Elasticity

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Price Elasticity of Demand
Measures buyers responsiveness to price
changes
Elastic demand
Sensitive to price changes
Large change in quantity when price
changes
Inelastic demand
Insensitive to price changes
Small change in quantity when price
changes
LO1
Price Elasticity of Demand Formula



E
d

=

Percent change in Quantity
Demanded of Product X
Percent change in Price
of Product X
Price Elasticity of Demand Formula
Use the midpoint formula
Ensures consistent results

Where the change in quantity: =
1

0
; the change in price: =
1

0
;
the average quantity:

= (
0
+
1
)/2; and the average price: = (
0
+
1
)/2.

0
+
1
2
(
1

0
)(

0
+
1
2
)






Price Elasticity of Demand Formula
It is in percentages
Unit free measure
Compares responsiveness across
products
Eliminates the minus sign
Easier to compare elasticities
LO1
4-5
Interpretation of Elasticity of Demand
E
d
> 1 demand is elastic
E
d
= 1 demand is unit elastic
E
d
< 1 demand is inelastic
Extreme cases
Perfectly inelastic
Perfectly elastic
Extreme Cases
D
1
P


Perfectly inelastic demand
Perfectly
inelastic
demand
(Ed = 0)
0

Extreme Cases

Perfectly elastic demand
P

D
2
Perfectly
elastic
demand
(Ed = )
0
Total Revenue Test
Total expenditure by buyers =Total
revenue of sellers: R= p Q
Inelastic demand
P and R move in the same direction
Elastic demand
P and R move in opposite directions
Total Revenue Test
$3

2

1

0 10 20 30 40
Q
P
a
b
D
1
Increase price with elastic demand: orange gain is less than blue
loss
Decrease price with elastic demand: orange loss is less than blue
gain
Elastic demand forces sellers to lower prices
Total Revenue Test
$4

3

2

1

0 10 20
Q
P
c
d
D
2
Increase price with inelastic demand: orange gain is more than blue loss
Decrease price with inelastic demand: orange loss exceeds blue gain
With inelastic demand, sellers can increase prices and gain
Total Revenue Test
$3

2

1

0 10 20 30
Q
P
e
f
D
3
With unit elastic demand: increasing or
decreasing price leaves R unchanged
Total Revenue Test
Price Elasticity of Demand for Movie Tickets as Measured by the Elasticity
Coefficient and the Total-Revenue Test
(1)
Total Quantity of
Tickets Demanded per
Week, Thousands
(2)
Price per Ticket
(3)
Elasticity
Coefficient
(E
d
)
(4)
Total
Revenue
(1) X (2)
(5)
Total
Revenue
Test
1 $8 $8,000
2 7 5.00 14,000 Elastic
3 6 2.60 18,000 Elastic
4 5 1.57 20,000 Elastic
5 4 1.00 20,000 Unit Elastic
6 3 0.64 18,000 Inelastic
7 2 0.38 14,000 Inelastic
8 1 0.20 8,000 Inelastic
Elasticity and Total Revenue
0 1 2 3 4 5 6 7 8
0 1 2 3 4 5 6 7 8
Quantity Demanded
Quantity Demanded
P
r
i
c
e

T
o
t
a
l

R
e
v
e
n
u
e

(
T
h
o
u
s
a
n
d
s

o
f

D
o
l
l
a
r
s
)

$20
18
16
14
12
10
8
6
4
2
$8
7
6
5
4
3
2
1
a
b
c
d
e
f
g
h
Elastic
E
d
> 1
Unit Elastic
E
d
= 1
Inelastic
E
d
< 1
D
TR
Summary of Price Elasticity of Demand
Price Elasticity of Demand: A Summary
Absolute Value
of Elasticity
Coefficient Demand Is: Description
Impact on Total Revenue of a:
Price Increase Price Decrease
Greater than 1
(E
d
> 1)
Elastic or
relatively
elastic
Q
d
changes by a
larger
percentage than
does price
Total Revenue
decreases
Total Revenue
increases
Equal to 1
(E
d
= 1)
Unit or unitary
elastic
Q
d
changes by
the same
percentage as
does price
Total revenue
is unchanged
Total revenue
is unchanged
Less than 1
(E
d
< 1)
Inelastic or
relatively
inelastic
Q
d
changes by a
smaller
percentage than
does price
Total revenue
increases
Total revenue
decreases
Determinants of Elasticity of Demand
Substitutability
More substitutes, demand is more elastic
Proportion of Income
Higher proportion of income, demand is more elastic
Luxuries vs. Necessities
Luxury goods, demand is more elastic
Time
More time available, demand is more elastic
Selected Price Elasticities of Demand
Product or Service
Price Elasticity
of Demand (E
d
) Product or Service
Price Elasticity
of Demand (E
d
)
Newspapers .10 Milk .63
Electricity (household) .13 Household appliances .63
Bread .15 Liquor .70
MLB Tickets .23 Movies .87
Telephone Service .26 Beer .90
Cigarettes .25 Shoes .91
Sugar .30 Motor vehicles 1.14
Medical Care .31 Beef 1.27
Eggs .32 China, glassware 1.54
Legal Services .37 Residential land 1.60
Automobile repair .40 Restaurant meals 2.27
Clothing .49 Lamb and mutton 2.65
Gasoline .60 Fresh peas 2.83
Price Elasticity of Demand
Applications of E
d
Large Crop Yields
Inelastic demand, lower total revenue
Excise Taxes
Inelastic demand, more total revenue
Decriminalization of Illegal Drugs
Inelastic demand, more total revenue
Price Elasticity of Supply
Measures sellers responsiveness
to price changes
Elastic supply, producers are
responsive to price changes
Inelastic supply, producers are
not responsive to price changes

Price Elasticity of Supply
Formula to compute elasticity
E
s
> 1 supply is elastic
E
s
< 1 supply is inelastic

Percentage Change in Quantity
Supplied of Product X
Percentage Change in Price
of Product X
E
s
=
Price Elasticity of Supply
Time is primary determinant of
elasticity of supply
Time periods considered
Market period
Short Run
Long Run
Elasticity of Supply: The Market Period
P
Q
Perfectly inelastic supply
D
1
D
2
S
m
Q
0
P
m
P
0
Elasticity of Supply: The Short Run
Supply is more elastic than in market
period
P
Q
D
1
D
2
S
s
Q
0
P
s
P
0
Q
s
Elasticity of Supply: The Long Run
Supply is even more elastic than in
the short run
P
Q
D
1
D
2
S
l
Q
0
P
l
P
0
Q
l
Applications of Elasticity of Supply
Antiques
Inelastic supply
Reproductions
More elastic supply
Volatile gold prices
Inelastic supply
Cross Elasticity of Demand
Measures responsiveness of sales
to change in the price of another
good
Substitutes positive sign
Complements negative sign
Independent goods - zero

Percentage change in quantity demanded of
product X
E
x,y
= Percentage change in price of product Y
Cross Elasticity of Demand
Application
Change the price?
Allow a merger?
Income Elasticity of Demand
Measures responsiveness of buyers
to changes in income
Normal goods positive sign
Inferior goods negative sign

Percentage change
in quantity demanded
E
i
=
Percentage change in income
Income Elasticity Insights
High income elasticities
Most affected by a recession
Low or negative income
Least affected by a recession
E
x,y
and E
i
Cross and Income Elasticities of Demand
Value of
Coefficient Description Type of Good(s)
Cross elasticity:
Positive (E
wz
> 0)

Negative (E
xy
< 0)
Quantity demanded of W changes in same
direction as change in price of Z

Quantity demanded of X changes in
opposite direction from change in price of Y
Substitutes


Complements
Income elasticity:
Positive (E
i
>0)

Negative (E
i
<0)

Quantity demanded of the product changes
in same direction as change in income

Quantity demanded of the product changes
in opposite direction from change in income
Normal or superior


Inferior
Elasticity and Pricing Power
Charge different prices based on
price elasticities
Examples:
Business air travelers
Adult vs. child
Summary
Price elasticity of demand
Income elasticity of demand
Cross-price elasticity of demand
Price elasticity of supply