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ELASTICITY OF DEMAND AND SUPPLY
Chapter 5Chapter 5
Price Elasticity of Demand
Price elasticity of demand allows us to measure the relative size of changes in the price and the quantity demanded
The price elasticity of demand formula is used to measure the degree of consumer responsiveness, or sensitivity to a change in price. The idea is to take a closer look at how sensitive
quantity is to the changes.
Price Elasticity of Demand
Question: “Is the response a little or a lot?”What does it measure?
The price elasticity of demand measures HOW RESPONSIVE CONSUMERS ARE TO A CHANGE IN PRICE!!!!
The elasticity formula
priceinchangepercentage
demandedquantityinchangepercentageEd
Price Elasticity of Demand
LO1
Law of demand ED negative
Absolute value of ED positive
2/)'(2/)'(
%
%
pp
p
qE
p
qE
D
D
The elasticity formula
So, what does the percentage change in quantity demanded and the percentage change in price mean??
d
ddd Qold
QoldQnewQinchangepercentage
Pold
PoldPnewPinchangepercentage
LO1
Demand Curve for Tacos
D
10595 Thousands per day 0
0.90
Pric
e pe
r ta
co
$1.10
b
a
If the price of tacos drops from $1.10 to $0.90, the quantity demanded increases from 95,000 to 105,000.
Exhibit 1
Categories of ED
LO1
If %∆q < %∆p– ED between 0 and 1
– Inelastic D If %∆q > %∆p
– ED greater than 1
– Elastic D If %∆q = %∆p
– ED = 1
– Unit elastic D
Elasticity and Total Revenue
LO1
Total revenue = price * quantity demanded at this price
TR= p * q As p decreases
If D elastic, TR increases
If D inelastic, TR decreases
If D unit elastic, TR unchanged
Price Elasticity and the Linear D Curve
LO1
Linear D curve– Constant slope– Different elasticity– D becomes less elastic as we move
downward D upper half: elastic D lower half: inelastic D midpoint: unit elastic
LO1
Demand, Price Elasticity, and Total
RevenueWhere D is elastic, a lower P increases TR
Where D is inelastic, a lower P decreases TR
TR reaches a maximum at the rate of output where D is unit elastic
Exhibit 2
D
90
60
10
70
Pric
e pe
r un
it
$100
80
50403020
b
a
de
800500200100 Quantity per period1,000 0 900
Tot
al r
even
ue
$25,000
500 Quantity per period1,000 0
(a) Demand and price elasticity
(b) Total revenue
Total
revenue
Unit elastic, ED =1
Elastic, ED >1
Inelastic, ED <1c
Constant-Elasticity Demand Curves
LO1
Perfectly elastic D curve– Horizontal; ED = ∞
– Consumers don’t tolerate P increases Perfectly inelastic D curve
– Vertical; ED = 0
– ‘Price is no object’ Unit-elastic D curve
– %∆p causes an exact opposite %∆q
LO1
Constant-Elasticity Demand Curves
0 Quantity per period
Pric
e pe
r un
it
pED = ∞
(a) Perfectly elastic
D
Pric
e pe
r un
itED’’ = 0
(b) Perfectly inelastic
ED ’’ = 1
(c) Unit elastic
D’
0 Quantity
per periodQ
Pric
e pe
r un
it
$10
6
0 Quantity
per period60 100
D’’
a
Consumers demand all quantity offered for sale at p, but demand nothing at a price above p
Consumers demand Q regardless of price
Total revenue is the same for each p-q combination
b
Exhibit 3
LO1
Summary of Price Elasticity of DemandEffects of a 10 Percent Increase in Price
Exhibit 4
Determinants of Price Elasticity of D
LO2
ED is greater:
– The greater the availability of substitutes, and the more similar the substitutes
– The more important the good as a share of the consumer’s budget
– The longer the period of adjustment (time)
LO2
Demand Becomes More Elastic over Time
Dw
Pric
e pe
r un
it
$1.25
1.00
Dm
Quantity per day95 10075500
Dy
e
Dy is more elastic than Dm , which is more elastic than Dw
Dw: one week after the price increase
Dm: one month after the price increase
Dy: one year after the price increase
Exhibit 5
Elasticity Estimates
LO2
Short run– Consumers have little time to adjust
Long run– Consumers can fully adjust to a price change
Demand is more elastic in the long run
LO2 Selected Price Elasticities of Demand (Absolute Values)
Exhibit 6
Price Elasticity of Supply
LO3
Elasticity– Responsiveness
Price elasticity of supply– Producers’ responsiveness to a change
in price– Percentage change in quantity supplied
divided by percentage change in price
Price Elasticity of Supply
LO3
Law of supply ES positive
2/)'(2/)'(
%
%
pp
p
qE
p
qE
S
S
LO3
Price Elasticity of Supply
S
Pric
e pe
r un
it
p
p’
Quantity per periodq q’0
If the price increases from p to p’, the quantity supplied increases from q to q’.
Price and quantity supplied move in the same direction, so the price elasticity of supply is a positive number.
Exhibit 7
Categories of ES
LO3
If %∆q < %∆p– ES between 0 and 1
– Inelastic S If %∆q > %∆p
– ES greater than 1
– Elastic S If %∆q = %∆p
– ES = 1
– Unit elastic S
Constant-Elasticity Supply Curves
LO3
Perfectly elastic S curve– Horizontal; ES = ∞
– Producers supply 0 at a price below P Perfectly inelastic S curve
– Vertical; ES = 0
– Goods in fixed supply Unit-elastic S curve
– %∆p causes an exact opposite %∆q– S curve is a ray from the origin
LO3
Constant-Elasticity Supply Curves
0 Quantity
per period
Pric
e pe
r un
it
pES = ∞
(a) Perfectly elastic
S
Pric
e pe
r un
itES’ = 0
(b) Perfectly inelastic
ES’’ = 1
(c) Unit elastic
S’
0 Quantity
per period
Q
Pric
e pe
r un
it
$10
5
0 Quantity
per period
10 20
S’’
Firms supply any amount of output demanded at p, but supply 0 at prices below p.
Quantity supplied is independent of the price
Any %∆p results in the same %∆q supplied.
Exhibit 8
Determinants of Supply Elasticity
LO3
ES is greater:
– If the marginal cost rises slowly as output expands
– The longer the period of adjustment (time)
LO3
Supply Becomes More Elastic over Time
Sw
Pric
e pe
r un
it
1.00
$1.25
Quantity per day110 2000 100 140
Sm
Sy
Sw: one week after the price increase
Sm: one month after the price increase
Sy: one year after the price increase
Sw is less elastic than Sm, which is less elastic than Sy
Exhibit 9
Income Elasticity of Demand
LO4
Demand responsiveness to a change in consumer income
Percentage change in demand divided by the percentage change in income that caused it
Inferior goods– Negative income elasticity
Normal goods– Positive income elasticity
Other Elasticity Measures
Income Elasticity Measure: Def: Income elasticity of demand is the ratio of the
percentage change in quantity demanded of a good or service to a given percentage change in income.
21
12
21
12
II
II
QQEI
Income Elasticity of Demand
LO4
Normal goods– Income inelastic
• Elasticity between 0 and 1• Necessities
– Income elastic• Elasticity > 1• Luxuries
LO4
Selected Income Elasticities of Demand
Exhibit 10
Cross-Price Elasticity of Demand
LO4
Responsiveness of D for one good to changes in P of another good
%∆ in demand for one good divided by %∆ in price of another good– If positive: substitutes– If negative: complements– If zero: unrelated
Cross-Price Elasticity of Demand
Def: The ratio of the percentage change in the quantity demanded of a good or service to a given percentage change in the price of another good or service
21
12
21
12
yy
yy
xx
xxc PP
PP
QQE
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