Topic 2 Elasticity

Topic 2
Elasticity and its Applications
Dr. Mina Sami Ayad

Outline
1. The Price Elasticity of Demand.
1. Main Factors
2. Cross Elasticity
2. Total Revenue and Elasticity.
3. Expenditure and Elasticity.
4. Income and Elasticity Of Demand.
5. Elasticity Of Supply
1. Main Factors
6. Elasticity Of Credit Card.
2
The Price Elasticity of Demand
• It is a units-free measure of the responsiveness of the

quantity demanded to a change in its price when all
other influences on buying plans remains the same.
3
Example for a change in Price
4
5
6
Applications: Calculate Elasticities in the following cases and interpret:
(1) Price Falls from 15 to 10 dollars, Quantity demanded increased from 20 to 30 units.
(2) Price Falls from 10 to zero, Quantity demanded increased from 30 to 50 units.
(1) 1 , (2) 1/4
7
8
9
Check three movements of prices:
(1) 20.5 to 19.5 → E=4
(2) 15 to 10 → E=1
(3) 10 to 0 → E=1/4
10
1. Main Factors
Factors to affect Elasticity:
Example: When the price of oil increased by

400 percent during the 1970s, people barely
changed the quantity of oil and gasoline they
bought.
11
2. Cross Elasticity
• A 10 percentage change increase in the price of a

Pepsi increases the quantity demanded for a Coca-
Cola by 50 percentage change. Calculate the cross
elasticity of demand between a Pepsi and Coca-Cola.
(5)
12
2. Cross Elasticity
• 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 close substitutes, 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.
13
2. Cross Elasticity
• Now suppose that the price of pizza is constant and

11 pizzas an hour are bought. Then the price of a soft
drink rises from $1.50 to $2.50. No other influence on
buying plans changes and the quantity of pizzas
bought falls to 9 an hour.
Answer:
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Total Revenue and Elasticity
Price Quantity
0 10
1 9
2 8
3 7
4 6
5 5
6 4
7 3 (1) Calculate Elasticity.
8 2 (2) Calculate Revenue.
(3) Graph Elasticity and Revenue and Discuss.
9 1
10 0
15
16
Expenditure and Elasticity
You will be motived to expend more on the product
You already expend enough on the product
17
Income Elasticity Of Demand
• 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
18
Income Elasticity Of Demand
• Income Elastic Demand Suppose that the price of

pizza is constant and 9 pizzas an hour are bought.
Then incomes rise from $975 to $1,025 a week. No
other influence on buying plans changes and the
quantity of pizzas sold increases to 11 an hour.
• Inferior Goods If the income elasticity of demand is

negative, the good is an inferior good. The quantity
demanded of an inferior good and the amount spent
on it decrease when income increases (motorcycles).
19
Elasticity of Supply
Quantity
Point Price
Supplied
J $8 50
K $9 70
L $10 80
M $11 88
N $12 95
P $13 100
- Calculate Elasticity of supply for a move from J to K.
2.83
20
• Elastic Supply means that it can be increased and

decreased easily by the producers.
• Inelastic Supply means it is costly and hard to

increase or decrease it.
21
• An increase in Demand will affect the market.

Elasticity of supply matters to decide new
equilibrium.
Inelastic Supply (0.65) Elastic Supply (13.67)

22
• For an increase in Demand, If supply is inelastic:

– Quantity increases by marginally.
– Price increases significantly.
• For an increase in Demand, If supply is elastic:

– Quantity increases significantly.
– Price increases marginally.
23
Elasticity Of Supply
1. Main Factors
• Resources Substitution Possibilities.

– Some goods and services can be produced only by
using unique or rare productive resources. (inelastic)
24
Elasticity Of Supply
1. Main Factors
• Time Frame for the Supply Decision.

– the amount of time elapsed since a price change.
• Momentary Supply: Some Goods hard to change : Fruits.

Unlike, Calls on existent cables.
• Short Run Supply: With shocks and reduction in demand,

firms can lay off works or hire workers.
• Long Run Supply: Firms can adapt and elasticity

expected to be more elastic.
25
Elasticity of Credit Cards
• In 2018, Chiu and Hill study : The elasticity of

household deposits with respect to the interest rate
paid is typically of the order of 0.3, indicating that
retail deposits are rate inelastic.
• “Consumer Response to Changes in Credit Supply:

Evidence from Credit Card Data,” by Gross and Souleles.
• They measure the dynamic effects of changes in the credit

limit and in interest rates on consumption.
26
• At High Prices Credit Card, it became elastic for

consumers due to:
– Competition and contemporaneous substitution
(raising rates drives borrowers to other lenders).
– Intertemporal substitution (borrowers simply wait for
the Lender’s rates to drop).
– Behavioral explanations (fairness or loss aversion)
• Price elasticities appear to increase with income and

maturity elasticities decrease with income.
27
• Other Studies:
– Cash and Credit Card Elasticity
https://mpra.ub.uni-
muenchen.de/15040/4/MPRA_paper_15040.pdf
28

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Topic 2

Elasticity and its Applications

Dr. Mina Sami Ayad

3. Expenditure and Elasticity.

4. Income and Elasticity Of Demand.

6. Elasticity Of Credit Card.

• It is a units-free measure of the responsiveness of the

Example for a change in Price

Applications: Calculate Elasticities in the following cases and interpret:

(1) 1 , (2) 1/4

Example: When the price of oil increased by

• A 10 percentage change increase in the price of a

• The magnitude of the cross elasticity of demand

• If two items are close substitutes, the cross elasticity is

• If two items are somewhat unrelated to each other, such

• Now suppose that the price of pizza is constant and

You will be motived to expend more on the product

You already expend enough on the product

• The income elasticity of demand, which is a measure

• Income Elastic Demand Suppose that the price of

• Inferior Goods If the income elasticity of demand is

- Calculate Elasticity of supply for a move from J to K.

• Elastic Supply means that it can be increased and

• Inelastic Supply means it is costly and hard to

• An increase in Demand will affect the market.

Inelastic Supply (0.65) Elastic Supply (13.67)

• For an increase in Demand, If supply is inelastic:

• For an increase in Demand, If supply is elastic:

• Resources Substitution Possibilities.

• Time Frame for the Supply Decision.

• Momentary Supply: Some Goods hard to change : Fruits.

• Short Run Supply: With shocks and reduction in demand,

• Long Run Supply: Firms can adapt and elasticity

• In 2018, Chiu and Hill study : The elasticity of

• “Consumer Response to Changes in Credit Supply:

• They measure the dynamic effects of changes in the credit

• At High Prices Credit Card, it became elastic for

• Price elasticities appear to increase with income and

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