Micro ch4

4
ELASTICITY
© 2012 Pearson Addison-Wesley
Price Elasticity of Demand
In Figure 4.1(a), an
increase in supply brings
 A large fall in price
A small increase in the
quantity demanded

In Figure 4.1(b), an
increase in supply brings
 A small fall in price
 A large increase in the
quantity demanded

The contrast between the two outcomes in Figure 4.1

highlights the need for
A measure of the responsiveness of the quantity

demanded to a price change.
The price elasticity of demand is a units-free measure of

the responsiveness of the quantity demanded of a good to
a change in its price when all other influences on buying
plans remain the same.

Calculating Price Elasticity of Demand
The price elasticity of demand is calculated by using the

formula:
Percentage change in quantity demanded
Percentage change in price

To calculate the price elasticity of demand:
We express the change in price as a percentage of the

average price—the average of the initial and new price,
and we express the change in the quantity demanded as a

percentage of the average quantity demanded—the
average of the initial and new quantity.

Figure 4.2 calculates the

price elasticity of demand
for pizza.
The price initially is $20.50

and the quantity
demanded is 9 pizzas an
hour.

The price falls to $19.50

and the quantity
demanded increases to 11
pizzas an hour.
The price falls by $1 and

the quantity demanded
increases by 2 pizzas an
hour.

The average price is

$20 and the average
quantity demanded is
10 pizzas an hour.

The percentage change in

quantity demanded, %Q,
is calculated as
Q/Qave x 100, which is
(2/10) x 100 = 20%.
The percentage change in

price, %P, is calculated
as P/Pave x 100, which is
($1/$20) x 100 = 5%.

The price elasticity of

demand is
%Q / %P = 20% / 5%

= 4.

Average Price and Quantity
By using the average price and average quantity, we get

the same elasticity value regardless of whether the price
rises or falls.
Percentages and Proportions
The ratio of two proportionate changes is the same as the

ratio of two percentage changes.
%Q / %P = Q / P

A Units-Free Measure
Elasticity is a ratio of percentages, so a change the units

of measurement of price or quantity leaves the elasticity
value the same.
Minus Sign and Elasticity
The formula yields a negative value, because price and

quantity move in opposite directions.
But it is the magnitude, or absolute value, that reveals how

responsive the quantity change has been to a price
change.
Inelastic and Elastic Demand
Demand can be inelastic, unit elastic, or elastic, and can

range from zero to infinity.
If the quantity demanded doesn’t change when the price

changes, the price elasticity of demand is zero and the
good as a perfectly inelastic demand.

Figure 4.3(a) illustrates the

case of a good that has a
perfectly inelastic demand.
The demand curve is

vertical.

If the percentage change in

the quantity demanded
equals the percentage
change in price, …
the price elasticity of

demand equals 1 and the
good has unit elastic
demand.
Figure 4.3(b) illustrates this

case—a demand curve with
ever declining slope.

If the percentage change in the quantity demanded is

smaller than the percentage change in price,
 the price elasticity of demand is less than 1 and the

good has inelastic demand.
If the percentage change in the quantity demanded is

greater than the percentage change in price,
the price elasticity of demand is greater than 1 and the

good has elastic demand.

If the percentage change in
the quantity demanded is
infinitely large when the
price barely changes, …
the price elasticity of

demand is infinite and the
good has a perfectly
elastic demand.
Figure 4.3(c) illustrates the

case of perfectly elastic
demand—a horizontal
demand curve.
Elasticity Along a
Linear Demand Curve
Figure 4.4 shows how

the elasticity of
demand changes
along a linear demand
curve.
At the mid-point of the

demand curve,
demand is unit elastic.

At prices above the

mid-point of the
demand curve,
demand is elastic.
At prices below the

mid-point of the
demand curve,
demand is inelastic.

For example, if the price

falls from $25 to $15, the
quantity demanded
increases from 0 to 20
pizzas an hour.
The average price is $20

and the average quantity
is 10 pizzas.
The price elasticity of

demand is (20/10)/(10/20),
which equals 4.

If the price falls from

$10 to $0, the quantity
demanded increases
from 30 to 50 pizzas an
hour.
The average price is $5

and the average quantity
is 40 pizzas.
The price elasticity is

(20/40)/(10/5), which
equals 1/4.

If the price falls from
$15 to $10, the quantity
demanded increases
from 20 to 30 pizzas an
hour.
The average price is
$12.50 and the average
quantity is 25 pizzas.
The price elasticity is
(10/25)/(5/12.5), which
equals 1.

Total Revenue and Elasticity
The total revenue from the sale of good or service equals

the price of the good multiplied by the quantity sold.
When the price changes, total revenue also changes.
But a rise in price doesn’t always increase total revenue.

The change in total revenue due to a change in price

depends on the elasticity of demand:
If demand is elastic, a 1 percent price cut increases

the quantity sold by more than 1 percent, and total
revenue increases.
If demand is inelastic, a 1 percent price cut increases

the quantity sold by less than 1 percent, and total
revenues decreases.
If demand is unit elastic, a 1 percent price cut

increases the quantity sold by 1 percent, and total
revenue remains unchanged.
The total revenue test is a method of estimating the price

elasticity of demand by observing the change in total
revenue that results from a price change (when all other
influences on the quantity sold remain the same).
 If a price cut increases total revenue, demand is

elastic.
 If a price cut decreases total revenue, demand is

inelastic.
 If a price cut leaves total revenue unchanged, demand

is unit elastic.

Figure 4.5 shows the
relationship between
elasticity of demand and
the total revenue.
As the price falls from
$25 to $12.50, the
quantity demanded
pizzas.
Demand is elastic, and
total revenue increases.

In part (b), as the quantity

pizzas, demand is elastic,
and total revenue
increases.

At $12.50, demand is
unit elastic and total
revenue stops
increasing.

At 25, demand is unit

elastic, and total revenue
is at its maximum.

As the price falls from

$12.50 to zero, the
quantity demanded
pizzas.
Demand is inelastic, and

total revenue decreases.

As the quantity increases

from 25 to 50 pizzas,
demand is inelastic, and
total revenue decreases.

Your Expenditure and Your Elasticity
 If your demand is elastic, a 1 percent price cut

increases the quantity you buy by more than 1 percent
and your expenditure on the item increases.
 If your demand is inelastic, a 1 percent price cut

increases the quantity you buy by less than 1 percent
and your expenditure on the item decreases.
 If your demand is unit elastic, a 1 percent price cut

increases the quantity you buy by 1 percent and your
expenditure on the item does not change.

The Factors That Influence the Elasticity of Demand
The elasticity of demand for a good depends on:
 The closeness of substitutes

 The proportion of income spent on the good
 The time elapsed since a price change

Closeness of Substitutes
The closer the substitutes for a good or service, the more

elastic are the demand for the good or service.
Necessities, such as food or housing, generally have

inelastic demand.
Luxuries, such as exotic vacations, generally have elastic

demand.

Proportion of Income Spent on the Good
The greater the proportion of income consumers spend on

a good, the larger is the elasticity of demand for that good.
Time Elapsed Since Price Change
The more time consumers have to adjust to a price

change, or the longer that a good can be stored without
losing its value, the more elastic is the demand for that
good.

More Elasticities of Demand
Cross Elasticity of Demand
The cross elasticity of demand is a measure of the

responsiveness of demand for a good to a change in the
price of a substitute or a complement, other things
remaining the same.
The formula for calculating the cross elasticity is:

Percentage change in price of substitute or complement

The cross elasticity of demand for
 a substitute is positive.
 a complement is negative.

Figure 4.6 shows the

increase in the quantity of
pizza demanded when the
price of burger (a
substitute for pizza) rises.
The figure also shows the

decrease in the quantity of
pizza demanded when the
price of a soft drink (a
complement of pizza)
rises.

Income Elasticity of Demand
The income elasticity of demand measures how the

quantity demanded of a good responds to a change in
income, other things remaining the same.
The formula for calculating the income elasticity of

demand is
Percentage change in income

If the income elasticity of demand is greater than 1,

demand is income elastic and the good is a normal good.
If the income elasticity of demand is greater than zero but

less than 1, demand is income inelastic and the good is a
normal good.
If the income elasticity of demand is less than zero

(negative) the good is an inferior good.

Elasticity of Supply
When demand increases,

is the change in the
quantity supplied small or
large?
In Figure 4.7(a), an
increase in demand brings
 A large rise in price
 A small increase in the
quantity supplied

In Figure 4.7(b), an
increase in demand brings
 A small rise in price
 A large increase in the
quantity supplied

The contrast between the two outcomes in Figure 4.7

highlights the need for
 A measure of the responsiveness of the quantity
supplied to a price change.
The elasticity of supply measures the responsiveness of

the quantity supplied to a change in the price of a good
when all other influences on selling plans remain the
same.

Calculating the Elasticity of Supply
The elasticity of supply is calculated by using the formula:

Percentage change in quantity supplied
Percentage change in price

Figure 4.8 on the next slide shows three cases of the

elasticity of supply.
Supply is perfectly inelastic if the supply curve is vertical

and the elasticity of supply is 0.
Supply is unit elastic if the supply curve is linear and

passes through the origin. (Note that slope is irrelevant.)
Supply is perfectly elastic if the supply curve is horizontal

and the elasticity of supply is infinite.


The Factors That Influence the Elasticity of Supply
The elasticity of supply depends on
 Resource substitution possibilities

 Time frame for supply decision
Resource Substitution Possibilities
The easier it is to substitute among the resources used to

produce a good or service, the greater is its elasticity of
supply.

Time Frame for Supply Decision
The more time that passes after a price change, the

greater is the elasticity of supply.
Momentary supply is perfectly inelastic. The quantity

supplied immediately following a price change is constant.
Short-run supply is somewhat elastic.
Long-run supply is the most elastic.
Table 4.1 (page 97) provides a glossary of the all elasticity

measures.

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4

© 2012 Pearson Addison-Wesley

© 2012 Pearson Addison-Wesley

The contrast between the two outcomes in Figure 4.1

A measure of the responsiveness of the quantity

The price elasticity of demand is a units-free measure of

© 2012 Pearson Addison-Wesley

Calculating Price Elasticity of Demand

The price elasticity of demand is calculated by using the

© 2012 Pearson Addison-Wesley

To calculate the price elasticity of demand:

We express the change in price as a percentage of the

and we express the change in the quantity demanded as a

© 2012 Pearson Addison-Wesley

Figure 4.2 calculates the

The price initially is $20.50

© 2012 Pearson Addison-Wesley

The price falls to $19.50

The price falls by $1 and

© 2012 Pearson Addison-Wesley

The average price is

© 2012 Pearson Addison-Wesley

The percentage change in

(2/10) x 100 = 20%.

The percentage change in

($1/$20) x 100 = 5%.

© 2012 Pearson Addison-Wesley

The price elasticity of

%Q / %P = 20% / 5%

© 2012 Pearson Addison-Wesley

Average Price and Quantity

By using the average price and average quantity, we get

Percentages and Proportions

The ratio of two proportionate changes is the same as the

© 2012 Pearson Addison-Wesley

Elasticity is a ratio of percentages, so a change the units

Minus Sign and Elasticity

The formula yields a negative value, because price and

But it is the magnitude, or absolute value, that reveals how

Inelastic and Elastic Demand

Demand can be inelastic, unit elastic, or elastic, and can

If the quantity demanded doesn’t change when the price

© 2012 Pearson Addison-Wesley

Figure 4.3(a) illustrates the

The demand curve is

© 2012 Pearson Addison-Wesley

If the percentage change in

the price elasticity of

Figure 4.3(b) illustrates this

© 2012 Pearson Addison-Wesley

If the percentage change in the quantity demanded is

 the price elasticity of demand is less than 1 and the

If the percentage change in the quantity demanded is

the price elasticity of demand is greater than 1 and the

© 2012 Pearson Addison-Wesley

the price elasticity of

Figure 4.3(c) illustrates the

Figure 4.4 shows how

At the mid-point of the