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

Ed =

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: ; the change in price: ; the average quantity: ;
and the average price: .

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

Ed > 1 demand is elastic

Ed = 1 demand is unit elastic
Ed < 1 demand is inelastic
Extreme cases
Perfectly inelastic
Perfectly elastic

Extreme Cases
P

D1
Perfectly
inelastic
demand
(Ed = 0)

Perfectly inelastic demand

Extreme Cases
P

D2
Perfectly
elastic
demand
(Ed = )

Perfectly elastic demand

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

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
P
$3

D1

10

20

30

40

Total Revenue Test

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
P

$4

c
3

D2
0

10

20

Total Revenue Test

With unit elastic demand: increasing or
decreasing price leaves R unchanged
P
$3

D3
0

10

20

30

Total Revenue Test

Price Elasticity of Demand for Movie Tickets as Measured by the Elasticity
Coefficient and the Total-Revenue Test
(3)
Elasticity
Coefficient
(Ed)

(1)
Total Quantity of
Tickets Demanded per
Week, Thousands

(4)
Total
Revenue
(1) X (2)

(5)
Total
Revenue
Test

(2)
Price per Ticket

$8

5.00

14,000

Elastic

2.60

18,000

Elastic

1.57

20,000

Elastic

1.00

20,000

Unit Elastic

0.64

18,000

Inelastic

0.38

14,000

Inelastic

0.20

8,000

Inelastic

$8,000

Price

Elasticity and Total Revenue

$8
7 a
b
6
c
5
d
4
e
3
2
f
g
1

Elastic
Ed > 1
Unit Elastic
Ed = 1
Inelastic
Ed < 1
h

0 1 2 3 4 5 6 7 8

Total Revenue
(Thousands of Dollars)

Quantity Demanded

$20
18
16
14
12
10
8
6
4
2

TR
0 1Quantity
2 3 4Demanded
5 6 7 8

Summary of Price Elasticity of

Demand
Price Elasticity of Demand: A Summary
Absolute Value
of Elasticity
Coefficient
Demand Is:

Impact on Total Revenue of a:

Description

Price Increase Price Decrease

Qd changes by a
larger
percentage than
does price

Total Revenue
decreases

Total Revenue
increases

Greater than 1
(Ed > 1)

Elastic or
relatively
elastic

Equal to 1
(Ed = 1)

Unit or unitary Qd changes by

elastic
the same
percentage as
does price

Total revenue
is unchanged

Total revenue
is unchanged

Less than 1
(Ed < 1)

Inelastic or
relatively
inelastic

Total revenue
increases

Total revenue
decreases

Qd changes by a
smaller
percentage than
does price

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

Price
Elasticity
of
Demand
Selected Price Elasticities of Demand
Product or Service

Price Elasticity
of Demand (Ed) Product or Service

Price Elasticity
of Demand (Ed)

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

Applications of Ed

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

Es > 1 supply is elastic
Es < 1 supply is inelastic
Es =

Percentage Change in Quantity

Supplied of Product X
Percentage Change in Price
of Product X

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
Perfectly inelastic supply
P
Sm
Pm

P0

D2
D1
Q0

Elasticity of Supply: The Short

Run

Supply is more elastic than in market

period

Ss

Ps

P0

D2
D1
Q0 Qs

Elasticity of Supply: The Long Run

Supply is even more elastic than in

the short run
P
Sl

Pl
P0

D2
D1
Q0

Ql

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

Ex,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
Ei =
Percentage change in income

Income Elasticity Insights

High income elasticities

Most affected by a recession
Low or negative income
Least affected by a recession

Ex,y and Ei
Cross and Income Elasticities of Demand
Value of
Coefficient
Cross elasticity:
Positive (Ewz > 0)
Negative (Exy < 0)

Description
Quantity demanded of W changes in same
direction as change in price of Z

Type of Good(s)
Substitutes

Quantity demanded of X changes in

Complements
opposite direction from change in price of Y

Income elasticity:
Positive (Ei >0)

Quantity demanded of the product changes

in same direction as change in income

Normal or superior

Negative (Ei<0)

Quantity demanded of the product changes

in opposite direction from change in income

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