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Principles of Economics,

9e

; ; By

Karl E. Case,

Ray C. Fair &

Sharon M. Oster

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 1 of 45

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 2 of 45

PART I INTRODUCTION TO ECONOMICS

Elasticity

5

Prepared by:

Fernando & Yvonn Quijano

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster

PART I INTRODUCTION TO ECONOMICS

Elasticity

5

CHAPTER OUTLINE

Price Elasticity of Demand

Slope and Elasticity

Types of Elasticity

Calculating Elasticities

Calculating Percentage Changes

Elasticity Is a Ratio of Percentages

The Midpoint Formula

Elasticity Changes Along a Straight-Line

Demand Curve

Elasticity and Total Revenue

The Determinants of Demand Elasticity

CHAPTER 5 Elasticity

Availability of Substitutes

The Importance of Being Unimportant

The Time Dimension

Other Important Elasticities

Income Elasticity of Demand

Cross-Price Elasticity of Demand

Elasticity of Supply

Looking Ahead

Appendix: Point Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 4 of 45

Elasticity

response in one variable when another variable

changes.

%A

elasticity of A with respect to B

%B

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 5 of 45

Price Elasticity of Demand

CHAPTER 5 Elasticity

Changing the unit of measure from pounds to ounces changes the numerical value of the

demand slope dramatically, but the behavior of buyers in the two diagrams is identical.

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 6 of 45

The slope of a demand curve is:

a. The best way of measuring the responsiveness in quantity

demanded to changes in price.

b. Equivalent to elasticity as a measure of responsiveness.

c. A poor measure of the responsiveness compared to elasticity.

d. A measure of the proportional change in quantity demanded,

given a proportional change in price.

e. A negative value, while demand elasticity is always a positive

value.

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 7 of 45

The slope of a demand curve is:

a. The best way of measuring the responsiveness in quantity

demanded to changes in price.

b. Equivalent to elasticity as a measure of responsiveness.

c. A poor measure of the responsiveness compared to

elasticity.

d. A measure of the proportional change in quantity demanded,

given a proportional change in price.

e. A negative value, while demand elasticity is always a positive

value.

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 8 of 45

Price Elasticity of Demand

percentage of change in quantity demanded to

the percentage of change in price; measures

the responsiveness of quantity demanded to

changes in price.

price elasticity of demand

CHAPTER 5 Elasticity

% change in price

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 9 of 45

Price Elasticity of Demand

Types of Elasticity

% Change

% Change In In Quantity

Price Demanded Elasticity

Product (% P) (% QD) (% QD ÷ %P)

Insulin +10% 0% .0 Perfectly inelastic

Basic telephone service +10% -1% -.1 Inelastic

Bananas +10% -30% -3.0 Elastic

CHAPTER 5 Elasticity

quantity demanded does not respond at all to a

change in price.

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 10 of 45

Price Elasticity of Demand

Types of Elasticity

CHAPTER 5 Elasticity

Figure 5.2(a) shows a perfectly inelastic demand curve for insulin. Price elasticity of demand

is zero. Quantity demanded is fixed; it does not change at all when price changes.

Figure 5.2(b) shows a perfectly elastic demand curve facing a wheat farmer. A tiny price

increase drives the quantity demanded to zero. In essence, perfectly elastic demand implies

that individual producers can sell all they want at the going market price but cannot charge a

higher price.

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 11 of 45

When a good has few close substitutes readily available:

a. Quantity demanded is not nearly as responsive to a change

in price.

b. Price tends to remain the same, regardless of quantity

demanded.

c. Proportional changes in quantity demanded tend to be

greater than proportional changes in price.

d. Elasticity cannot be measured.

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 12 of 45

When a good has few close substitutes readily available:

a. Quantity demanded is not nearly as responsive to a

change in price.

b. Price tends to remain the same, regardless of quantity

demanded.

c. Proportional changes in quantity demanded tend to be

greater than proportional changes in price.

d. Elasticity cannot be measured.

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 13 of 45

Price Elasticity of Demand

Types of Elasticity

somewhat, but not a great deal, to changes in

price. Inelastic demand always has a numerical

value between zero and -1.

Because it is generally understood that demand

elasticities are negative (demand curves have a

negative slope), they are often reported and

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 14 of 45

Price Elasticity of Demand

Types of Elasticity

the percentage change in quantity of a product

demanded is the same as the percentage change in

price in absolute value (a demand elasticity of -1).

percentage change in quantity demanded is larger

than the percentage change in price in absolute

value (a demand elasticity with an absolute value

greater than 1).

CHAPTER 5 Elasticity

quantity drops to zero at the slightest increase in

price.

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 15 of 45

When the percentage change in quantity demanded is greater

than the percentage change in price:

a. The value of demand elasticity is greater than one.

b. The demand curve is relatively steep.

c. There are few substitutes for the good in question.

d. There is little responsiveness in quantity demanded to

changes in price.

e. All of the above.

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 16 of 45

When the percentage change in quantity demanded is greater

than the percentage change in price:

a. The value of demand elasticity is greater than one.

b. The demand curve is relatively steep.

c. There are few substitutes for the good in question.

d. There is little responsiveness in quantity demanded to

changes in price.

e. All of the above.

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 17 of 45

Price Elasticity of Demand

Types of Elasticity

the two “perfect” elasticities is:

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 18 of 45

Calculating Elasticities

demanded using the initial value as the base, the

following formula is used:

% change in quantity demanded x 100%

Q 1

Q -Q

2

x 100%1

CHAPTER 5 Elasticity

Q 1

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 19 of 45

Calculating Elasticities

in a similar way. Once again, let us use the initial

value of P—that is, P1—as the base for calculating

the percentage. By using P1 as the base, the

formula for calculating the percentage of change in

P is

change in price

% change in price x 100%

P

CHAPTER 5 Elasticity

P -P

2

x 100% 1

P 1

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 20 of 45

Calculating Elasticities

price have been converted to percentages,

calculating elasticity is a matter of simple division.

Recall the formal definition of elasticity:

price elasticity of demand

% change in price

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 21 of 45

Calculating Elasticities

calculating percentages using the value halfway

between P1 and P2 for the base in calculating the

percentage change in price, and the value halfway

between Q1 and Q2 as the base for calculating the

percentage change in quantity demanded.

% change in quantity demanded x 100%

(Q Q ) / 2

CHAPTER 5 Elasticity

1 2

Q -Q

2

x 100%

1

(Q Q ) / 2

1 2

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 22 of 45

Calculating Elasticities

base for calculating the percentage change in

price, we get

change in price

% change in price x 100%

(P P ) / 2

1 2

P -P

x 100%

CHAPTER 5 Elasticity

2 1

(P P ) / 2

1 2

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 23 of 45

Refer to the figure below. Using the arc elasticity formula, the

value of price elasticity of demand equals:

a. 2.5.

b. 6.0

c. 3.7.

d. 0.27.

e. None of the above.

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 24 of 45

Refer to the figure below. Using the arc elasticity formula, the

value of price elasticity of demand equals:

a. 2.5.

b. 6.0

c. 3.7.

d. 0.27.

e. None of the above.

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 25 of 45

Calculating Elasticities

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 26 of 45

Calculating Elasticities

Elasticity Changes Along a Straight-Line Demand Curve

for Office Dining

Room Lunches

Price Quantity

(per Demanded

Lunch) (Lunches per Month)

$11 0

10 2

9 4

8 6

7 8

6 10

5 12

CHAPTER 5 Elasticity

4 14

3 16

2 18

1 20

22 FIGURE 5.3 Demand Curve for

0

Lunch at the Office Dining Room

Between points A and B, demand is quite elastic at -6.4.

Between points C and D, demand is quite inelastic at -.294.

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 27 of 45

Refer to the figure. Using the midpoint

formula, calculate the values of

elasticity between points A and B,

and then between points C and D.

Those values are, respectively:

a. –6.4 and –0.294

b. –0.1 and –4.54

c. –0.15 and –3.40

d. –0.5 and –0.5. Elasticity is the same

for both sets of points because the

demand curve is linear; thus, the

slope of the line remains constant.

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 28 of 45

Refer to the figure. Using the midpoint

formula, calculate the values of

elasticity between points A and B,

and then between points C and D.

Those values are, respectively:

a. –6.4 and –0.294

b. –0.1 and –4.54

c. –0.15 and –3.40

d. –0.5 and –0.5. Elasticity is the same

for both sets of points because the

demand curve is linear; thus, the

slope of the line remains constant.

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 29 of 45

Calculating Elasticities

by producers:

TR = P x Q

total revenue = price x quantity

increases. The two factors, P and QD move in

opposite directions:

CHAPTER 5 Elasticity

on quantity demanded: and

P QD

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 30 of 45

Calculating Elasticities

whether TR rises or falls in response to a price

increase depends on which is bigger: the

percentage increase in price or the percentage

decrease in quantity demanded.

a product with inelastic demand: P x QD TR

CHAPTER 5 Elasticity

percentage increase in price, total revenue will fall.

a product with inelastic demand: P x QD TR

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 31 of 45

Calculating Elasticities

is elastic, a cut in price increases total revenues:

with elastic demand: P x QD TR

total revenues:

CHAPTER 5 Elasticity

with inelastic demand: P x QD TR

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 32 of 45

When demand is elastic, a decrease in price leads to:

a. A decrease in total revenue.

b. An increase in total revenue.

c. An increase in quantity demanded, but no change in revenue.

d. A change in revenue, without a change in quantity demanded.

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 33 of 45

When demand is elastic, a decrease in price leads to:

a. A decrease in total revenue.

b. An increase in total revenue.

c. An increase in quantity demanded, but no change in revenue.

d. A change in revenue, without a change in quantity demanded.

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 34 of 45

The Determinants of Demand Elasticity

Availability of Substitutes

elasticity is the availability of substitutes.

our total budget, we tend to pay little attention to

its price.

CHAPTER 5 Elasticity

very different from the elasticity of demand in the

long run. In the longer run, demand is likely to

become more elastic, or responsive, simply

because households make adjustments over time

and producers develop substitute goods.

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 35 of 45

The Determinants of Demand Elasticity

Smokers?

Bill aims to raise tax on

cigarettes

Seattle Times

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 36 of 45

The Determinants of Demand Elasticity

Elasticities at a

Delicatessen in the Short

Run and Long Run

The graph shows the expected

relationship between long-run

and short-run demand for

Frank’s sandwiches. Notice if

you raise prices above the

CHAPTER 5 Elasticity

quantity change read off the

short-run curve is less than that

from the long-run curve.

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 37 of 45

Other Important Elasticities

responsiveness of demand to changes in income.

income elasticity of demand

% change in income

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 38 of 45

Which of the following is a true statement?

a. The fewer substitutes available for a product, the greater the

price elasticity of demand.

b. The more time that passes, the more inelastic the demand for a

product becomes.

c. When an item represents a small portion of our total budget,

demand for that item is likely to be inelastic.

d. All of the above.

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 39 of 45

Which of the following is a true statement?

a. The fewer substitutes available for a product, the greater the

price elasticity of demand.

b. The more time that passes, the more inelastic the demand for a

product becomes.

c. When an item represents a small portion of our total budget,

demand for that item is likely to be inelastic.

d. All of the above.

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 40 of 45

Other Important Elasticities

the response of the quantity of one good

demanded to a change in the price of another

good.

cross - price elasticity of demand

% change in price of X

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 41 of 45

Other Important Elasticities

Elasticity Of Supply

of quantity of a good supplied to a change in price

of that good. Likely to be positive in output

markets.

elasticity of supply

% change in price

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 42 of 45

Other Important Elasticities

Elasticity Of Supply

response of labor supplied to a change in the price

of labor.

elasticity of labor supply

% change in the wage rate

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 43 of 45

REVIEW TERMS AND CONCEPTS

elastic demand midpoint formula

elasticity perfectly elastic demand

elasticity of labor supply perfectly inelastic demand

elasticity of supply price elasticity of demand

income elasticity of demand unitary elasticity

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 44 of 45

APPENDIX

POINT ELASTICITY (OPTIONAL)

Along a Demand Curve

demand curve in Figure 5A.1.

We can write an expression for

elasticity at point C as follows:

CHAPTER 5 Elasticity

Q Q

100

%Q Q Q1 Q P1

elasticity

%P P 100 P P Q1

P P1

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 45 of 45

APPENDIX

POINT ELASTICITY (OPTIONAL)

Slope in the diagram is constant along the curve,

and it is negative. To calculate the reciprocal of

the slope to plug into the previous electricity

equation, we take Q1B, or M1, and divide by minus

the length of line segment CQ1. Thus,

Q M 1

P CQ1

Since the length of CQ1 is equal to P1, we can

write:

Q M 1

CHAPTER 5 Elasticity

P P1

By substituting we get:

M 1 P1 M 1 P1 M

elasticity 1

P1 Q1 P1 M 2 M 2

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 46 of 45

APPENDIX

POINT ELASTICITY (OPTIONAL)

Elasticity Changes Along

a Demand Curve

CHAPTER 5 Elasticity

© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 47 of 45

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