ECON1101: Microeconomics 1

Chapter 4: Elasticity
Price elasticity of demand
Price elasticity of demand is the percentage change in quantity demanded
that results from a 1% change in price.

Price elasticity of demand()

Percentage changequantity demanded

Percentage change price

Q
P Q
P
1
=
=
( Q
P P ) ( Q P ) ( Q slope )
where 0

The law of demand

Price elasticity of demand is negative or zero because quantity demanded
and price are negatively correlated.

Elastic, inelastic and unit elastic

Perfectly inelastic demand=0

Elastic demand>1

Unit elastic demand=1

Inelastic demand<1

Perfectly elastic demand =

Determinants of price elasticity of demand

1. Substitutes The more substitute, the more price elasticity of demand
(e.g. the demand for different brands of salt is price elastic because there
are many substitute brands).
2. Budget share The larger the share of your budget a good or service,
the more price elasticity of demand (e.g. the demand for international air
travel is more price elastic than key rings).
3. Time The more time there is to respond to price changes, the more price
elasticity of demand (e.g. the demand for air conditioners is price inelastic
in summer, and price elastic in winter).

Multiple demand curves

If there are multiple demand curves, the steeper curves are more price
inelastic than the flatter curves because the reciprocal of the slope of the
steeper curves is less.

Straight-line demand curves

=0

Vertical demand curve:

Below the midpoint:

At the midpoint:

Above the midpoint: >1

Horizontal demand curve:

<1

=1

Price elasticity of demand and total expenditure

Total revenue=Total expenditure=P Q

Total expenditure is maximised at the midpoint.
Above the midpoint, total expenditure and price are negatively correlated.
Below the midpoint, total expenditure and price are positively correlated.

Cross-price elasticity of demand

Cross-price elasticity of demand is the percentage change in quantity
demanded that results from a 1% change in price.

Cross price elasticity of demand=

Percentage changequantity demanded

(all real values)
Percentage change price

Complements have a negative cross-price elasticity of demand.

Substitutes have a positive cross-price elasticity of demand.

Income elasticity of demand

Income elasticity of demand is the percentage change in quantity demanded
that results from a 1% change in income.

Income elasticity of demand =

Percentage changequantity demanded

(all real values)
Percentage change income

Normal goods have a positive income elasticity of demand.

Inferior goods have a negative income elasticity of demand.

Price elasticity of supply

Price elasticity of supply is the percentage change in quantity supplied that
results from a 1% change in price.

Elastic, inelastic and unit elastic

Perfectly inelastic suppy=0

Elastic supply>1

Unit elastic supply=1

Inelastic supply <1

Perfectly elastic supply=

Straight-line supply curves

For a supply curve that intersects the y-axis, price elasticity of supply
decreases as we move up the curve.
For a straight-line supply curve that intersects the origin, supply is unit
elastic.
For a vertical supply curve, supply is perfectly price inelastic.
For a horizontal supply curve, supply is perfectly price elastic.

Determinants of price elasticity of supply

1. Flexibility of inputs The more easily inputs can be lured from their
current uses, the more price elasticity of supply (e.g. a factory which can
easily switch from making Coke to making lemonade has price elastic
supply).
2. Mobility of inputs The more easily inputs can be transported, the more
price elasticity of supply (e.g. entertainers have price elastic supply
because they are willing to travel to where work is available).
3. Substitute inputs The more substitute inputs available, the more price
elasticity of supply (e.g. land historically had price inelastic supply, but the
recent ability to create artificial land has made its supply more price
elastic).
4. Time The more time to respond to price changes, the more price
elasticity of supply (e.g. movie stars have price inelastic supply because
they only have so much time a year to produce a handful of movies).

Appendix to Chapter 4: Elasticity

and the midpoint formula
If only two points

(Q A , P A ) and

(QB , PB )

are provided, use the following

formula to determine the price elasticity:

Q A +Q B
Small increaseQ Average of Q A QB
2
Price elasticity ( )=
=
Small increaseP Average P A P B
P +P
P A B
2
Q