CHAPTER 5 (ECONOMICS)

ELASTICITY’S OF SUPPLY
AND DEMAND
 Elasticity . . .
 … allows us to analyze supply and demand with
greater precision.

 … is a measure of how much buyers and sellers

respond to changes in market conditions

2
 PRICE ELASTICITY OF DEMAND (Ed )
 Price Elasticity of Demand (Ed) is a measure of
the responsiveness of the quantity demand for a
good to a change in price.
FORMULA

P ercen tag e ch an g e in q u an tity d em an d ed

P rice elasticity o f d em an d =
P ercen tag e ch an g e in p rice

CHAPTER 5 ELASTICITY AND ITS APPLICATIONS 3

 PRICE ELASTICITY OF DEMAND FORMULA
Ed = % Qd / %P
= [ (Q1 – Q0) ÷ Q0 x 100] ÷ [(P1 – P0) ÷ P0 x 100]
Ed = (Q ÷ P) X (P0 ÷ Q0 )
Where,
Q0 = Original quantity of demand
Q1 = New quantity demanded
Q = Change in quantity of demanded
P0 = Original price
P1 = New Price
P = Change in Price OR,

4
Ed = % Qd / %P
= [(Q1 – Q0) ÷ Q0 x 100] ÷ [(P1 – P0) ÷ P0 x
100]
= [Q1 – Q0 ÷ Q0 ] X [P0 ÷ (P1 – P0) ]
= (Q ÷ Q0 ) X (P0 ÷ P)
OR
= (Q ÷ P) X (P0 ÷ Q0 )

CHAPTER 5 ELASTICITY AND ITS APPLICATIONS 5

 Remember,!!!!
The value of price elasticity of demand is always
negative (-).
This is due to the negative slope of the demand
curve and the inverse relationship between price
and quantity demanded

CHAPTER 5 ELASTICITY AND ITS APPLICATIONS 6

 The Price Elasticity of Demand and
Its Determinants
 Availability of Close Substitutes
 Necessities versus Luxuries
 Definition of the Market
 Time Horizon

7
 The Price Elasticity of Demand and
Its Determinants
 Demand tends to be more elastic:
• the larger the number of close substitutes.
• if the good is a luxury.
• the more narrowly defined the market.
• the longer the time period.

8
 Computing the Price Elasticity of
Demand
 The price elasticity of demand is computed as
the percentage change in the quantity
demanded divided by the percentage change in
price.

P ercen tag e ch an g e in q u an tity d em an d ed

P rice elasticity o f d em an d =
P ercen tag e ch an g e in p rice

9
 Computing the Price Elasticity of
Demand

 Example: If the price of an ice cream cone

increases from $2.00 to $2.20 and the amount
you buy falls from 10 to 8 cones, then your
elasticity of demand would be calculated as:
P ercen tag e ch an g e in q u an tity d em an d ed
P rice elasticity o f d em an d =
P ercen tag e ch an g e in p rice

(1 0  8 )
1 0 0 20%
10  2
( 2 .2 0  2 .0 0 )
1 0 0 1 0 %
2 .0 0
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 The Midpoint Method: A Better Way to
Calculate Percentage Changes and
Elasticities
 The midpoint formula is preferable when
calculating the price elasticity of demand
because it gives the same answer regardless of
the direction of the price change.

(Q2  Q1 ) /[(Q2  Q1 ) / 2]
Price elasticity of demand =
( P2  P1 ) /[( P2  P1 ) / 2]

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 The Midpoint Method: A Better Way to
Calculate Percentage Changes and
Elasticities
 Example: If the price of an ice cream cone
increases from $2.00 to $2.20 and the amount
you buy falls from 10 to 8 cones, then your
elasticity of demand, using the midpoint formula,
would be calculated as:

(10  8)
(10  8) / 2 22%
  2.32
(2.20  2.00) 9.5%
(2.00  2.20) / 2

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 The Variety of Demand Curves
 Inelastic Demand
• Quantity demanded does not respond strongly
to price changes.
• Price elasticity of demand is less than one.
 Elastic Demand
• Quantity demanded responds strongly to
changes in price.
• Price elasticity of demand is greater than one.

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 Computing the Price Elasticity of
Demand
(100  50)
(100  50)/2
ED 
(4.00  5.00)
Price (4.00  5.00)/2
$5
67 percent
4   3
Demand  22 percent

0 50 100 Quantity
Demand is price elastic.
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 The Variety of Demand Curves
 Perfectly Inelastic
• Quantity demanded does not respond to price
changes.
 Perfectly Elastic
• Quantity demanded changes infinitely with any
change in price.
 Unit Elastic
• Quantity demanded changes by the same
percentage as the price.

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 The Variety of Demand Curves
 Because the price elasticity of demand
measures how much quantity demanded
responds to the price, it is closely related to the
slope of the demand curve.
 But it is not the same thing as the slope!

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 Figure 1 The Price Elasticity of
Demand
(a) Perfectly Inelastic Demand: Elasticity Equals 0

Price
Demand

$5

4
1. An
increase
in price . . .

0 100 Quantity

2. . . . leaves the quantity demanded unchanged.

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 Figure 1 The Price Elasticity of
Demand
(b) Inelastic Demand: Elasticity Is Less Than 1

Price

$5

4
1. A 22% Demand
increase
in price . . .

0 90 100 Quantity

2. . . . leads to an 11% decrease in quantity demanded.

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 Figure 1 The Price Elasticity of
Demand
(c) Unit Elastic Demand: Elasticity Equals 1
Price

$5

4
1. A 22% Demand
increase
in price . . .

0 80 100 Quantity

2. . . . leads to a 22% decrease in quantity demanded.

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 Figure 1 The Price Elasticity of
Demand
(d) Elastic Demand: Elasticity Is Greater Than 1
Price

$5

4 Demand
1. A 22%
increase
in price . . .

0 50 100 Quantity

2. . . . leads to a 67% decrease in quantity demanded.

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 Figure 1 The Price Elasticity of
Demand
(e) Perfectly Elastic Demand: Elasticity Equals Infinity
Price

1. At any price
above $4, quantity
demanded is zero.
$4 Demand

2. At exactly $4,
consumers will
buy any quantity.

0 Quantity
3. At a price below $4,
quantity demanded is infinite.

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Total Revenue and the Price Elasticity
of Demand
 Total revenue is the amount paid by buyers and
received by sellers of a good.
 Computed as the price of the good times the
quantity sold.
TR  P  Q

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 Figure 2 Total Revenue
Price

When the price is $4, consumers

will demand 100 units, and spend
$400 on this good.

$4

P × Q = $400
P
(revenue) Demand

0 100 Quantity

Q 23
 Elasticity and Total Revenue along a
Linear Demand Curve
 With an inelastic demand curve, an increase in
price leads to a decrease in quantity that is
proportionately smaller. Thus, total revenue
increases.

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 Figure 3 How Total Revenue
Changes When Price Changes:
Inelastic Demand
Price Price
An Increase in price from $1 … leads to an Increase in
to $3 … total revenue from $100 to
$240

$3

Revenue = $240
$1
Revenue = $100 Demand Demand

0 100 Quantity 0 80 Quantity

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Elasticity and Total Revenue along a Linear Demand
Curve
 With an elastic demand curve, an increase in the
price leads to a decrease in quantity demanded
that is proportionately larger. Thus, total revenue
decreases.

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 Figure 3 How Total Revenue
Changes When Price Changes:
Elastic Demand
Price Price

An Increase in price from $4 … leads to an decrease in

to $5 … total revenue from $200 to
$100

$5

$4

Demand
Demand

Revenue = $200 Revenue = $100

0 50 Quantity 0 20 Quantity

Note that with each price increase, the Law of Demand still holds – an
increase in price leads to a decrease in the quantity demanded. It is the
change in TR that varies! 27
Elasticity of a Linear Demand Curve

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 Figure 4 Elasticity of a Linear
Demand Curve
Demand is elastic; When price increases from
Price demand is responsive$4
to to $5, TR declines from
changes in price. $24 to $20.
$7 Elasticity is > 1 in this range.
6

4
Elasticity is is<inelastic;
Demand 1 in this range.
demand is
3
not very responsive to changes
2 When price increases from
in price.
$2 to $3, TR increases from
1 $20 to $24.

0 2 4 6 8 10 12 14
Quantity

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 Other Demand Elasticities
 Income Elasticity of Demand
• Income elasticity of demand measures how
much the quantity demanded of a good
responds to a change in consumers’ income.
• It is computed as the percentage change in the
quantity demanded divided by the percentage
change in income.

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 Other Demand Elasticities
 Computing Income Elasticity

P ercen tag e ch an g e
in q u an tity d em an d ed
In co m e elasticity o f d em an d =
P ercen tag e ch an g e
in in co m e

Remember, all elasticities are

measured by dividing one
percentage change by another

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 Other Demand Elasticities
 Income Elasticity
• Types of Goods
- Normal Goods
- Inferior Goods
• Higher income raises the quantity demanded
for normal goods but lowers the quantity
demanded for inferior goods.

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 Other Demand Elasticities
 Income Elasticity
• Goods consumers regard as necessities tend to
be income inelastic
- Examples include food, fuel, clothing, utilities, and
medical services.
• Goods consumers regard as luxuries tend to be
income elastic.
- Examples include sports cars, furs, and expensive
foods.

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 Other Demand Elasticities

 Cross-price elasticity of demand

• A measure of how much the quantity demanded of one
good responds to a change in the price of another good,
computed as the percentage change in quantity
demanded of the first good divided by the percentage
change in the price of the second good
%change in quantity demanded of good 1
Cross - price elasticity of demand 
%change in price of good 2

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 THE ELASTICITY OF SUPPLY
 Price elasticity of supply is a measure of how
much the quantity supplied of a good responds
to a change in the price of that good.
 Price elasticity of supply is the percentage
change in quantity supplied resulting from a
percentage change in price.

35
 Figure 5 The Price Elasticity of
Supply
(a) Perfectly Inelastic Supply: Elasticity Equals 0

Price
Supply

$5

4
1. An
increase
in price . . .

0 100 Quantity

2. . . . leaves the quantity supplied unchanged.

36
 Figure 5 The Price Elasticity of
Supply
(b) Inelastic Supply: Elasticity Is Less Than 1

Price

Supply
$5

4
1. A 22%
increase
in price . . .

0 100 110 Quantity

2. . . . leads to a 10% increase in quantity supplied.

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 Figure 5 The Price Elasticity of
Supply
(c) Unit Elastic Supply: Elasticity Equals 1
Price

Supply
$5

4 (If SUPPLY is unit

elastic and linear, it will
1. A 22%
increase
begin at the origin.)
in price . . .

0 100 125 Quantity

2. . . . leads to a 22% increase in quantity supplied.

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 Figure 5 The Price Elasticity of
Supply
(d) Elastic Supply: Elasticity Is Greater Than 1
Price

Supply

$5

4
1. A 22%
increase
in price . . .

0 100 200 Quantity

2. . . . leads to a 67% increase in quantity supplied.

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 Figure 5 The Price Elasticity of
Supply
(e) Perfectly Elastic Supply: Elasticity Equals Infinity
Price

1. At any price
above $4, quantity
supplied is infinite.

$4 Supply

2. At exactly $4,
producers will
supply any quantity.

0 Quantity
3. At a price below $4,
quantity supplied is zero.

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The Price Elasticity of Supply and Its
Determinants
 Ability of sellers to change the amount of the
good they produce.
• Beach-front land is inelastic.
• Books, cars, or manufactured goods are elastic.
 Time period
• Supply is more elastic in the long run.

41
 Computing the Price Elasticity of
Supply
 The price elasticity of supply is computed as the
percentage change in the quantity supplied
divided by the percentage change in price.

P ercen tag e ch an g e
in q u an tity su p p lied
P rice elasticity o f su p p ly =
P ercen tag e ch an g e in p rice

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THREE APPLICATIONS OF SUPPLY,
DEMAND, AND ELASTICITY

 Can good news for farming be bad news for

farmers?
 What happens to wheat farmers and the market
for wheat when university agronomists discover
a new wheat hybrid that is more productive than
existing varieties?

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 Can Good News for Farming Be Bad
News for Farmers?

 Examine whether the supply or demand curve

shifts.
 Determine the direction of the shift of the curve.
 Use the supply-and-demand diagram to see how
the market equilibrium changes.

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Figure 7 An Increase in Supply in the
Market for Wheat
Price of
Wheat 1. When demand is inelastic,
2. . . . leads an increase in supply . . .
to a large fall S1
in price . . . S2

$3

Demand

0 100 110 Quantity of

Wheat
3. . . . and a proportionately smaller
increase in quantity sold. As a result,
revenue falls from $300 to $220.
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 Compute the Price Elasticity of
Demand When There Is a Change in
Supply
1 0 0 1 1 0
(1 0 0  1 1 0 ) / 2
ED 
3 .0 0  2 .0 0
( 3 .0 0  2 .0 0 ) / 2

0 .0 9 5
  0 .2 4
0 .4

Demand is inelastic.
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 Why Did OPEC Fail to Keep the Price
of Oil High?
 Supply and Demand can behave differently in
the short run and the long run
• In the short run, both supply and demand for oil
are relatively inelastic
• But in the long run, both are elastic
- Production outside of OPEC
- More conservation by consumers

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 Does Drug Interdiction Increase or
Decrease Drug-Related Crime?
 Drug interdiction impacts sellers rather than
buyers.
• Demand is unchanged.
• Equilibrium price rises although quantity falls.
 Drug education impacts the buyers rather than
sellers.
• Demand is shifted.
• Equilibrium price and quantity are lowered.

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 Figure 9 Policies to Reduce the Use
of Illegal Drugs
Drug Education
Drug Interdiction
Price of Drugs Price of Drugs

S2

S1 S1

It is amazing how
useful knowledge
of elasticities can
be!
D1
D1
D2

Quantity of Drugs Quantity of Drugs

The demand for illegal

Interdiction shifts the supply, while education shifts the demand.
drugs is inelastic. And in the other it goes down.
In each case, the change in price is the same.
The changes in quantities (and TR) are But in one market the price
49
remarkable. goes up.
 Price elasticity of demand measures how much
the quantity demanded responds to changes in
the price.
 Price elasticity of demand is calculated as the
percentage change in quantity demanded
divided by the percentage change in price.
• If a demand curve is elastic, total revenue falls
when the price rises.
• If it is inelastic, total revenue rises as the price
rises.

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 The income elasticity of demand measures how
much the quantity demanded responds to
changes in consumers’ income.
 The cross-price elasticity of demand measures
how much the quantity demanded of one good
responds to the price of another good.
 The price elasticity of supply measures how
much the quantity supplied responds to changes
in the price.

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 In most markets, supply is more elastic in the
long run than in the short run.
 The price elasticity of supply is calculated as the
percentage change in quantity supplied divided
by the percentage change in price.
 The tools of supply and demand can be applied
in many different types of markets.

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