Elasticity of Demand 2019

Elasticity of Demand and
Supply
Copyright 2003 South-Western

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Thomson Learning. All rights reserved.
Definition
• Elasticity of demand means responsiveness
of quantity demand to percentage change in
price.
Types of Elasticity of Demand
 Price Elasticity of Demand

 Income Elasticity of Demand
 Arc Elasticity of Demand
 Cross Elasticity of Demand

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Sign of Price Elasticity
• According to the law of demand, whenever
the price rises, the quantity demanded falls.
Thus the price elasticity of demand is
always negative.
• Because it is always negative, economists

usually state the value without the sign.

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Price Elasticity of Demand
• Price elasticity reveals the responsiveness of
the Quantity Demand to % age change in
price.
% Change in
quantity demanded % Q
Price Elasticity = =
of demand % Change in Price % P
dQ P
Eld  *
dP Q
(Q0  Q1 ) (Q0 Q1 )
OR we can rewrite it ( P0  P1 ) ( P0 P1 )
as follows

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Practice Questions
Q  140  2 P1
d 2
Suppose Demand and Supply
function then find equilibrium
price and quantity Q  50  3P1
s
Q  140  2 P1  15P1
d 2
price and quantity Q  114  2.5P1
s
Q d  145  3P1  110 P1

2
price and quantity Q s  135  12 P1
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Classifying Demand and
Supply as Elastic or Inelastic
• Demand is inelastic or Less Elastic if
the percentage change in quantity is
less than the percentage change in
price.
E<1

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• After calculating the price elasticity of
demand, you can determine whether it is
elastic, inelastic, or unitary elastic with the
following chart:
• If the absolute value of the elasticity term < 1,
then the demand is inelastic.
• If the absolute value of the elasticity term > 1,
then the demand is elastic.
• If the absolute value of the elasticity term = 1,
then the demand is unitary elastic.

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Elasticity of Demand
• Perfectly inelastic:
Perfectly inelastic An increase in price results in no
demand change in consumers purchases.
curve
The vertical demand curve is
imaginary as the substitution and
income effects prevent this from
Quantity happening in the real world.
(a)
• Relatively inelastic:
A percent increase in price results Demand for
Less elastic
in a smaller % reduction in sales.
The demand for less elastic has
been estimated to be highly
inelastic or less elastic.
Quantity
(b)

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• Unitary elasticity:
Demand curve of The percent change in quantity
unitary elasticity demanded due to an increase in
price is equal to the % change in
price. A decreasing slope
results. Sales revenue (price
Quantity times quantity) is constant.
(c)

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• More elastic:
More Elastic
Demand A % increase in price leads to a
larger % reduction in purchases.
When good are substitutes
then quantity demand will be
highly sensitive to changes in
price.
Quantity
(d)
• Perfectly elastic: Perfectly Elastic

Demand
If price remains constant but
quantity demand is increasing with
the passage of time
Quantity
(e)

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(Q0  Q1 ) (Q0 Q1 )
Recall - ( P0  P1 ) ( P0 P1 )
(110 - 100) (110 + 100)

• With this straight-line (constant-slope) ($1 - $2) ($1 + $2)
demand curve, demand varies across
a range of prices.
= ( - ) 0.14
Elasticity = (-) 0.14
• Using the equation for elasticity, the
formula shows that, when price rises
from $1 to $2 … while quantity
demanded falls from 110 to 100 …
the elasticity for that region of the
demand curve is ( - .14 ) – inelastic.
2
1
D
Quantity
100 110 demanded

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(Q0  Q1 ) (Q0 Q1 )
Recall - ( P0  P1 ) ( P0 P1 )
(20 - 10) (20 + 10)

• A price increase of the same amount, ($10 - $11) ($10 + $11)
from $10 to $11, . . . leads to a decline = (-) 7.0
in quantity demanded from 20 to 10. 11
10 Elasticity = (-) 7. 0
• Note that this change in price was
smaller (as a %) than in the previous
slide but resulted in the same change
in quantity demanded.
• Using the equation for elasticity, the
elasticity amounts to - 7.0 (greater
than - .14 from before).
• The price-elasticity of a straight-line
demand curve increases as price rises. D
Quantity
10 20 demanded

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Elasticity Along a Demand
Curve
Ed = ∞
Elasticity declines along
$10 demand curve as we move
9 toward the quantity axis
8 Ed > 1
7
6
Price
Ed = 1
5
4
3 Ed < 1
2
1 Ed = 0
0 1 2 3 4 5 6 7 8 9 10 Quantity

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Determinants of
• Availability of substitutes
• When good substitutes for a product are
available, a rise in price induces many
consumers to switch to another product.
• The greater the availability of substitutes,
the more elastic demand will be.
• Share of total budget expended on product
• As the share of the total budget expended on
the product rises, demand is more elastic.

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Elastic and Inelastic Demand
Price Price
$1.50 $1.50
$1.00 $1.00
D
D
25 100 90 100
(a) Ballpoint pens per week (in thousands) (b) Cigarette packs per week (in millions)
• As the price of ballpoint pens (a) rises from $1.00 to $1.50 . . . the
quantity demanded plunges from 100,000 to 25,000 per week.
• The % reduction in quantity demanded is larger than the % increase in
price, hence the demand for ballpoint pens is relatively elastic.
• As the price of cigarettes (b) rises from $1.00 to $1.50 . . . quantity
demanded plunges from 100 million to 90 million packs per week.
• The % reduction in quantity demanded is smaller than the % increase
in price, hence the demand for cigarettes is relatively inelastic.
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Income Elasticity of Demand

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Income Elasticity of demand
• Income elasticity indicates responsiveness of
a product’s demand to a change in income.
% Change in
Income Elasticity quantity demanded
of demand = % Change in Income
• A normal good is a good with a positive

income elasticity of demand.
• As income expands, the demand for normal
goods will rise.
• Goods with a negative income elasticity are
inferior goods.
• As income expands, the demand for inferior
goods will decline.
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Practice Questions
Q  140  2 P1  12Y 2
d 2
price and quantity if Y=05 Q s  50  3P1
Q  125  3P1  15P1  10Y

d 2
price and quantity if Y=12 Q s  110  12.5 P1
Q  145  3P1  110 P1  12Y 2

Suppose Demand and d 2
Supply function then find

equilibrium price and Q s  18  15 P1
quantity if Y=10
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Arc Elasticity of Demand
• Arc Elasticity of demand is used to find an
average of two point elasticities on the
demand curve.
p a
b
Qd

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Formula for Arc Elasticity
• The formula for Arc elasticity of demand is

as follows
dQ P1  P2
E= 
dP Q1  Q2

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Cross Elasticity of demand
• If the objective is to check the
responsiveness of quantity demand to
percentage change in the price of substitute
goods then cross elasticity of demand
would be used.
dQ1 P2
• Elc  *
dP2 Q1

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Inelastic Approximately Unitary Elasticity
Salt 0.1 Movies 0.9
Matches 0.1 Homes, owner occupied (long run) 1.2
Toothpicks 0.1 Shellfish (consumed at home) 0.9
Airline travel (short run) 0.1
Gasoline (short run) 0.2 Private education 1.1
Gasoline (long run) 0.7 Tires (short run 0.9
Natural gas, home (short run) 0.1 Tires (long run) 1.2
Natural gas, home (long run) 0.5 Radio and television receivers 1.2
Coffee 0.3
Fish (cod), at home 0.5 Elastic
Tobacco products (short run) 0.5 Restaurant meals 2.3
Foreign travel (long run) 4.0
Legal services (short run) 0.4
Airline travel (long run) 2.4
Physician services 0.6
Fresh green peas 2.8
Taxi (short run) 0.6
Automobiles (short run 1.4
Automobiles (long run) 0.2
Chevrolet automobiles 4.0
Fresh tomatoes 4.6
• Can you explain why the demand for some goods

is highly inelastic while that for others is elastic.
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Relationship between Total
Revenue and Price

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Total Expenditures
and Demand Elasticity
Impact of higher price Impact of lower price
Elasticity on total consumer on total consumer
Price elasticity coefficient expenditures or a expenditures or a
of demand (in absolute value) firm’s total revenue firm’s total revenue
More Elastic 1 to  decrease increase

Unitary Elastic 1 -- unchanged-- -- unchanged--
Less elastic 0 to 1 increase decrease
• The table above summarizes the relationship

between changes in price and total expenditures
for demand curves of varying elasticity.
• When the total revenue is maximized , marginal
revenue is Zero and elasticity of demand would
be elastic.
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Total Revenues and Demand Elasticity
The Firm’s Demand Curve, Total Revenue, and Elasticity
Price Here demand is More elastic so
lower prices result in more
Price
elasticity revenue and higher prices result in
P X Q = TR
e = 17.00
less revenue
$9 $9 x 0 = $0 Total revenue unchanged by price
$8 $8 x 1 = $8 e = 5.00
e = 2.60
when demand is unitary elastic
$7 $7 x 2 = $14
e = 1.57
$6 $6 x 3 = $18 Here demand is less elastic
$5 $5 x 4 = $20 e = 1.00 so lower prices result in less
$4 $4 x 5 = $20 e = 0.64 revenue and higher prices
$3 $3 x 6 = $18 e = 0.38 result in more revenue
$2 $2 x 7 = $14 e = 0.20
$1 $1 x 8 = $8 e = 0.06
$0 x 9 = $0
$0 Quantity
0 1 2 3 4 5 6 7 8 9
Qty Total
Price sold revenue Price elasticity of demand
$9 x 0 = $0
• By tracing out the demand curve, one
$8 x 1 = $8
((0-1) / (0+1)) / ((9-8) / (9+8)) = 17.00 can see how changes in price (through
$7 x 2 = $14
((1-2) / (1+2)) / ((8-7) / (8+7)) = 5.00 changes in quantity demanded) change
((2-3) / (2+3)) / ((7-6) / (7+6)) = 2.60 total revenue collected.
$6 x 3 = $18
((3-4) / (3+4)) / ((6-5) / (6+5)) = 1.57
$5 x 4 = $20
((4-5) / (4+5)) / ((5-4) / (5+4)) = 1.00 • By calculating the price elasticity of
$4 x 5 = $20 demand at different points along the
((5-6) / (5+6)) / ((4-3) / (4+3)) = 0.64
$3 x 6 = $18
x =
((6-7) / (6+7)) / ((3-2) / (3+2)) = 0.38 demand curve, one can follow how
$2 7 $14
$1 x 8 = $8
((7-8) / (7+8)) / ((2-1) / (2+1)) = 0.20 and where total revenue is maximized.
((8-9) / (8+9)) / ((1-0) / (1+0)) = 0.06
$0 x 9 = $0 Copyright 2003 South-Western
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Total Revenues and Demand Elasticity
• The firm maximizes its revenue at the price (or quantity)
where demand is unitary elastic.
Total Revenue is maximized Total Revenue is maximized
somewhere between $4 and $5 somewhere between 4 and 5 units
(where demand is unitary elastic). (again, where demand is unitary elastic).
Quantity Total
Price sold revenue Elasticity
Price
$9 x 0 = $0
17.00 Total
$9
$8 x 1 = $8
5.00 revenue
$8
$7 x 2 = $14
2.60 $20
$7 $6 x 3 = $18
1.57
$6 $5 x 4 = $20
1.00 $15
$5 $4 x 5 = $20
.64
$4 $3 x 6 = $18
.38 $10
$3 $2 x 7 = $14
.20
$2 $1 x 8 = $8
.06 $5
$1 $0 x 9 = $0
$0 Total Qty
revenue $0
$0 $5 $10 $15 $20 0 1 2 3 4 5 6 7 8 9
(c) Price versus Total Revenue (d) Quantity versus Total Revenue

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Price Elasticity of Supply

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Price Elasticity of Supply
• The price elasticity of supply is the percent
change in quantity supplied divided by the
percent change of the price causing the
supply response.
• Analogous to the price elasticity of demand.
• However, the price elasticity of supply will
be positive because the quantity producers are
willing to supply is directly related to price.
• Formula for finding Price Elasticity of supply

is same as price elasticity of demand. To
calculate elasticity of supply, derivative of
supply equation is taken
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Concepts of Consumer
Surplus and Producer Surplus

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Consumer Surplus
Consumer surplus is the difference between
the amount consumers are willing to pay and
the amount they have to pay for a good.
Lower market prices increase the amount of
consumer surplus in the market.
• Consumer Surplus:
the area below the demand curve but above the
actual price paid.

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Market Demand Schedule
Price
• Consider the market for cellular (monthly bill)
phones service . This time we
will assume that the demand 140
for cell service is more linear
and that the market price is $100.
120
• If the market price is $100, then
the 30th unit will not sell Market price = $100
because those who demand it are 100
only willing to pay $60 for
cellular phone service.
80
• At $100, the 17th unit will sell
because those who demand it are
willing to pay up to $100 for 60
cellular phone service. Demand
• At $100, the 5th unit will sell Quantity
because those who demand it are 5 10 15 20 25 30 (millions of
willing to pay up to $133 for subscribers)
cellular phone service.
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Market Demand Schedule
Price
(monthly bill)
Consumer
• For all those goods under 17 surplus
units, people are willing to 140
pay more than $100 for service.
• The area, represented by the 120
distance above the actual price
paid and below the demand Market price = $100
curve, is called consumer 100
surplus.
• This area represents the net 80
gains to buyers from market
exchange.
60
Demand
Quantity
5 10 15 20 25 30 (millions of
subscribers)

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Producer Surplus
• It means the difference between the
minimum amount required to induce
producers to supply a good and the amount
they actually receive.

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Market Supply Schedule
Price
• Consider the market for cellular (monthly bill)
phones service again. This time Supply
we will assume that the supply 140
for cell phones is more linear
and that the market price is $100.
120
• If the market price is $100, then
the 30th unit will not be produced Market price = $100
because the cost of supplying it 100
exceeds the market price of $140.
• At $100, the 17th unit will be 80
produced because those who
supply it are willing to do so for
at least $100. 60
• At $100, the 5th unit will be
produced because those who
supply it are willing to do so for Quantity
5 10 15 20 25 30 (millions of
at least $60. subscribers)

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Elasticity of Demand 2019

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 Price Elasticity of Demand

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• Because it is always negative, economists

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Q d  145  3P1  110 P1

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• Perfectly elastic: Perfectly Elastic

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(110 - 100) (110 + 100)

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(20 - 10) (20 + 10)

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• A normal good is a good with a positive

Q  125  3P1  15P1  10Y

Q  145  3P1  110 P1  12Y 2

Supply function then find

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• The formula for Arc elasticity of demand is

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• Can you explain why the demand for some goods

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More Elastic 1 to  decrease increase

• The table above summarizes the relationship

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• Formula for finding Price Elasticity of supply

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