1

ElasticityElasticity

©©1999 South-Western College Publishing

2

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.

3

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?

4

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

5

Classifying EClassifying EddClassifying EClassifying Edd

• Ed = 1 Unitary elasticity• Ed > 1 Elastic demand• Ed < 1 Inelastic demand

6

Extreme elasticitiesExtreme elasticitiesExtreme elasticitiesExtreme elasticities

• Ed = 0 Perfectly inelastic (vertical demand curve)

• Ed = Perfectly elastic (horizontal demand curve)

7

DP

Q

Perfectly inelastic Perfectly inelastic demanddemand

P

Q

D

Perfectly elastic Perfectly elastic demanddemand

8

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

9

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

11

When price increases, When price increases, what two things happen?what two things happen?

• more money per unit

•fewer units are sold

12

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

13

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

14

P

Q0

P

Q0

A B

D D

Which demand curve is for spark plugs and which for Coca-Cola?

15

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!

16

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!

17

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?

18

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?

19

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

20

If total revenue does not change when price increases, the demand curve is unitary elastic, value equals 1

21

If price increases and the revenue gained is less than the revenue lost, the demand curve is price elastic, > 1

22

If price increases and the revenue gained is greater than the revenue lost, the demand curve is price inelastic, < 1

23

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

24

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?

25

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?

26

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

27

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

28

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

29

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?

30

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?

31

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

32

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

33

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

34

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

35

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