here

Elasticity of
Demand and Supply
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Price Elasticity of Demand
• Elasticity
– Responsiveness
• Price elasticity of demand
– How responsive quantity demanded is to
a price change
– Percentage change in quantity
demanded divided by percentage change
in price
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Price Elasticity of Demand
%q
ED 
%p
q
p
ED 

(q  q' ) / 2 ( p  p' ) / 2
• %Δq – percentage change in quantity
– Δq – change in quantity
• %Δp – percentage change in price
– Δp – change in price
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Price Elasticity of Demand
• Price elasticity of demand, ED
– Law of demand
• Price and quantity demanded are inversely
related
– ED negative
– Absolute value of ED positive
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Exhibit 1
Demand Curve for Tacos
Price per taco
$1.10
a
b
0.90
D
0
95 105
Thousands per day
If the price of tacos drops from $1.10 to $0.90, the quantity demanded increases from
95,000 to 105,000.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Categories of ED
• If %∆q < %∆p
– A change in price has relatively little
effect on quantity demanded
– ED between 0 and 1
– Inelastic demand
• If %∆q = %∆p
– ED = 1
– Unit elastic demand
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Categories of ED
• If %∆q > %∆p
– A change in price has a relatively large
effect on quantity demanded
– ED greater than 1
– Elastic demand
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Elasticity and Total Revenue
• Total revenue = price * quantity
demanded at this price
• TR= p ˣ q
• As price decreases
– If demand is elastic, TR increases
– If demand is inelastic, TR decreases
– If demand is unit elastic, TR constant
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Price Elasticity and Linear Demand Curve
• Linear demand curve
– Straight line demand curve
– Constant slope
– Varying elasticity
• Demand becomes less elastic as we move
downward
– Upper half: elastic
– Lower half: inelastic
– Midpoint: unit elastic
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Exhibit 2
Price per unit
Demand, Price Elasticity, and Total Revenue
$100
90
80
70
60
50
40
30
20
10
0
(a) Demand and price elasticity
a
Elastic, ED >1
b
Unit elastic, ED =1
c
Inelastic, ED <1
d
100 200
500
Where the demand curve
is elastic, a lower price
increases total revenue.
Total revenue reaches a
maximum at the rate of
output where the demand
curve is unit elastic.
D
e
800 900 1,000 Quantity per period
(b) Total revenue
Total revenue
$25,000
Total
revenue
0
500
1,000
Where the demand curve
is inelastic, further
decreases in price reduce
total revenue.
Quantity per period
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Constant Elasticity Demand Curves
• Perfectly elastic demand curve
– Horizontal line
• Any price increase would reduce quantity
demanded to zero
– ED = ∞
– Consumers don’t tolerate price increases
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Constant Elasticity Demand Curves
• Perfectly inelastic demand curve
– Vertical line
• Any price change has no effect on the
quantity demanded
– ED = 0
– ‘Price is no object’
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Constant Elasticity Demand Curves
• Unit-elastic demand curve
– Everywhere along the demand curve
• % Δp causes an equal but offsetting %Δq
• Total revenue remains the same
– ED = 1
• Constant-elasticity demand curve
– Price elasticity is the same everywhere
along the curve
– Elasticity value is unchanged
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Exhibit 3
Constant-Elasticity Demand Curves
ED’ = 0
Price per unit
Price per unit
Price per unit
D’
ED = ∞
p
(c) Unit elastic
(b) Perfectly inelastic
(a) Perfectly elastic
a
$10
D
ED’’ = 1
b
6
0
Quantity
per period
0
Q
Quantity
per period
D’’
0
60 100
Quantity
per period
The three panels show constant-elasticity demand curves, so named because the elasticity value
does not change along the demand curve. Along the perfectly elastic, or horizontal, demand curve
of panel (a), consumers demand all that is offered for sale at price p, but demand nothing at a
price above p. Along the perfectly inelastic, or vertical, demand curve of panel (b), consumers
demand amount Q regardless of price. Along the unit-elastic demand curve of panel (c), total
revenue is the same for each price-quantity combination.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Exhibit 4
Summary of Price Elasticity of Demand
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Determinants of Price Elasticity of D
• ED is greater:
– The greater the availability of substitutes,
and the more similar the substitutes
– The more important the good as a share
of the consumer’s budget
– The longer the period of adjustment
(time)
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Exhibit 5
Price per unit
Demand Becomes More Elastic Over Time
$1.25
e
1.00
Dw
0
50
75 95 100
Dm
Dy
Quantity per day
Dw is the demand curve one week after a price increase from $1.00 to $1.25. Along this curve,
quantity demanded per day falls from 100 to 95. One month after the price increase, quantity
demanded has fallen to 75 along Dm. One year after the price increase, quantity demanded has
fallen to 50 along Dy. At any given price, Dy is more elastic than Dm, which is more elastic than Dw.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Elasticity Estimates
• Short run
– Consumers have little time to adjust
• Long run
– Consumers can fully adjust to a price
change
• Demand is more elastic in the long run
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Exhibit 6
Selected Price Elasticities of Demand (Absolute Values)
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Price Elasticity of Supply
• Elasticity
– Responsiveness
• Price elasticity of supply
– Responsiveness of quantity supplied to a
price change
– Percentage change in quantity supplied
divided by percentage change in price
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Price Elasticity of Supply
%q
ES 
%p
q
p
ES 

(q  q' ) / 2 ( p  p' ) / 2
• Law of supply
• ES positive
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Exhibit 7
Price per unit
Price Elasticity of Supply
S
p’
p
0
q
q’
Quantity per period
If the price increases from p to p’, the quantity supplied increases from q to q’.
Price and quantity supplied move in the same direction, so the price elasticity of supply
is a positive number.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Categories of ES
• If %∆q < %∆p
– A change in price has relatively little
effect on quantity supplied
– ES between 0 and 1
– Inelastic supply
• If %∆q = %∆p
– ES = 1
– Unit elastic supply
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Categories of ES
• If %∆q > %∆p
– A change in price has a relatively large
effect on quantity supplied
– ES greater than 1
– Elastic supply
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Constant Elasticity Supply Curves
• Perfectly elastic supply curve
– Horizontal line
• Any price decrease drops the quantity
supplied to zero
– ES = ∞
• Unit-elastic supply curve, ES=1
– %∆p causes an identical %∆q
– Straight line from the origin
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Constant Elasticity Supply Curves
• Perfectly inelastic supply curve
– Vertical line
• A price change has no effect on the quantity
supplied
– ES = 0
– Goods in fixed supply
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Exhibit 8
Constant-Elasticity Supply Curves
ES’ = 0
Price per unit
Price per unit
Price per unit
S’
ES = ∞
p
(c) Unit elastic
(b) Perfectly inelastic
(a) Perfectly elastic
S’’
ES’’ = 1
$10
S
5
0
Quantity
per period
0
Q
Quantity
per period
0
10
20
Quantity
per period
In each of the three panels is a constant-elasticity supply curve, so named because the elasticity
value does not change along the curve. Supply curve S in panel (a) is perfectly elastic, or
horizontal. Along S, firms supply any amount of output demanded at price p, but supply none at
prices below p. Supply curve S’ is perfectly inelastic, or vertical. S’ shows that the quantity supplied
is independent of the price. In panel (c), S”, a straight line from the origin, is a unit-elastic supply
curve. Any percentage change in price results in the same percentage change in quantity supplied.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Determinants of Supply Elasticity
• ES is greater:
– If the marginal cost rises slowly as output
expands
– The longer the period of adjustment
(time)
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Exhibit 9
Supply Becomes More Elastic Over Time
Sw
Sm
Sy
Price per unit
$1.25
1.00
Quantity per day
0
100 110 140
200
The supply curve one week after a price increase, Sw, is less elastic, at a given price,
than the supply curve one month later, Sm, which is less elastic than the supply curve
one year later, Sy. Given a price increase from $1.00 to $1.25, quantity supplied per
day increases to 110 units after one week, to 140 units after one month, and to 200
units after one year.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Income Elasticity of Demand
• Income elasticity of demand
– Demand responsiveness to a change in
consumer income
– Percentage change in demand divided
by the percentage change in income that
caused it
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Income Elasticity of Demand
• Inferior goods
– Negative income elasticity
• Normal goods
– Positive income elasticity
– Income inelastic, necessities
• Elasticity between 0 and 1
– Income elastic, luxuries
• Elasticity > 1
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Exhibit 10
Selected Income Elasticities of Demand
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Cross-Price Elasticity of Demand
• Cross-price elasticity of demand
– The percentage change in the demand of
one good, divided by the percentage
change in the price of another good
– Positive for substitutes
– Negative for complements
– Zero for unrelated goods
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Appendix Price Elasticity and Tax Incidence
• Tax
– Decrease in supply by the amount of tax
• Tax incidence
– Consumers : high price
– Producers: lower net-of-tax receipt
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Appendix Price Elasticity and Tax Incidence
• The more price elastic the demand:
– The more tax producers pay
– The less tax consumers pay
• The more elastic the supply:
– The less tax producers pay
– The more tax consumers pay
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Exhibit 13
Effects of Price Elasticity of Demand on Tax Incidence
(a) Less elastic demand
(b) More elastic demand
St
$0.20 Tax
St
S
1.00
0.95
$0.20 Tax
D
0
9 10
Price per ounce
Price per ounce
$1.15
Millions of
ounces per day
$1.05
1.00
S
0.85
D’
7
10
Millions of
ounces per day
The imposition of a $0.20-per-ounce tax on tea shifts the supply curve leftward from S to St. In
panel (a), which has a less elastic demand curve, the market price rises from $1.00 to $1.15 per
ounce and the market quantity falls from 10 million to 9 million ounces. In panel (b), which has a
more elastic demand curve, the same tax leads to an increase in price from $1.00 to $1.05; market
quantity falls from 10 million to 7 million ounces. The more elastic the demand curve, the more the
tax is paid by producers in the form of a lower net-of-tax receipt.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Exhibit 14
Effects of Price Elasticity of Supply on Tax Incidence
(b) Less elastic supply
(a) More elastic supply
$0.20 Tax St’
S’
1.00
0.95
D’’
0
8
10
$1.05
1.00
Price per ounce
Price per ounce
$1.15
St”
S”
$0.20 Tax
0.85
Millions of ounces per day
D’’
9 10
The imposition of a $0.20-per-ounce tax on tea shifts the supply curve leftward from S to St. In
panel (a), which has a less elastic demand curve, the market price rises from $1.00 to $1.15 per
ounce and the market quantity falls from 10 million to 9 million ounces. In panel (b), which has a
more elastic demand curve, the same tax leads to an increase in price from $1.00 to $1.05;
market quantity falls from 10 million to 7 million ounces. The more elastic the demand curve, the
more the tax is paid by producers in the form of a lower net-of-tax receipt.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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