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ElasticityElasticity
©©1999 South-Western College Publishing
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What is Elasticity?What is Elasticity?What is Elasticity?What is Elasticity?
A term economists use to describe sensitivity of quantity
demanded or supplied to a change in price.
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The percentage change in quantity demandedquantity demanded
divided by the percentage change in priceprice
How do we measure the Price How do we measure the Price Elasticity of Demand?Elasticity of Demand?
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Price Elasticity of Price Elasticity of DemandDemand
Price Elasticity of Price Elasticity of DemandDemand
Ed = % change in Qd
% change in P
Ed = % in Qd
% in P
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Classifying EClassifying EddClassifying EClassifying Edd
• Ed = 1 Unitary elasticity• Ed > 1 Elastic demand• Ed < 1 Inelastic demand
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Extreme elasticitiesExtreme elasticitiesExtreme elasticitiesExtreme elasticities
• Ed = 0 Perfectly inelastic (vertical demand curve)
• Ed = Perfectly elastic (horizontal demand curve)
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DP
Q
Perfectly inelastic Perfectly inelastic demanddemand
P
Q
D
Perfectly elastic Perfectly elastic demanddemand
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When consumers are When consumers are very very sensitivesensitive to a price change to a price change
what does the demand curve what does the demand curve look like?look like?
Very horizontal
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When consumers are less When consumers are less sensitive to a price change sensitive to a price change
what does the demand curve what does the demand curve look like?look like?
Very vertical
1010
135
64
90
75
220
70
4030
NewNew
.2-inelastic50%10%15050
2-elastic10%20%80200
0.33-inelastic75%25%12040
3-elastic.6/.2
20%5/25
60%60/100
10025
InitialInitial
Price Elasticity of
Demand
% change in
P
% change in Qd
Quantity
Price
Ed = % in Qd
% in P
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When price increases, When price increases, what two things happen?what two things happen?
• more money per unit
•fewer units are sold
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What factors influence Demand What factors influence Demand Sensitivity (elasticity)?Sensitivity (elasticity)?
What factors influence Demand What factors influence Demand Sensitivity (elasticity)?Sensitivity (elasticity)?
• Number and closeness of Substitute goods
• % of income a good makes up
• Basic goods or “needs”
• Time to adjust
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What do substitutes have to What do substitutes have to do with sensitivity?do with sensitivity?
The more substitutes a good has, the more sensitive consumers are to a price change
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P
Q0
P
Q0
A B
D D
Which demand curve is for spark plugs and which for Coca-Cola?
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The lower the % of ones budget a good is, the less sensitive consumers are to a price change
What does % of income a good makes What does % of income a good makes up have to do with sensitivity?up have to do with sensitivity?
SALT!
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The greater the need a good has to the consumer, the less sensitive the consumer is to a price change
What do basic goods have What do basic goods have to do with sensitivity?to do with sensitivity?
WATER!
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The more time to adjust, the more sensitive consumers are to a price change
What does time have to What does time have to do with sensitivity?do with sensitivity?
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If demand is elasticelastic - revenue goes down
If demand is inelasticinelastic - revenue goes up
If a college raises tuition, If a college raises tuition, what happens to revenue?what happens to revenue?
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Elasticity and Total Elasticity and Total Revenue (TR)Revenue (TR)
Elasticity and Total Elasticity and Total Revenue (TR)Revenue (TR)
TR = PQ (price times quantity)
Ed = % change in Qd
% change in P
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If total revenue does not change when price increases, the demand curve is unitary elastic, value equals 1
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If price increases and the revenue gained is less than the revenue lost, the demand curve is price elastic, > 1
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If price increases and the revenue gained is greater than the revenue lost, the demand curve is price inelastic, < 1
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Summary, elasticity, price changes, Summary, elasticity, price changes, and total revenueand total revenue
Summary, elasticity, price changes, Summary, elasticity, price changes, and total revenueand total revenue
Total revenue falls
Total revenue rises
Ed < 1
Total revenue rises
Total revenue falls
Ed > 1
Total revenue same
Total revenue same
Ed = 1
Price increase
Price Decrease
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The percentage change in the quantity demanded of one commodity resulting from a 1 percent change in price of another commodity
What is Cross Elasticity What is Cross Elasticity of Demand?of Demand?
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The ratio of the percentage change in quantity
demanded to the percentage change in income
What is Income What is Income Elasticity of Demand?Elasticity of Demand?
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E E ii = = % % Quantity Quantity % % Income Income
E E ii = = % % Quantity Quantity % % Income Income
• E i > 0 Normal goods• E i < 0 Inferior goods• E i > 1 Luxury goods• 0 < E i < 1 Necessities
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When does a good face When does a good face an income elastic an income elastic demand curve?demand curve?
When does a good face When does a good face an income elastic an income elastic demand curve?demand curve?
A 1% change in income generates a greater than 1% change quantity demanded
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When does a good face When does a good face an income inelastic an income inelastic
demand curve?demand curve?
When does a good face When does a good face an income inelastic an income inelastic
demand curve?demand curve?A 1% change in income
generates a less than 1% change quantity demanded
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Something that people will buy less of as their incomes increase
What is an What is an Inferior Good?Inferior Good?
I bought Mac and Cheese in college, but refuse to buy it now! What’s the difference in my income?
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Something that people will buy more of as their incomes increase
What is a What is a Normal Good?Normal Good?
I bought bologna in college, but now I buy steak! What’s the difference in my income?
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What is Price Elasticity What is Price Elasticity of Supply?of Supply?
What is Price Elasticity What is Price Elasticity of Supply?of Supply?
The ratio of the percentage change in quantity supplied to the percentage change in price
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E E ss = = % % Q supplied Q supplied % % Price Price
E E ss = = % % Q supplied Q supplied % % Price Price
• E s = 1 Unitary• E s > 1 Elastic• E s < 1 Inelastic
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Extreme cases of E Extreme cases of E ss Extreme cases of E Extreme cases of E ss • E s = 0, perfectly inelastic
(vertical supply curve
• E s = , perfectly elastic (horizontal supply curve)
SP
Q
SP
Q
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Does time effect Supply Does time effect Supply Elasticities?Elasticities?
Does time effect Supply Does time effect Supply Elasticities?Elasticities?
Yes! The more time, the more elastic the supply curve
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Which type of good Which type of good would be best to tax to would be best to tax to raise the most revenue?raise the most revenue?
Which type of good Which type of good would be best to tax to would be best to tax to raise the most revenue?raise the most revenue?
Goods that face a price inelastic demand curve will generate the most revenue
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