Micro Eco 5

Microeconomics
how the elasticity of demand and supply influences the

market outcomes
Sessions 5
July 2024
Imagine you are the author of a book who gets a royalty payment
of 10% of the total receipts from the sale of the book.
You get a phone call from your publisher telling you they are
increasing the price of your book from Rs 500 to Rs 600.
Should you be happy about this? Why or why not?

Sessions objectives
• What is the elasticity of demand and supply?
• Why and how it matters for firms? – relationship

between firm revenue and elasticity of demand
• What factors influence elasticity
• How the impact of taxes and subsidies on producers

and consumer differ depending on elasticities of
demand and supply
Elasticity of demand
• Demand curve – an inverse relationship between price and

quantity demanded.
• But how much does quantity demanded change when price

changes?
– By a lot or a little?
– Decides how much of an increase in cost of production can
be passed on to consumers
• Strategic pricing requires an understanding of demand

elasticity and how it impacts profitability.
Elasticity of demand
• A demand curve is elastic when a change in price
changes quantity demanded a lot
• A demand curve is inelastic when a change in price

changes quantity demand a little
• Draw two demand curve on one diagram and identify

more elastic curve
Elasticity of Demand
price
Price ↑ from Rs40 to Rs50:

• a → b less responsive
c
Rs50 b • a → c more responsive
40 a
Demand E
(more elastic)
Demand I (less elastic)
Quantity
20 95 100
Remember rubber bands..
“This is a continuous exercise. We always try to pass on
increasing costs to customers. But, in India, there is a certain
price point beyond which you can’t increase prices”
SpiceJet CEO (Aug 16, 2018)
The context – depreciating rupee – rise in costs
https://www.livemint.com/Companies/m6Yr9cWWIclxaWNUnt
YpdJ/Ticket-price-cant-be-increased-beyond-certain-point-in-
Indi.html
Elasticity of Demand and Total Revenue
• A firm’s revenues are equal to price per unit times

quantity sold.
– Revenue = Price x Quantity
• The elasticity of demand directly influences revenues

when the price of the good changes.
11
Revenues Rise as Price Rises if Demand is Inelastic
• P
$20
R=$20x90
=$1,800
$10
R=$10x100
=$1,000 D
Q
90 100
12
Revenues Fall as Price Rises with Elastic Demand Curves
P
$20
R=$20x50
=$1,000
$10
D
R=$10x250
=$2,500
Q
50 250
13
Calculating elasticity
• Elasticity of demand is equal to the percentage
change of quantity demanded divided by percentage
change in price
%Qdemanded
ED 
%Price
A demand curve is inelastic when % a change in price is more than % quantity demanded,
Ed<1
A demand curve is elastic when % a change in price is less than % quantity demanded,
Ed>1
Example
• If price of rice increases by 10% and quantity demanded falls

by 5% over the years, the long run elasticity of demand is
• -5%/10% = -0.5
• Elasticity of demand is typically negative, so we drop the sign

If price of CCD expresso
falls from Rs 60 to Rs 40,
total revenue changes by
_______, so demand is
_______.
a) Rs 120; inelastic
b) Rs 480; elastic
c) Rs 360; inelastic
d) Rs 120; elastic
“ I always spend a total of exactly Rs 200 per week on coffee”
What does this suggests about the elasticity of demand.
Unit-elastic
Whatever is the price, the revenue remains the same.
•
Summary of Relationship between Elasticity of Demand and Revenues
Absolute Value of
Name Price and Revenue
Elasticity
ED  1 Inelastic P and R Move Together
ED  1 Elastic P and R Move Opposite
ED  1 Unit Elastic P Moves but R Stays the Same
18
Is the elasticity of demand constant on all points of
a linear demand curve?
Industry applications
Case 1
• video
• Update re: Amazon/Hachette Business
Interruption, July 2014
• Initial post: Jul 29, 2014 1:29:59 PM PDT
• The Amazon Books team says:
https://www.forbes.com/sites/ryanmac/2014/07/29/amazon-
does-e-book-math-for-hachette-in-arguing-for-9-99-
prices/#4b1fc19170d0
Case 2
Shark Tank (2011) Season 2, Vurtego Pogo
Sticks
Note down the answers to the following

questions –
1) How much is the producer surplus per
unit at the current price point?
2) How does the investors’ opinion about
the price elasticity of demand differ
from the producer’s view ?
3) What is your opinion?
4) Is the product still in the market? A
price point?
Case 3 - Elasticity and the Hub-Spoke System
Inelastic
demand
Elastic
demand
Case 4
Case 5
If a government is planning to offer 10% off coupons for 3 fruits to get the biggest effect
on quantity demanded, which three fruits should get coupons?
Case 6 - GST
Economics: Key principle 1 - Incentives matter
The case of GST
Determinants of elasticity of demand
Less elastic More elastic
Fewer substitutes Many substitutes
Short run Long run
Necessities Luxuries
Small part of the budget Bigger part of the budget

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Microeconomics

how the elasticity of demand and supply influences the

Should you be happy about this? Why or why not?

• What is the elasticity of demand and supply?

• Why and how it matters for firms? – relationship

• What factors influence elasticity

• How the impact of taxes and subsidies on producers

• Demand curve – an inverse relationship between price and

• But how much does quantity demanded change when price

• Strategic pricing requires an understanding of demand

• A demand curve is inelastic when a change in price

• Draw two demand curve on one diagram and identify

Price ↑ from Rs40 to Rs50:

The context – depreciating rupee – rise in costs

• A firm’s revenues are equal to price per unit times

• The elasticity of demand directly influences revenues

• If price of rice increases by 10% and quantity demanded falls

• Elasticity of demand is typically negative, so we drop the sign

What does this suggests about the elasticity of demand.

Note down the answers to the following

Less elastic More elastic

Fewer substitutes Many substitutes

Short run Long run

Small part of the budget Bigger part of the budget

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