L04 Chapter 6: Elasticity: The Responsiveness of

Demand and Supply

Elasticity

Demand shows us the relationship

between price and quantity demanded, all

else constant

Does quantity respond to price changes

in the same way for all goods?

Elasticity

Price Elasticity of Demand – The

responsiveness of quantity to a change in

price

◦ How people respond to a change in price

◦ Simply measuring a behavioral response to

price changing.

Calculating Elasticity: The Midpoint

Formula

The twos cancel out leaving:

Example: Calculate Elasticity from Point A to B

Quantity

B

Price per

5 10 15 20 25 30

10

8

4

2

C

D

A

D

P1=___, P2=__, Q1=5, Q2=10

-3=)93

1(-=)

2

18)(

15

5-(=

18

2-15

5

=

10+8

10-85+10

5-10

=Ed

11

33

11

6

5

6

5

42

42230

230

-=)1

(-=)2

)(5

5-(=

2-5

5

=

+

-5+

5-

=Ed

Example: Calculate Elasticity from Point C to D

Quantity

B

Price per

5 10 15 20 25 30

10

8

4

2

C

D

A

D

P1=_, P2=_, Q1=_, Q2=_

Elasticity

Notice that the linear demand curve had

the same slope all over the entire curve,

but the ELASTICITY CHANGED

Demand

$ Price

Quantity

P*

Q*

Elastic

ε > | -1 |

Elastic demand |%∆Q| is greater than |%∆P|

so the elasticity is greater than 1 in absolute

value. Quantity responds strongly

Inelastic

ε < | -1 |

Inelastic demand |%∆Q| is less than

|%∆P| so the elasticity is less than

than 1 in absolute value. Quantity

responds weakly

Unit-Elastic

ε = | -1 |

Unit-Elastic Demand |%∆Q| is equal

to the |%∆P| so the elasticity is

equal to 1 in absolute value.

Quantity responds equally

ε = Elasticity changes as we move

along a demand curve

Examples of Price Elasticities

Price Elasticity of Demand for:

◦ Marijuana among HS Seniors -0.3

◦ What is the interpretation of this number?

When price goes up by 1 percent, quantity demand

goes down ___ percent

◦ Motor Vehicles -1.14

◦ Beer -1.11

◦ Shoes -0.70

◦ Green Peas -2.8

What do the negative signs indicate?

◦ When price goes up, quantity goes down.

Elasticity and Slope

• Slope and elasticity are not the same thing

(two different numbers), BUT…

• Comparing ______ slopes of two

demand curves allows you to compare

elasticity

Question: Which is more elastic, the demand for cigarettes or

the demand for potato chips?

D

(a)

Quantity

Price per

Unit

1

2

3

$4

20 40 60 80 100

(b)

D

Quantity 20 40 60 80 100

1

2

3

$4

Price per

Unit

•Key Point: When comparing two demand curves:

•The steeper one is more _______

•The flatter one is more _______

Extreme Cases of Demand

D

________________________Demand, Ed = 0

Quantity

Price per

Unit

1

2

3

$4

20 40 60 80 100

(b)

D

Quantity 20 40 60 80 100

1

2

3

$4

Price per

Unit

___________ ___________Demand Ed=

No change (think Zero)

Some change Huge Percent Change

Super Small Percent Change

Determinants of Price Elasticity of

Demand 1. Availability of Close Substitutes

• More Substitutes _____________

2. Passage of time

• More time _____________

3. Luxury vs Necessities

• Luxury Goods _____________

4. Definition of the Market

• Narrower the market _____________

CEREAL

PRICE ELASTICITY

OF DEMAND

Post Raisin Bran -2.5

All family breakfast cereals -1.8

All types of breakfast cereals -0.9

Determinants of Price Elasticity of

Demand 5. Share of a Consumers Budget

• Smaller share __________

• Bigger share __________

Revenue and Elasticity

Revenue = Price * Quantity

If we lower price, what happens to revenue?

Does it depend on the resulting change in

quantity?

Does it depend on people’s behavioral response

to a change in price?

Does it depend on elasticity?

___________________________________

_________________________________

Revenue and Elasticity

Key Point:

• Price and revenue move in the _____ direction for _____ region of

the demand curve

•Price and revenue move in the _____ direction in the _____ Region

Demand

$ Price

Quantity

P*

Q*

Elastic

ε > | -1 |

•Elastic demand: When price decreases, quantity

responds so strongly that revenue goes up.

•Price and Revenue move in _______ directions

Inelastic

ε < | -1 |

•Inelastic demand: When Price

decreases, quantity responds so

weakly that revenue goes down.

•Price and revenue move in the

________direction

Unit-Elastic

ε = | -1 |

Unit-Elastic Demand :When price

decreases, quantity responds to

exactly offset the change. Revenue

does not change

ε =

Demand

$ Price

Quantity

Q*

Quantity

Total Revenue

Elastic

When Price goes down,

revenue goes ___________.

Inelastic

When Price Goes

down revenue goes

_______

Q* is the middle

of the demand

curve

Relates to

Inelastic

Demand

Relates to

Elastic

Demand

Total Revenue

Curve

Other Elasticities

1. Price Elasticity of Demand

2. Cross Price Elasticity of Demand

3. Income Elasticity of Demand

4. Price Elasticity of Supply

Cross-Price Elasticity

•For Substitutes:

•Price of one goes up, what happens to demand (and

quantity demanded) for its substitute?

•____________________________

•Key Point: Cross Price Elasticity for Substitutes is

_________

Quantity of Xbox sold goes up goes up

Price of PS3

goes up

•For Complements

•Price of one goes up, what happens to demand

(and quantity demanded) for its Complement?

•_____________________________________

_________

•Key Point: Cross Price Elasticity for complements is

________________

Price of Coffee

goes up

Quantity of

Donuts sold

Goes down

Wii

Income Elasticity of Demand

•For Inferior goods

•What happens to demand (and thus

quantity demanded) when income goes up?

•_______________________________

______________________________

•Key point: For inferior goods, the income

elasticity of demand is ____________.

•For Normal Goods

•What happens to demand (and thus

quantity demanded) when income goes up?

•_______________________________

______________________________

•Key Point: For normal goods, the income

elasticity of demand is _______

Increase in

income

Quantity

demand of

Ramen

Goes down

Quantity demanded

of Steak Goes up

Income Elasticity of Demand

Normal Goods

•Luxury

•Imagine your income

goes down, what are the

first things your are

going to cut back?

•_________

•Income elasticity of

demand is greater than 1

•Necessity

•Imagine your income

goes down, are your

purchases of

necessities going to be

affected that much?

•______

•Income Elasticity is

between 0 and 1

•Why do we spend so much on health care?

•When our incomes go up, do we want more health care?

•In other words, what do you think is the income elasticity of

demand for health care?

Some Elasticity Examples

Cross-price elasticity of demand between

beer and wine

0.31

Cross-price elasticity of demand between

beer and spirits

0.15

Income elasticity of demand for beer -0.09

Income elasticity of demand for wine 5.03

Income elasticity of demand for spirits 1.21

Price Elasticity of Supply

Recall: Price Elasticity of Demand – the

responsiveness of quantity demanded to a

change in price

Price Elasticity of Supply?

◦ Responsiveness of quantity supplied to a

change in price

◦ Behavior of Producers

Review Price Elasticity of Demand

Review

Review