticity of demand. Lets examine this elasticity measure.
Cross Elasticity of Demand
We measure the influence of a change in the price of
a substitute or complement by using the concept of
the cross elasticity of demand. The cross elasticity of
demand is a measure of the responsiveness of the
demand for a good to a change in the price of a substitute or complement, other things remaining the
same. We calculate the cross elasticity of demand by
using the formula:
DEMAND
89
The change in the price of a burger, a substitute

for pizza, is the new price, $2.50, minus the original
price, $1.50, which is +$1. The average price is $2.
So the price of a burger rises by 50 percent (+50).
That is,
P>Pave 11>22 100 50%.
So the cross elasticity of demand for pizza with

respect to the price of a burger is
20%
0.4.
50%
Figure 4.7 illustrates the cross elasticity of
demand. Pizza and burgers are substitutes. Because
they are substitutes, when the price of a burger rises,
the demand for pizza increases. The demand curve for
pizza shifts rightward from D0 to D1. Because a rise in
the price of a burger brings a increase in the demand
for pizza, the cross elasticity of demand for pizza with
respect to the price of a burger is positive. Both the
price and the quantity change in the same direction.
FIGURE 4.7
Cross Elasticity of Demand
Price of pizza
More Elasticities
of Demand
OF
Price of a burger,
a substitute, rises.
Positive cross elasticity
Percentage change
Cross elasticity
of demand Percentage change in price of .
a substitute or complement
The cross elasticity of demand can be positive or
negative. It is positive for a substitute and negative for
a complement.
Substitutes Suppose that the price of pizza is constant and 9 pizzas an hour are sold. The price of a
burger then rises from $1.50 to $2.50. No other
influence on buying plans changes and the quantity
of pizzas sold increases to 11 an hour.
The change in the quantity demanded is the new
quantity, 11 pizzas, minus the original quantity, 9
pizzas, which is +2 pizzas. The average quantity is 10
pizzas. So the quantity of pizzas demanded increases
by 20 percent (+20). That is,
Q>Qave 12>102 100 20%.
Price of soft drink,

a complement,
rises. Negative
cross elasticity
0
D1
D0
D2
Quantity of pizza
A burger is a substitute for pizza.When the price of a

burger rises, the demand for pizza increases and the
demand curve for pizza shifts rightward from D0 to D1. The
cross elasticity of the demand is positive.
Soft drinks are a complement of pizza.When the price
of soft drinks rises, the demand for pizza decreases and the
demand curve for pizza shifts leftward from D0 to D2. The
cross elasticity of the demand is negative.
90
C HAPTER 4
ELASTICITY
Complements Now suppose that the price of pizza
is constant and 11 pizzas an hour are sold. The price

of a soft drink rises from $1.50 to $2.50. No other
of pizzas sold falls to 9 an hour.
The change in the quantity demanded is the
opposite of what weve just calculated: The quantity
of pizzas demanded decreases by 20 percent (20).
The change in the price of a soft drink, a
complement of pizza, is the same as the percentage
change in the price of a burger that weve just calculated: The price rises by 50 percent (+50). So the
cross elasticity of demand for pizza with respect to
the price of a soft drink is
20%
0.4.
50%
Because pizza and soft drinks are complements,
when the price of a soft drink rises, the demand for
pizza decreases. The demand curve for pizza shifts
leftward from D0 to D2. Because a rise in the price of
soft drinks brings a decrease in the demand for pizza,
the cross elasticity of demand for pizza with respect
to the price of soft drinks is negative. The price and
quantity change in opposite directions.
The magnitude of the cross elasticity of demand
determines how far the demand curve shifts. The
larger the cross elasticity (absolute value), the greater
is the change in demand and the larger is the shift in
the demand curve.
If two items are very close substitutes, such as
two brands of spring water, the cross elasticity is
large. If two items are close complements, such as
movies and popcorn, the cross elasticity is large.
If two items are somewhat unrelated to each
other, such as newspapers and orange juice, the cross
elasticity is small perhaps even zero.
Income Elasticity of Demand
Suppose the economy is expanding and people are
enjoying rising incomes. This prosperity is bringing
an increase in the demand for most types of goods
and services. But by how much will the demand for
pizza increase? The answer depends on the income
elasticity of demand, which is a measure of the
responsiveness of the demand for a good or service
to a change in income, other things remaining
the same.
The income elasticity of demand is calculated by

using the formula:
Income elasticity

of demand
Percentage change
.
Percentage change in income
Income elasticities of demand can be positive or

negative and fall into three interesting ranges:
Greater than 1 (normal good, income elastic)

Positive and less than 1 (normal good, income
inelastic)
Negative (inferior good)
Income Elastic Demand Suppose that the price of

pizza is constant and 9 pizzas an hour are sold. Then
incomes rise from $975 to $1,025 a week. No other
of pizzas sold increases to 11 an hour.
The change in the quantity demanded is +2
pizzas. The average quantity is 10, so the quantity
demanded increases by 20 percent. The change in
income is +$50 and the average income is $1,000, so
incomes increase by 5 percent. The income elasticity
of demand for pizza is
20%
4.
5%
As income increases, the quantity of pizza
demanded increases faster than income. The demand
for pizza is income-elastic. Other goods in this category include ocean cruises, international travel, jewelry, and works of art.
Income Inelastic Demand If the percentage
increase in the quantity demanded is less than the

percentage increase in income, the income elasticity
of demand is positive and less than 1. In this case, the
quantity demanded increases as income increases, but
income increases faster than the quantity demanded.
The demand for the good is income inelastic. Goods
in this category include food, clothing, newspapers,
and magazines.
Inferior Goods If when income increases the quan-
tity demanded of a good decreases, the income elasticity of demand is negative. Goods in this category
include small motorcycles, potatoes, and rice. Lowincome consumers buy most of these goods.
MORE ELASTICITIES
Real-World Income Elasticities

of Demand
FIGURE 4.8
Table 4.2 shows estimates of some real-world income

elasticities of demand. The demand for a necessity
such as food or gasoline is income inelastic, while the
demand for a luxury such as transportation, which
includes airline and foreign travel, is income elastic.
But what is a necessity and what is a luxury
depends on the level of income. For people with a low
income, food and clothing can be luxuries. So the level
of income has a big effect on income elasticities of
demand. Figure 4.8 shows this effect on the income
elasticity of demand for food in 10 countries. In countries with low incomes, such as Tanzania and India, the
income elasticity of demand for food is high. In countries with high incomes, such as the United States, the
income elasticity of demand for food is low.
TABLE 4.2
Some Real-World Income

Elasticities of Demand
Elastic Demand
Airline travel
5.82
Movies
3.41
Foreign travel
3.08
Electricity
1.94
Restaurant meals
1.61
Local buses and trains
1.38
Haircuts
1.36
Automobiles
1.07
Inelastic Demand
Tobacco
0.86
Alcoholic drinks
0.62
Furniture
0.53
Clothing
0.51
Newspapers and magazines
0.38
Telephone
0.32
Food
0.14
Sources: H.S. Houthakker and Lester D. Taylor, Consumer Demand in the

United States (Cambridge, Mass.: Harvard University Press, 1970), and Henri
Theil, Ching-Fan Chung, and James L. Seale, Jr., Advances in Econometrics,
Supplement 1, 1989, International Evidence on Consumption Patterns (Greenwich, Conn.: JAI Press, Inc., 1989).
OF
DEMAND
91
Income Elasticities in
10 Countries
Country
Income
(percentage of U.S. income)
Tanzania
3.3
India
5.2
Korea
20.4
Brazil
36.8
Greece
41.3
Spain
55.9
Japan
61.6
France
81.1
Canada
99.2
United States
100
0
0.2
0.4
0.6
0.8
1.0
Income elasticity
As income increases, the income elasticity of demand for

food decreases. For low-income consumers, a larger percentage of any increase in income is spent on food than for
high-income consumers.
Source: Henri Theil, Ching-Fan Chung, and James L. Seale, Jr., Advances in
Econometrics, Supplement 1, 1989, International Evidence on Consumption
Patterns (Greenwich, Conn.: JAI Press, Inc., 1989).
1 What does the cross elasticity of demand measure?

2 What does the sign (positive versus negative) of
the cross elasticity of demand tell us about the
relationship between two goods?
3 What does the income elasticity of demand
measure?
4 What does the sign (positive versus negative) of
the income elasticity of demand tell us about a
good?
5 Why does the level of income influence the
magnitude of the income elasticity of demand?
Youve now completed your study of the cross

elasticity of demand and the income elasticity of
demand. Lets look at the other side of a market
and examine the elasticity of supply.
ELASTICITY
Elasticity of Supply
Y ,
price rises and the quantity increases. But does the
price rise by a large amount and the quantity increase
by a little? Or does the price barely rise and the quantity increase by a large amount?
The answer depends on the responsiveness of the
quantity supplied to a change in price. You can see
why by studying Fig. 4.9, which shows two possible
scenarios in a local pizza market. Figure 4.9(a) shows
one scenario, and Fig. 4.9(b) shows the other.
In both cases, demand is initially D0. In part (a),
the supply of pizza is shown by the supply curve SA.
In part (b), the supply of pizza is shown by the supply curve SB. Initially, in both cases, the price is $20 a
pizza and the quantity produced and consumed is 10
pizzas an hour.
Now increases in income and population increase
the demand for pizza. The demand curve shifts rightward to D1. In case (a), the price rises by $10 to $30
a pizza, and the quantity increases by only 3 to 13 an
hour. In contrast, in case (b), the price rises by only
$1 to $21 a pizza, and the quantity increases by 10 to
20 pizzas an hour.
The different outcomes arise from differing
degrees of responsiveness of the quantity supplied to a
change in price. We measure the degree of responsiveness by using the concept of the elasticity of supply.
40.00
Elasticity
of supply
Percentage change in
quantity supplied
.
We use the same method that you learned when you

studied the elasticity of demand. (Refer back to page
83 to check this method.) Lets calculate the elasticity
of supply for the supply curves in Fig. 4.9.
In Fig. 4.9(a), when the price rises from $20 to
$30, the price rise is $10 and the average price is $25,
so the price rises by 40 percent of the average price.
The quantity increases from 10 to 13, so the increase
An increase in
demand brings ...
SA
30.00
20.00
... a large
price rise ...
D1
10.00
D0
... and a small

quantity increase
0
10
13 15
20
25
(a) Large price change and small quantity change
40.00
An increase
in demand
brings ...
30.00
21.00
20.00
SB
D1
... a small
price rise ...
Calculating the Elasticity of Supply

The elasticity of supply measures the responsiveness
of the quantity supplied to a change in the price of a
good when all other influences on selling plans remain
the same. It is calculated by using the formula:
How a Change in Demand

Changes Price and Quantity
FIGURE 4.9
C HAPTER 4
92
10.00
... and a large

quantity increase
0
D0
10
15
20
25
(b) Small price change and large quantity change
Initially, the price is $20 a pizza, and the quantity sold is 10

pizzas an hour. Then increases in incomes and population
increase the demand for pizza. The demand curve shifts
rightward to D1. In part (a) the price rises by $10 to $30 a
pizza, and the quantity increases by only 3 to 13 pizzas an
hour. In part (b), the price rises by only $1 to $21 a pizza,
and the quantity increases by 10 to 20 pizzas an hour. The
price change is smaller and the quantity change is larger in
case (b) than in case (a). The quantity supplied is more
responsive to price in case (b) than in case (a).
ELASTICITY
The magnitude of the elasticity of supply depends on
Resource substitution possibilities

Time frame for the supply decision
Resource Substitution Possibilities Some goods
and services can be produced only by using unique or

rare productive resources. These items have a low,
even perhaps a zero, elasticity of supply. Other goods
and services can be produced by using commonly
available resources that could be allocated to a wide
variety of alternative tasks. Such items have a high
elasticity of supply.
A Van Gogh painting is an example of a good
with a vertical supply curve and a zero elasticity of
supply. At the other extreme, wheat can be grown on
land that is almost equally good for growing corn.
So it is just as easy to grow wheat as corn, and the
opportunity cost of wheat in terms of forgone corn is
almost constant. As a result, the supply curve of
wheat is almost horizontal and its elasticity of supply
is very large. Similarly, when a good is produced in
many different countries (for example, sugar and
beef ), the supply of the good is highly elastic.
S1
(a) Perfectly inelastic supply
S2
Elasticity of
supply =
Elasticity of
supply = 0
Price
Inelastic and Elastic Supply

Price
Price
93
S U P P LY
The Factors That Influence the

Elasticity of Supply
is 3, the average quantity is 11.5, and the quantity

increases by 26 percent. The elasticity of supply is
equal to 26 percent divided by 40 percent, which
equals 0.65.
In Fig. 4.9(b), when the price rises from $20 to
$21, the price rise is $1 and the average price is
$20.50, so the price rises by 4.8 percent of the average price. The quantity increases from 10 to 20, so
the increase is 10, the average quantity is 15, and the
quantity increases by 67 percent. The elasticity of
supply is equal to 67 percent divided by 4.8 percent,
which equals 13.67.
Figure 4.10 shows the range of supply elasticities.
If the quantity supplied is fixed regardless of the
price, the supply curve is vertical and the elasticity of
supply is zero. Supply is perfectly inelastic. This case
is shown in Fig. 4.10(a). A special intermediate case
is when the percentage change in price equals the
percentage change in quantity. Supply is then unit
elastic. This case is shown in Fig. 4.10(b). No matter
how steep the supply curve is, if it is linear and passes
through the origin, supply is unit elastic. If there is a
price at which sellers are willing to offer any quantity
for sale, the supply curve is horizontal and the elasticity of supply is infinite. Supply is perfectly elastic.
This case is shown in Fig. 4.10(c).
FIGURE 4.10
OF
S3
Elasticity of
supply = 1
Quantity
0
(b) Unit elastic supply
Each supply illustrated here has a constant elasticity. The

supply curve in part (a) illustrates the supply of a good that
has a zero elasticity of supply. The supply curve in part (b)
illustrates the supply for a good with a unit elasticity of
Quantity
Quantity
(c) Perfectly elastic supply
supply. All linear supply curves that pass through the origin
illustrate supplies that are unit elastic. The supply curve in
part (c) illustrates the supply for a good with an infinite elasticity of supply.
94
C HAPTER 4
ELASTICITY
The supply of most goods and services lies

between the two extremes. The quantity produced
can be increased but only by incurring a higher cost.
If a higher price is offered, the quantity supplied
increases. Such goods and services have an elasticity
of supply between zero and infinity.
Time Frame for Supply Decisions To study the
influence of the length of time elapsed since a price
change, we distinguish three time frames of supply:
1. Momentary supply
2. Long-run supply
3. Short-run supply
When the price of a good rises or falls, the momentary supply curve shows the response of the quantity
supplied immediately following a price change.
Some goods, such as fruits and vegetables, have a
perfectly inelastic momentary supply a vertical
supply curve. The quantities supplied depend on
crop-planting decisions made earlier. In the case of
oranges, for example, planting decisions have to be
made many years in advance of the crop being available. The momentary supply curve is vertical because,
on a given day, no matter what the price of oranges,
producers cannot change their output. They have
picked, packed, and shipped their crop to market,
and the quantity available for that day is fixed.
In contrast, some goods have a perfectly elastic
momentary supply. Long-distance phone calls are an
example. When many people simultaneously make a
call, there is a big surge in the demand for telephone
cables, computer switching, and satellite time, and
the quantity bought increases. But the price remains
constant. Long-distance carriers monitor fluctuations
in demand and reroute calls to ensure that the quantity supplied equals the quantity demanded without
changing the price.
The long-run supply curve shows the response of
the quantity supplied to a change in price after all the
technologically possible ways of adjusting supply
have been exploited. In the case of oranges, the long
run is the time it takes new plantings to grow to full
maturity about 15 years. In some cases, the longrun adjustment occurs only after a completely new
production plant has been built and workers have
been trained to operate it typically a process that
might take several years.
The short-run supply curve shows how the quantity supplied responds to a price change when only
some of the technologically possible adjustments to

production have been made. The short-run response
to a price change is a sequence of adjustments. The
first adjustment that is usually made is in the amount
of labor employed. To increase output in the short
run, firms work their labor force overtime and perhaps hire additional workers. To decrease their output
in the short run, firms either lay off workers or reduce
their hours of work. With the passage of time, firms
can make additional adjustments, perhaps training
additional workers or buying additional tools and
other equipment.
The short-run supply curve slopes upward
because producers can take actions quite quickly to
change the quantity supplied in response to a price
change. For example, if the price of oranges falls,
growers can stop picking and leave oranges to rot on
the trees. Or if the price rises, they can use more fertilizer and improved irrigation to increase the yields
of their existing trees. In the long run, they can plant
more trees and increase the quantity supplied even
more in response to a given price rise.
1 Why do we need to measure the responsiveness

of the quantity supplied of a good or service to
a change in its price?
2 Can you define and calculate the elasticity of
supply?
3 What are the main influences on the elasticity
of supply that make the supply of some goods
elastic and the supply of other goods inelastic?
4 Can you provide examples of goods or services
whose elasticity of supply are (a) zero, (b) greater
than zero but less than infinity, and (c), infinity?
5 How does the time frame over which a supply
decision is made influence the elasticity of
supply?
You have now studied the theory of demand and

supply, and you have learned how to measure the
elasticities of demand and supply. All the elasticities
that youve met in this chapter are summarized in
Table 4.3. In the next chapter, we are going to study
the efficiency of competitive markets. But before
doing that, take a look at Reading Between the Lines
on pp. 9697 to see elasticity in action.
ELASTICITY
TABLE 4.3
OF
S U P P LY
95
A Compact Glossary of Elasticities
Price Elasticities of Demand

A relationship is described as
When its magnitude is
Which means that
Perfectly elastic or
infinitely elastic
Elastic
Infinity
Greater than zero

but less than 1
Zero
The smallest possible increase in price causes an infinitely

large decrease in the quantity demanded*
The percentage decrease in the quantity demanded
exceeds the percentage increase in price
The percentage decrease in the quantity demanded equals
the percentage increase in price
The percentage decrease in the quantity demanded is less
than the percentage increase in price
The quantity demanded is the same at all prices
When its value is
Which means that
Perfect substitutes
Infinity
Substitutes
Independent
Positive, less
than infinity
Zero
Complements
Less than zero
The smallest possible increase in the price of one good

causes an infinitely large increase in the quantity
demanded of the other good
If the price of one good increases, the quantity demanded
of the other good also increases
of the other good remains the same
of the other good decreases
Unit elastic
Inelastic
Perfectly inelastic
or completely inelastic
Less than infinity

but greater than 1
1
Cross Elasticities of Demand
Income Elasticities of Demand

When its value is
Which means that
Income elastic
(normal good)
Income inelastic
(normal good)
Negative income elastic
(inferior good)
Greater than 1
Less than 1 but
greater than zero
Less than zero
The percentage increase in the quantity demanded is

greater than the percentage increase in income
The percentage increase in the quantity demanded is
less than the percentage increase in income
When income increases, quantity demanded decreases
When its magnitude is
Which means that
Perfectly elastic
Infinity
Elastic
Less than infinity but

greater than 1
Greater than zero but
less than 1
Zero
The smallest possible increase in price causes an

infinitely large increase in the quantity supplied
The percentage increase in the quantity supplied
exceeds the percentage increase in the price
The percentage increase in the quantity supplied is less
than the percentage increase in the price
The quantity supplied is the same at all prices
Elasticities of Supply
Inelastic
Perfectly inelastic
*In each description, the directions of change may be reversed. For example, in this case, the smallest possible decrease in price causes an infinitely large increase in the
quantity demanded.
Elasticities of Demand and Supply

in the Global Oil Market
Essence of the Story
The Organization of
Petroleum Exporting
Countries (OPEC) said
that it would cut oil production by 1.5 million
barrels a day, or 6 percent, if non-OPEC
members also made deep
cuts to production.
Please see page 96 of your

printed textbook to
read this article.
On the same day, the

price of oil fell and
OPEC ministers predicted a price of $10 a barrel
if non-OPEC producers
didnt decrease output.
Analysts did not expect other producers to

decrease output.
96
Economic Analysis
If OPEC cuts production by 1.5 million barrels a day, supply in 2002

would decrease to S2002.
But the actions of individual OPEC members

and of non-OPEC producers make it impossible for OPEC to control
the price of crude oil.
Figure 1 shows that

the price of crude oil
fluctuates (an example of
a price roller coaster).
During 2001, the

price fell below $20 a
barrel and OPEC worried that without a
decrease in supply, the
price might fall to $10
a barrel.
30
We can work out the

effect of OPEC's cut in
production on price and
quantity because we have
estimates of the price
elasticity of demand and
the elasticity of supply.
Price (dollars per barrel)
OPEC is the largest

supplier of oil (with a 36
percent market share), and
it tries to limit production
to raise the price.
OPEC predicted that

demand would decrease
in 2002 to D2002 so with
no change in supply, the
price would fall to $10 a
barrel and the quantity
would decrease to 71
million barrels a day.
25
Price rise as
demand
increased
20
15
Forecasts
made in 2001
10
The elasticity of demand is 0.05, and the

elasticity of supply is 0.1.
These elasticity values are
suggested by Geoffrey
Heal of Columbia University, a leading natural
resource economist.
In 2001, the supply

curve was S2001 and the
demand curve was D2001.
The quantity was 75 million barrels a day, and the
price was $18 a barrel.
2002:4
Figure 3 shows that

the price would rise to
$11.50 a barrel and the
quantity would decrease
to 70.5 million barrels a
day.
Decrease
in demand
30.00
D2001
10.00
Price in 2002
with no cut in
production
0
Because demand is inelastic, a small quantity

decrease brings a large
price rise.
But because the price

rises, non-OPEC producers increase production an increase in the
quantity supplied.
The decrease in quantity of 0.5 million barrels

a day equals OPECs cut
of 1.5 million barrels a
day minus the 1 million
barrels a day increase in
production by the rest of
the world.
S2001
18.00
65
D2002
71
75
80
Quantity (millions of barrels per day)
Figure 2 The oil market with no production cuts
Price (dollars pe barrel)
Figure 2 shows demand and supply in the

market for crude oil.
2001:2
Figure 1 The price of crude oil
Price fall as
demand
decreased
1987:2
1999:4
Year/quarter
Price (dollars pe barrel)
Demand and supply

in a global market determine the price of crude oil.
20.00
Price in 2002
with OPEC
production cut
Decrease
in OPEC
production
S2002
S2001
15.00
Increase
in non-OPEC
quantity
supplied
11.50
10.00
D2002
0
69
70.5 71 72
73
74
75
Quantity (millions of barrels per day)
Figure 3 OPEC production cut
97
98
C HAPTER 4
ELASTICITY
Elasticity of Supply (pp. 9294)
KEY POINTS
Elasticity of Demand (pp. 8288)
Elasticity is a measure of the responsiveness of the

quantity demanded of a good to a change in its
price.
Price elasticity of demand equals the percentage
change in the quantity demanded divided by the
percentage change in price.
The larger the magnitude of the elasticity of
demand, the greater is the responsiveness of the
quantity demanded to a given change in price.
Price elasticity of demand depends on how easily
one good serves as a substitute for another, the
proportion of income spent on the good, and the
length of time elapsed since the price change.
If demand is elastic, a decrease in price leads to an
increase in total revenue. If demand is unit elastic,
a decrease in price leaves total revenue unchanged.
And if demand is inelastic, a decrease in price leads
to a decrease in total revenue.
Elasticity of supply measures the responsiveness of

the quantity supplied of a good to a change in its
price.
The elasticity of supply is usually positive and
ranges between zero (vertical supply curve) and
infinity (horizontal supply curve).
Supply decisions have three time frames: momentary, long run, and short run.
Momentary supply refers to the response of sellers
to a price change at the instant that the price
changes.
Long-run supply refers to the response of sellers to
a price change when all the technologically feasible
adjustments in production have been made.
Short-run supply refers to the response of sellers to
a price change after some of the technologically
feasible adjustments in production have been made.
KEY FIGURES
AND TABLE
Figure 4.2
Figure 4.3
Figure 4.4
More Elasticities of Demand (pp. 8991)
Cross elasticity of demand measures the responsiveness of demand for one good to a change in
the price of a substitute or a complement.
The cross elasticity of demand with respect to the
price of a substitute is positive. The cross elasticity
of demand with respect to the price of a complement is negative.
Income elasticity of demand measures the responsiveness of demand to a change in income. For a
normal good, the income elasticity of demand is
positive. For an inferior good, the income elasticity of demand is negative.
When the income elasticity is greater than 1, as
income increases, the percentage of income spent
on the good increases.
When the income elasticity is less than 1 but
greater than zero, as income increases, the percentage of income spent on the good decreases.
Figure 4.5
Figure 4.7
Table 4.3
Calculating the Elasticity of

Demand, 83
Inelastic and Elastic Demand, 84
Elasticity Along a Straight-Line
Demand Curve, 85
Elasticity and Total Revenue, 86
Cross Elasticity of Demand, 89
A Compact Glossary of
Elasticities, 95
KEY TERMS
Cross elasticity of demand, 89
Elastic demand, 85
Elasticity of supply, 92
Income elasticity of demand, 90
Inelastic demand, 85
Perfectly elastic demand, 85
Perfectly inelastic demand, 84
Price elasticity of demand, 82
Total revenue, 86
Total revenue test, 86
Unit elastic demand, 84
P RO B L E M S
Price (dollars per videotape)
*1. Rain spoils the strawberry crop. As a result, the

price rises from $4 to $6 a box and the quantity demanded decreases from 1,000 to 600
boxes a week. Over this price range,
a. What is the price elasticity of demand?
b. Describe the demand for strawberries.
2. Good weather brings a bumper tomato crop.
The price falls from $7 to $5 a basket, and the
quantity demanded increases from 300 to 500
baskets a day. Over this price range,
a. What is the price elasticity of demand?
b. Describe the demand for tomatoes.
*3. The figure shows the demand for videotape
rentals.
6
5
4
3
2
1
D
25
50
75
100 125 150

Videotapes per day
Price (dollars per pen)
a. Calculate the elasticity of demand for a rise

in rental price from $3 to $5.
b. At what price is the elasticity of demand
equal to 1?
4. The figure shows the demand for pens.
12
10
8
6
4
2
D
20
40
60
80
100 120
Pens per day
a. Calculate the elasticity of demand for a rise

in price from $6 to $10.
99
b. At what prices is the elasticity of demand

equal to 1, greater than 1, and less than 1?
*5. If the quantity of dental services demanded
increases by 10 percent when the price of dental
services falls by 10 percent, is the demand for
dental service inelastic, elastic, or unit elastic?
6. If the quantity of haircuts demanded decreases
by 10 percent when the price of a haircut rises
by 5 percent, is the demand for haircuts elastic,
inelastic, or unit elastic?
*7. The demand schedule for computer chips is
Price
Quantity demanded
(dollars per chip)
(millions of chips per year)
200
50
250
45
300
40
350
35
400
30
a. What happens to total revenue if the price
of a chip falls from $400 to $350?
b. What happens to total revenue if the price
of a chip falls from $350 to $300?
c. At what price is total revenue at a maximum?
Use the total revenue test to answer this
question.
d. At an average price of $350, is the demand
for chips elastic or inelastic? Use the total
revenue test to answer this question.
8. The demand schedule for sugar is
Price
Quantity demanded
(dollars per pound)
(millions of pounds per year)
5
25
10
20
15
15
20
10
25
5
a. What happens to total revenue if the price
of sugar rises from $5 to $15 per pound?
b. What happens to total revenue if the price
rises from $15 to $25 per pound?
c. At what price is total revenue at a maximum? Use the total revenue test to answer
this question.
d. At an average price of $20 a pound, is the
demand for sugar elastic or inelastic? Use the
total revenue test to answer this question.
*9. In problem 7, at $250 a chip, is the demand for
chips elastic or inelastic? Use the total revenue
test to answer this question.
100
C HAPTER 4
ELASTICITY
10. In problem 8, at $10 a pound, is the demand

for sugar elastic or inelastic? Use the total revenue test to answer this question.
*11. If a 12 percent rise in the price of orange juice
decreases the quantity of orange juice demanded
by 22 percent and increases the quantity of
apple juice demanded by 14 percent, calculate
the cross elasticity of demand between orange
juice and apple juice.
12. If a 5 percent fall in the price of chicken
decreases the quantity of beef demanded by 20
percent and increases the quantity of chicken
demanded by 15 percent, calculate the cross
elasticity of demand between chicken and beef.
*13. Alexs income has increased from $3,000 to
$5,000. Alex increased his consumption of
bagels from 4 to 8 a month and decreased his
consumption of doughnuts from 12 to 6 a
month. Calculate Alexs income elasticity of
demand for (a) bagels and (b) doughnuts.
14. Judys income has increased from $13,000 to
$17,000. Judy increased her demand for concert tickets by 15 percent and decreased her
demand for bus rides by 10 percent. Calculate
Judys income elasticity of demand for (a) concert tickets and (b) bus rides.
*15. The table gives the supply schedule for longdistance phone calls.
Price
Quantity supplied
(cents per minute)
(millions of minutes per day)
10
20
30
40
200
400
600
800
Calculate the elasticity of supply when

a. The price falls from 40 cents to 30 cents a
minute.
b. The price is 20 cents a minute.
16. The table gives the supply schedule for jeans.
Price
Quantity supplied
(dollars per pair)
(millions of pairs per year)
120
125
130
135
2,400
2,800
3,200
3,600
Calculate the elasticity of supply when

a. The price rises from $125 to $135 a pair.
b. The price is $125 a pair.
1. Study Reading Between the Lines (pp. 9697) on

the market for crude oil and then answer the
following questions:
a. Why did the price of oil fall during 2001?
b. What is the elasticity that tells us the effect
of a change in supply on the price and quantity of crude oil?
c. What is the elasticity that tells us the effect
of a change in demand on the price and
quantity of crude oil?
d. Why did OPEC want to cut production
during 2002?
e. Calculate the elasticity of supply in Figure 2
on page 97 when demand decreases and confirm that it is (approximately) 0.1.
f. Calculate the elasticity of demand in Figure
3 on page 97 when supply decreases and
confirm that it is (approximately) 0.05.
g. By how much would OPEC have needed to
cut production to raise the price to $15 a
barrel (assuming demand D2002)?
1. Use the link on the Parkin Web site and

a. Find the price of gasoline in the summer of
2002.
b. Use the concepts of demand, supply, and
elasticity to explain recent changes in the
price of gasoline.
c. Find the price of crude oil.
d. Use the concepts of demand, supply, and
elasticity to explain recent changes in the
price of crude oil.
2. Use the link of the Parkin Web site and:
a. Find the number of gallons in a barrel and
the cost of crude oil in a gallon of gasoline.
b. What are the other costs that make up the
total cost of a gallon of gasoline?
c. If the price of crude oil falls by 10 percent,
by what percentage would you expect the
price of gasoline to change, other things
remaining the same?
d. Which demand do you think is more elastic:
that for crude oil or gasoline? Why?
3. Use the link of the Parkin Web site to review
and write a brief report on Geoffrey Heals lecture on the market for oil during the 1990s.

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ELASTICITY

After studying this chapter,

Price Elasticity of Demand

How a Change in Supply

Price (dollars per pizza)

... and a small

(a) Large price change and small quantity change

Price (dollars per pizza)

(b) Small price change and large quantity change

Initially the price is $20 a pizza and the quantity sold is 10

To use this formula, we need to know the quantities

Price (dollars per pizza)

We calculate the price elasticity of demand by using

Calculating the Elasticity

The elasticity of demand is calculated by using the

This calculation measures the elasticity at an average price

Average Price and Quantity Notice that we use

the average price and average quantity. We do this

demand curve. Because a positive change in price

the $1 price change is 5.1 percent of $19.50. The 2

Inelastic and Elastic Demand

Percentages and Proportions Elasticity is the ratio

Figure 4.3 shows three demand curves that cover

of two percentage changes. So when we divide one

a price elasticity of demand, you can see why it is a

good rises, the quantity demanded decreases along the

Inelastic and Elastic Demand

(b) Unit elastic demand

Each demand illustrated here has a constant elasticity. The

(c) Perfectly elastic demand

Elasticity Along a Straight-Line

divided by $12.50 multiplied by 100, which equals

Elasticity Along a StraightLine Demand Curve

Price (dollars per pizza)

percentage change in price. In this case, the price

On a straight-line demand curve, elasticity decreases as the

Total Revenue and Elasticity

If demand is elastic, a 1 percent price cut increases

Elasticity and Total Revenue

If demand is inelastic, a 1 percent price cut

If a price cut increases total revenue, demand is

In Fig. 4.5(a), over the price range from $25 to

Total revenue (dollars)

(b) Total revenue

When demand is elastic, in the price range from $25 to

Your Expenditure and Your Elasticity

If your demand is elastic, a 1 percent price cut

So if when the price of an item falls, you spend

The closeness of substitutes

Closeness of Substitutes The closer the substitutes

for a good or service, the more elastic is the demand for

Some Real-World Price

Electrical engineering products

Mechanical engineering products

Instrument engineering products

Drinks (all types)

Banking and insurance services

Agricultural and fish products

Books, magazines, and newspapers

Sources: Ahsan Mansur and John Whalley,Numerical Specification of Applied

that has poor substitutes and that is crucial for our

Proportion of Income Spent on the Good Other

things remaining the same, the greater the proportion

As income increases and the proportion of income spent on