Elasticity . . .

Demand elasticity is a measure of how much buyers respond to changes price, income, and other things. Supply elasticity is a measure of how much sellers respond to changes in price and other things.

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Flavors of elasticity
Price Elasticity of Demand Income Elasticity of Demand Advertising Elasticity of Demand Price Elasticity of Supply

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Price Elasticity of Demand

Price elasticity of demand:

the percent change in quantity demanded in response to a percent change in price.

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Price Elasticity of Demand

Demand tends to be more elastic :

The

larger the number of close substitutes.

the longer the time period. the more narrowly defined the market. If the good is a luxury.
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Computing the Price Elasticity of Demand: A First Approach

Price elasticity of demand Percentage change in quatity demanded Percentage change in price

Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones then your price elasticity of demand is:

(8 10) 100 20 percent 10 2 (2.20 2.00) 10 percent 100 2.00

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Computing the Price Elasticity of Demand: Mid Point Method

(100 - 50)
Price

ED

(100 50)/2 (4.00 5.00)/2

(4.00- 5.00)

$5 4

Demand

67 percent -3 - 22 percent

Demand is price elastic

0 50 100 Quantity

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Perfectly Inelastic Demand

Qty demanded doesnt respond to price
Price

Elasticity=0
Demand

$5 1. An increase in price... 4

Quantity 100 2. ...leaves the quantity demanded unchanged.

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Inelastic Demand
A large percent change in price A small percent change in quantity demanded Elasticity < 1
Price

1. A 22% $5 increase in price... 4 Demand

Quantity 90 100 2. ...leads to a 11% decrease in quantity.

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Unit Elastic Demand

Each 1% increase in price a 1% decrease in quantity demanded Elasticity = 1
Price

1. A 22% $5 increase in price... 4 Demand

Quantity 80 100 2. ...leads to a 22% decrease in quantity.

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Elastic Demand
Small increase in price big decrease in quantity demanded Elasticity > 1
Price 1. A 22% $5 increase in price... 4 Demand

Quantity 50 100 2. ...leads to a 67% decrease in quantity.

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Perfectly Elastic Demand

The smallest change in price Huge change in quantity demanded Elasticity is INFINITE
Price

$4

Demand At exactly $4, consumers will buy any quantity and they wont pay a cent more theyll buy something else if price rises at all.

Demand facing a competitive firm.

Quantity
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Price Elasticity and Total Revenue

Total

revenue is the price of a good multiplied by the quantity sold.

TR = P x Q

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Total Revenue: A Picture

Price

$4

P x Q = $400
P

(total revenue)

Demand

100

Quantity

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Elasticity and Total Revenue

With

inelastic demand, an increase in price leads to a small decrease in quantity demanded. Total revenue increases when price rises. P x Q Increases when P rises
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Elasticity and Total Revenue

elastic demand, a small increase in price leads to a big decrease in quantity demanded.
T With

otal revenue decreases when price rises.

P x Q decreases when P rises

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Elasticity and Total Revenue: Elastic Demand

Price Price

An increase in price from $4 to $5...

$5 $4 Revenue = $200

leads to a decrease in total revenue from$200 to $100

Demand

Demand
Revenue = $100

50

Quantity

20

Quantity

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Income Elasticity of Demand

Quantity

demanded responds to consumer income. Income elasticity of demand:

percentage change in quantity demanded divided by the percentage change in income.

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Computing Income Elasticity

Percentage Change in Quantity Demanded Percentage Change in Income

Income Elasticity = of Demand

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Income Elasticity
- Types of Goods Necessities

are income inelastic

Examples: food, fuel, clothing, utilities, medical care.

Luxuries

are income elastic. Examples: sports cars, jewelry, gourmet foods.

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Use the midpoint method to calculate your price elasticity of demand as the price of compact discs increases from $8 to $10 if (i) your income is $10,000, and (ii) your income is $12,000.

[(40 32)/36] / [(8-10)/9] = [2/9]/[2/9] = 1

[(50-45)/47.5]/ [(8-10)/9] = 10.5% / 22.2% = .47

Calculate your income elasticity of demand as your income increases from $10,000 to $12,000 if (i) the price is $12, and (ii) the price is $16.

[(30 24)/27]/[(10-12)/11] = 22.2% / 18.2 % = 1.22

[(12 8)/10 ]/[(10-12)/11] = 40% / 18.2 % = 2.2

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Price Elasticity of Supply

Quantity

supplied responds to price. Price elasticity of supply

the percentage change in quantity supplied resulting from a percent change in price.

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Computing the Price Elasticity of Supply

The percentage change in quantity supplied divided by the percentage change in price.
Percentage Change in Quantity Supplied Elasticity of Supply = Percentage Change in Price
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Perfectly Inelastic Supply

Elasticity equals 0
Price

Supply

$5 1. An increase in price... 4

Quantity 100 2. ...leaves the quantity supplied unchanged.

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Inelastic Supply
Elasticity < 1
Price Supply 1. A 22% $5 increase in price... 4

Quantity 100 110 2. ...leads to a 9 % increase in quantity supplied.

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Unit Elastic Supply

Elasticity equals 1
Price Supply 1. A 22% $5 increase in price... 4

Quantity 100 125 2. ...leads to a 22% increase in quantity.

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Elastic Supply Elasticity > 1

Price Supply 1. A 22% $5 increase in price... 4

100 200 Quantity 2. ...leads to a 67% increase in quantity.

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Perfectly Elastic Supply Elasticity equals infinity

Price

$4 At exactly $4, producers will supply any quantity.

Supply

Quantity
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Determinants of Elasticity of Supply

Ability of sellers to change the amount they produce

Beach-front land is inelastic. Books, cars, or manufactured goods are elastic.

Time period

Supply is more elastic in the long run than in the short run.
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An Increase in Supply in the Market for Wheat

Price of Wheat

S1
$3

Demand
0 100 Quantity of Wheat

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An Increase in Supply in the Market for Wheat

Price of Wheat

1. When demand is inelastic, an increase in supply...

S1 S2

2. ...leads $3 to a large 2 fall in price...

Demand
0

3. ...and a proportionately smaller increase in quantity sold. As a result, revenue falls from $300 to $220.

100

110

Quantity of Wheat

Summary
Price

elasticity of demand measures how much the quantity demanded responds to changes in the price. If a demand curve is elastic, total revenue falls when the price rises. If it is inelastic, total revenue rises as the price rises.
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Summary
The

price elasticity of supply measures how much the quantity supplied responds to changes in the price. In most markets, supply is more elastic in the long run than in the short run.

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Graphical Review

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Computing the Price Elasticity of Demand

(100 - 50)
Price

ED

(100 50)/2 (4.00 5.00)/2

(4.00 - 5.00)

$5 4

Demand

67 percent -3 - 22 percent

Demand is price elastic

0 50 100 Quantity

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Elasticity and Total Revenue: Inelastic Demand Qd doesnt change much when price rises
Price Price

An increase in price from $1 to $3...

leads to an increase in total revenue from$100 to $240

$3
Revenue = $240

$1
0

Revenue = $100
100

Demand
Quantity
0 80

Demand
Quantity

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Elasticity and Total Revenue Elastic Demand Qd changes a lot when price rises
Price Price

An increase in price from $4 to $5...

$5 $4 Revenue = $200

leads to a decrease in total revenue from$200 to $100

Demand

Demand
Revenue = $100

50

Quantity

20

Quantity

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Perfectly Inelastic Supply

- Elasticity equals 0
Price

Supply

$5 1. An increase in price... 4

Quantity 100 2. ...leaves the quantity supplied unchanged.

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Inelastic Supply
- Elasticity is less than 1
Price Supply 1. A 22% $5 increase in price... 4

Quantity 100 110 2. ...leads to a 10% increase in quantity.

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Unit Elastic Supply

- Elasticity equals 1
Price Supply 1. A 22% $5 increase in price... 4

Quantity 100 125 2. ...leads to a 22% increase in quantity.

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Elastic Supply
- Elasticity is greater than 1
Price Supply 1. A 22% $5 increase in price... 4

100 200 Quantity 2. ...leads to a 67% increase in quantity.

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