elasticity

Wojciech Gerson (1831-1901)
Elasticity and its Application
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A scenario…
You design websites for local businesses.
You charge $200 per website,
and currently sell 12 websites per month.
Your costs are rising
(including the opportunity cost of your time),
so you consider raising the price to $250.
The law of demand says that you won’t sell as many
websites if you raise your price.
How many fewer websites? How much will your
revenue fall, or might it increase?
1
Elasticity
 Basic idea:
Elasticity measures how much one variable
responds to changes in another variable.
 One type of elasticity measures how much
demand for your websites will fall if you raise
your price.
 Definition:
Elasticity is a numerical measure of the
responsiveness of Qd or Qs to one of its
determinants.
2
Price Elasticity of Demand
Price elasticity Percentage change in Qd
=
of demand Percentage change in P
 Price elasticity of demand measures how

much Qd responds to a change in P.
 Loosely speaking, it measures the price-

sensitivity of buyers’ demand.
3
=
P
Example:
P rises
Price elasticity P2
by 10%
of demand P1
equals D
15% Q
= 1.5 Q2 Q1
10%
Q falls
by 15%
4
=
P
Along a D curve, P and Q
move in opposite directions, P2
which would make price
elasticity negative. P1
We will drop the minus sign D

and report all price Q
elasticities as Q2 Q1
positive numbers.
5
Calculating Percentage Changes
Standard method
of computing the
Demand for percentage (%) change:
your websites
P end value – start value
x 100%
start value
B
$250
A Going from A to B,
$200 the % change in P equals
D
($250–$200)/$200 = 25%
Q
8 12
6
Problem:
The standard method gives
Demand for different answers depending
your websites on where you start.
P
From A to B,
B P rises 25%, Q falls 33%,
$250
A elasticity = 33/25 = 1.33
$200
From B to A,
D
P falls 20%, Q rises 50%,
Q elasticity = 50/20 = 2.50
8 12
7
 So, we instead use the midpoint method:
end value – start value

x 100%
midpoint
 The midpoint is the number halfway between
the start and end values, the average of those
values.
 It doesn’t matter which value you use as the
start and which as the end—you get the same
answer either way!
8
 Using the midpoint method, the % change
in P equals
$250 – $200
x 100% = 22.2%
$225
 The % change in Q equals
12 – 8
x 100% = 40.0%
10
 The price elasticity of demand equals
40/22.2 = 1.8
9
ACTIVE LEARNING 1
Calculate an elasticity
Use the following
information to
calculate the
price elasticity
of demand
for hotel rooms:
if P = $135, Qd = 8600 ©stefanolunardi/Shutterstock.com
if P = $165, Qd = 7400
ACTIVE LEARNING 1
Applying the principles
Use midpoint method to calculate
% change in Qd
(8600 – 7400)/8000 = 15%
% change in P
($165 – $135)/$150 = 20%
The price elasticity of demand equals

15%
= 0.75
20%
What determines price elasticity?
To learn the determinants of price elasticity,
we look at a series of examples.
Each compares two common goods.
In each example:
 Suppose the prices of both goods rise by 20%.
 The good for which Qd falls the most (in percent)
has the highest price elasticity of demand.
Which good is it? Why?
 What lesson does the example teach us about the
determinants of the price elasticity of demand?
12
EXAMPLE 1
Breakfast Cereal (Corn flakes) vs. Salt
 The prices of both of these goods rise by 20%.
For which good does Qd drop the most? Why?
 Breakfast cereal has close substitutes
(e.g., pancakes, Eggo waffles, leftover pizza),
so buyers can easily switch if the price rises.
 Salt has no close substitutes,
so a price increase would not affect demand
very much.
 Lesson: Price elasticity is higher when close
substitutes are available.
13
EXAMPLE 2
“Blue Jeans” vs. “Clothing”
 The prices of both goods rise by 20%.
 For a narrowly defined good such as
blue jeans, there are many substitutes
(khakis, shorts, Speedos).
 There are fewer substitutes available for
broadly defined goods.
(Are there any substitutes for clothing?)
 Lesson: Price elasticity is higher for narrowly
defined goods than for broadly defined ones.
14
EXAMPLE 3
Doctor visit vs. Cruise
 The prices of both of these goods rise by 20%.
 Doctor visit is a necessity.
A rise in its price would cause little or no
decrease in demand.
 A cruise is a luxury. If the price rises,
some people will forego it.
 Lesson: Price elasticity is higher for luxuries
than for necessities.
15
EXAMPLE 4
Petrol in the Short Run vs.
Petrol in the Long Run
 The price of petrol rises 20%. Does Qd drop more
in the short run or the long run? Why?
 There’s not much people can do in the
short run, other than ride the bus or carpool.
 In the long run, people can buy smaller cars
or live closer to work.
 Lesson: Price elasticity is higher in the
long run than the short run.
16
The Determinants of Price Elasticity:
A Summary
The price elasticity of demand depends on:

 the extent to which close substitutes are
available
 whether the good is a necessity or a luxury
 how broadly or narrowly the good is defined
 the time horizon—elasticity is higher in the
long run than the short run
17
Which of the following is consistent with the elasticities given in Table 5-2?
Good Price Elasticity of Demand
A 1.3
B 2.1
a. A is a luxury, and B is a necessity.
b. A is a good several years after a price increase, and B is that same

good several days after thePrice
Good
price increase.
Elasticity of Demand
A 1.3
B 2.1
c. A is a Kit Kat bar, and B is candy.
d. A has fewer substitutes than B.
18
Which of the following is consistent with the elasticities given in Table 5-2?
a. A is grapes, and B is fruit.
b. A is T-shirts, and B is socks.
c. A is train tickets before cars were invented, and B is train tickets after cars were invented.
d. A is diamond necklaces, and B is beds.
19
If the price elasticity of demand for a good is 4.0, then a 10 percent increase in price results in a
a. 0.4 percent decrease in the quantity demanded.
b. 2.5 percent decrease in the quantity demanded.
c. 4 percent decrease in the quantity demanded.
d. 40 percent decrease in the quantity demanded.
20
If the price elasticity of demand for a good is 1, then a 3 percent decrease in price results in a
a. 0.1 percent increase in the quantity demanded.
b. 1 percent increase in the quantity demanded.
c. 3 percent increase in the quantity demanded.
d. 4 percent increase in the quantity demanded.
21
The Variety of Demand Curves
 The price elasticity of demand is closely related
to the slope of the demand curve.
 Rule of thumb:
The flatter the curve, the bigger the elasticity.
The steeper the curve, the smaller the elasticity.
 Five different classifications of D curves.…
22
“Perfectly inelastic demand” (one extreme case)
Price elasticity % change in Q 0%
= = =0
of demand % change in P 10%
D curve: P
D
vertical
P1
Consumers’
price sensitivity: P2
none
P falls Q
Elasticity: by 10% Q1
0 Q changes
by 0%
23
“Inelastic demand”
Price elasticity % change in Q < 10%
= = <1
D curve: P
relatively steep
P1
Consumers’
relatively low D
P falls Q
Elasticity: by 10% Q1 Q2
<1
Q rises less
than 10%
24
“Unit elastic demand”
= = =1
D curve: P
intermediate slope
P1
Consumers’
intermediate D
P falls Q
1
Q rises by 10%
25
“Elastic demand”
Price elasticity % change in Q > 10%
= = >1
D curve: P
relatively flat
P1
Consumers’
price sensitivity: P2 D
relatively high
P falls Q
>1
Q rises more
than 10%
26
“Perfectly elastic demand” (the other extreme)
Price elasticity % change in Q any %
= = = infinity
D curve: P
horizontal
P2 = P1 D
Consumers’
price sensitivity:
extreme
P changes Q
infinity
Q changes
by any %
27
Elasticity of a Linear Demand Curve
P The slope
200% of a linear
$30 E = = 5.0
40% demand
67% curve is
20 E = = 1.0 constant,
67%
but its
40% elasticity
10 E = = 0.2
200% is not.
$0 Q
0 20 40 60
28
Price Elasticity and Total Revenue
 Continuing our scenario, if you raise your price
from $200 to $250, would your revenue rise or fall?
Revenue = P x Q
 A price increase has two effects on revenue:
 Higher P means more revenue on each unit
you sell.
 But you sell fewer units (lower Q),
due to law of demand.
 Which of these two effects is bigger?
It depends on the price elasticity of demand.
29
Price elasticity Percentage change in Q
=
Revenue = P x Q
 If demand is elastic, then

price elast. of demand > 1
% change in Q > % change in P
 The fall in revenue from lower Q is greater
than the increase in revenue from higher P,
so revenue falls.
30
Elastic demand increased
Demand for
(elasticity = 1.8) P revenue due
your websiteslost
to higher P
If P = $200, revenue
due to
Q = 12 and lower Q
$250
revenue = $2400.
$200
If P = $250, D
Q = 8 and
revenue = $2000.
When D is elastic, Q
8 12
a price increase
causes revenue to fall.
31
Price elasticity Percentage change in Q
=
Revenue = P x Q
 If demand is inelastic, then
price elast. of demand < 1
% change in Q < % change in P
 The fall in revenue from lower Q is smaller
than the increase in revenue from higher P,
so revenue rises.
 In our example, suppose that Q only falls to 10
(instead of 8) when you raise your price to $250.
32
Now, demand is
increased
Demand for
inelastic:
revenue due
your websites
elasticity = 0.82 P to higher P lost
If P = $200, revenue
due to
Q = 12 and
$250 lower Q
revenue = $2400.
If P = $250, $200
Q = 10 and D
revenue = $2500.
When D is inelastic, Q
a price increase 10 12
causes revenue to rise.
33
ACTIVE LEARNING 2
Elasticity and expenditure/revenue
A. Pharmacies raise the price of insulin by 10%.
Does total expenditure on insulin rise or fall?
B. As a result of a fare war, the price of a luxury
cruise falls 20%.
Does luxury cruise companies’ total revenue
rise or fall?
ACTIVE LEARNING 1
Answers
A. Pharmacies raise the price of insulin by 10%.
Does total expenditure on insulin rise or fall?
Expenditure = P x Q
Since demand is inelastic, Q will fall less
than 10%, so expenditure rises.
ACTIVE LEARNING 2
Answers
B. As a result of a fare war, the price of a luxury
cruise falls 20%.
Does luxury cruise companies’ total revenue
rise or fall?
Revenue = P x Q
The fall in P reduces revenue,
but Q increases, which increases revenue.
Which effect is bigger?
Since demand is elastic, Q will increase more
than 20%, so revenue rises.
Imagine a local coffee shop sells a cup of coffee for
$5, and they currently sell 100 cups per day. The shop
decides to raise the price to $6 per cup. Assume that
price elasticity of demand for coffee at their
shop is 2. Calculate Total Revenue Before and
After the Price Change.
Step 1: Calculate the Percentage Change in Price
Initial Price = $5
New Price = $6
Percentage Change in Price = 20%
Step 2: Percentage Change in Quantity Demanded = PED ×

Percentage Change in Price
= 2 × 20%
= 40%
Step 3: Calculate the New Quantity Demanded

Initial Quantity = 100 cups
Decrease = 40% of 100 cups = 40 cups
New Quantity = 100 - 40 = 60 cups
Calculate Total Revenue Before and After the Price Change

•Before the Price Change: TR = Price × Quantity
TR = $5 × 100 = $500
•After the Price Change: TR = Price × Quantity
TR = $6 × 60 = $360
Price Elasticity of Supply
Price elasticity Percentage change in Qs
=
of supply Percentage change in P
 Price elasticity of supply measures how much

Qs responds to a change in P.
 Loosely speaking, it measures sellers’
price-sensitivity.
 Again, use the midpoint method to compute the
percentage changes.
39
Price Elasticity of Supply
Price elasticity Percentage change in Qs
=
of supply Percentage change in P
P
Example: S
P rises
Price P2
by 8%
elasticity P1
of supply
equals
Q
16% Q1 Q2
= 2.0
8% Q rises
by 16%
40
The Variety of Supply Curves
 The slope of the supply curve is closely related
to price elasticity of supply.
 Rule of thumb:
The flatter the curve, the bigger the elasticity.
The steeper the curve, the smaller the elasticity.
 Five different classifications…
41
“Perfectly inelastic” (one extreme)
= = =0
of supply % change in P 10%
S curve: P
S
vertical
P2
Sellers’
none
P rises Q
Elasticity: by 10% Q1
0
Q changes
by 0%
42
“Inelastic”
Price elasticity % change in Q < 10%
= = <1
S curve: P
S
relatively steep
P2
Sellers’
relatively low
P rises Q
<1
Q rises less
than 10%
43
“Unit elastic”
= = =1
S curve: P
intermediate slope S
P2
Sellers’
intermediate
P rises Q
=1
Q rises
by 10%
44
“Elastic”
Price elasticity % change in Q > 10%
= = >1
S curve: P
relatively flat S
P2
Sellers’
relatively high
P rises Q
>1
Q rises more
than 10%
45
“Perfectly elastic” (the other extreme)
Price elasticity % change in Q any %
= = = infinity
S curve: P
horizontal
P2 = P1 S
Sellers’
price sensitivity:
extreme
P changes Q
infinity
Q changes
by any %
46
The Determinants of Supply Elasticity
 The more easily sellers can change the quantity
they produce, the greater the price elasticity of
supply.
 Example: Supply of beachfront property is
harder to vary and thus less elastic than
supply of new cars.
 For many goods, price elasticity of supply
is greater in the long run than in the short run,
because firms can build new factories,
or new firms may be able to enter the market.
47
How the Price Elasticity of Supply Can Vary
P Supply often
S
elasticity becomes
$15 <1 less elastic
as Q rises,
12 due to
capacity
elasticity
>1 limits.
4
$3
Q
100 200
500 525
48
If the price elasticity of supply is 0.2, and a price increase led to a
3% increase in quantity supplied, then the price increase is about
a. 0.07%.
b. 0.60%.
c. 6%.
d. 15%.
49
Supply Curve A Supply Curve B Supply Curve C
Price $1.00 $2.00 $1.00 $3.00 $2.00 $5.00
Quantity 500 600 600 900 400 700
Supplied
50
Which of the three supply curves represents the least elastic supply?
a. supply curve A
b. supply curve B
c. supply curve C
d. There is no difference in the elasticity of the three supply curves.
51
Which of the three supply curves represents the most elastic supply?
a. supply curve A
b. supply curve B
c. supply curve C
d. There is no difference in the elasticity of the three supply curves.
52
On a certain supply curve, one point is (quantity supplied =
200, price = $4.00) and another point is (quantity supplied =
250, price = $4.50). Using the midpoint method, the price
elasticity of supply is about
a. 0.22.
b. 0.53.
c. 1.00.
d. 1.89.
53
Other Elasticities
 Income elasticity of demand: measures the
response of Qd to a change in consumer income
Income elasticity Percent change in Qd

=
of demand Percent change in income
 Recall from Chapter 4: An increase in income

causes an increase in demand for a normal good.
 Hence, for normal goods, income elasticity > 0.
 For inferior goods, income elasticity < 0.
54
Other Elasticities
 Cross-price elasticity of demand:
measures the response of demand for one good to
changes in the price of another good
Cross-price elast. % change in Qd for good 1

=
of demand % change in price of good 2
 For substitutes, cross-price elasticity > 0
(e.g., an increase in price of beef causes an
increase in demand for chicken)
 For complements, cross-price elasticity < 0
(e.g., an increase in price of computers causes
decrease in demand for software)
55
Can Good News for Farming Be Bad News for
Farmers?
Agricultural State University announces a major

discovery. Researchers in its agronomy
department have devised a new hybrid of wheat
that raises the amount farmers can produce from
each acre of land by 20 percent. How should you
react to this news? Does this discovery make you
better off or worse off than you were before?
56
How does total revenue change as one moves
downward and to the right along a linear demand
curve?
a. It always increases.
b. It always decreases.
c. It first increases, then decreases.
d. It is unaffected by a movement along the demand curve.
57
If a change in the price of a good results in no change in total revenue, then
a. the demand for the good must be elastic.

b. the demand for the good must be inelastic.
c. the demand for the good must be unit elastic.
d. buyers must not respond very much to a change in price.
58
Summary
• Elasticity measures the responsiveness of
Qd or Qs to one of its determinants.
• Price elasticity of demand equals percentage
change in Qd divided by percentage change in P.
When it’s less than one, demand is “inelastic.”
When greater than one, demand is “elastic.”
• When demand is inelastic, total revenue rises
when price rises. When demand is elastic, total
revenue falls when price rises.
Summary
• Demand is less elastic in the short run,
for necessities, for broadly defined goods,
and for goods with few close substitutes.
• Price elasticity of supply equals percentage
change in Qs divided by percentage change in
P.
When it’s less than one, supply is “inelastic.”
When greater than one, supply is “elastic.”
• Price elasticity of supply is greater in the long
run than in the short run.
Summary
• The income elasticity of demand measures how
much quantity demanded responds to changes
in buyers’ incomes.
• The cross-price elasticity of demand measures
how much demand for one good responds to
changes in the price of another good.

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Wojciech Gerson (1831-1901)

Elasticity and its Application

 Price elasticity of demand measures how

 Loosely speaking, it measures the price-

We will drop the minus sign D

end value – start value

The price elasticity of demand equals

The price elasticity of demand depends on:

Good Price Elasticity of Demand

a. A is a luxury, and B is a necessity.

b. A is a good several years after a price increase, and B is that same

c. A is a Kit Kat bar, and B is candy.

d. A has fewer substitutes than B.

a. A is grapes, and B is fruit.

b. A is T-shirts, and B is socks.

d. A is diamond necklaces, and B is beds.

a. 0.4 percent decrease in the quantity demanded.

b. 2.5 percent decrease in the quantity demanded.

c. 4 percent decrease in the quantity demanded.

d. 40 percent decrease in the quantity demanded.

a. 0.1 percent increase in the quantity demanded.

b. 1 percent increase in the quantity demanded.

c. 3 percent increase in the quantity demanded.

d. 4 percent increase in the quantity demanded.

 If demand is elastic, then

Step 2: Percentage Change in Quantity Demanded = PED ×

Step 3: Calculate the New Quantity Demanded

Calculate Total Revenue Before and After the Price Change

 Price elasticity of supply measures how much

d. There is no difference in the elasticity of the three supply curves.

Income elasticity Percent change in Qd

 Recall from Chapter 4: An increase in income

Cross-price elast. % change in Qd for good 1

Agricultural State University announces a major

a. the demand for the good must be elastic.

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