In the Name of God
Sharif University of Technology
Graduate School of Management and Economics
Microeconomics (for MBA students)
44111 (1393-94 1st term) - Group 2
Dr. S. Farshad Fatemi
Elasticities of Demand and Supply
 Price Elasticity of Demand
measures the sensitivity of the quantity demanded of a good to a change
in its price. It is defined as:
% change in quantity demanded
% change in price
Δ𝑞
𝑞
𝜀=
Δ𝑝
𝑝
Or
𝜀=
𝑝 𝜕𝑞
.
𝑞 𝜕𝑝
Negative or positive?
Microeconomics (for MBA students)
Dr. F. Fatemi
Graduate School of Management and Economics – Sharif University of Technology
Page 34
 Elastic Demand
When the price elasticity (ignoring the negative sign) is greater than 1; i.e.
when the % change in quantity demanded exceeds the change in price
- e.g. if quantity demanded falls by 7% in response to a 5% increase in
price elasticity is -7  5 = -1.4
 Inelastic Demand
When the price elasticity lies between 0 and 1; i.e. when the % change in
quantity demanded is smaller than the change in price
- e.g. if quantity demanded falls by 3.5% in response to a 5% increase in
price elasticity is -3.5  5 = - 0.7
Microeconomics (for MBA students)
Dr. F. Fatemi
Graduate School of Management and Economics – Sharif University of Technology
Page 35
The price elasticity varies along the length of a straight-line demand curve.
Microeconomics (for MBA students)
Dr. F. Fatemi
Graduate School of Management and Economics – Sharif University of Technology
Page 36
What determines the price elasticity?
The ease with which consumers can substitute another good.
- consumers can readily substitute one brand of detergent for another if
the price rises so we expect demand to be elastic
- but if all detergent prices rise, the consumer cannot switch so we
expect demand to be inelastic
Demand tends to be more elastic in the long run but relatively inelastic in
the short run.
Microeconomics (for MBA students)
Dr. F. Fatemi
Graduate School of Management and Economics – Sharif University of Technology
Page 37
 Return to the Example of Metro Fare
How should metro fares be changed to increase revenues?
If passengers can use buses, taxis, and cars, then demand may be elastic
and an increase in fares will reduce the number of journeys demanded and
total spending.
If passengers do not have travel options, then demand may be inelastic; so
raising fares will have less effect on journeys demanded and revenue will
improve.
Microeconomics (for MBA students)
Dr. F. Fatemi
Graduate School of Management and Economics – Sharif University of Technology
Page 38
 The Cross Price Elasticity of Demand
The cross price elasticity of demand for good i with respect to the price of
good j is:
% change in quantity demanded of good i
% change in the price of good j
Δ𝑞𝑖
𝑞
𝜀𝑖𝑗 = 𝑖
Δ𝑝𝑗
𝑝𝑗
Or
𝑝𝑗 𝜕𝑞𝑖
𝜀𝑖𝑗 = .
𝑞𝑖 𝜕𝑝𝑗
Negative or positive?
Microeconomics (for MBA students)
Dr. F. Fatemi
Graduate School of Management and Economics – Sharif University of Technology
Page 39
 The Income Elasticity of Demand
The income elasticity of demand measures the sensitivity of quantity
demanded to a change in income:
% change in quantity demanded of a good
% change in consumer income
Δ𝑞
𝑞
𝜎=
Δ𝐼
𝐼
Or
𝜎=
𝐼 𝜕𝑞
.
𝑞 𝜕𝐼
Negative or positive?
Microeconomics (for MBA students)
Dr. F. Fatemi
Graduate School of Management and Economics – Sharif University of Technology
Page 40
A NORMAL GOOD has a positive income elasticity of demand (an increase
in income leads to an increase in the quantity demanded) e.g. dairy
products; rice; phone calls
An INFERIOR GOOD has a negative income elasticity of demand (an
increase in income leads to a fall in quantity demanded) e.g. coal; potatoes
- the reason we used term usually when discussed about the effect of an
increase in income on demand curve
A normal good might be
A LUXURY GOOD which has an income elasticity of demand greater
than 1; e.g. eating out, possibly furniture
A NECESSITY GOOD which has a positive income elasticity of demand
less than 1.
Microeconomics (for MBA students)
Dr. F. Fatemi
Graduate School of Management and Economics – Sharif University of Technology
Page 41
 Elasticity of Supply
The elasticity of supply measures the responsiveness of the quantities
supplied to the change in price of that good:
% change in quantity supplied
% change in the price
Positive or negative?
Horizontal (flat) supply has an infinite supply elasticity.
Vertical supply has a zero supply elasticity.
Microeconomics (for MBA students)
Dr. F. Fatemi
Graduate School of Management and Economics – Sharif University of Technology
Page 42
 Who really pays the tax?
Depends on the demand and supply elasticities.
Microeconomics (for MBA students)
Dr. F. Fatemi
Graduate School of Management and Economics – Sharif University of Technology
Page 43