Unit 2: Consumer
Choice, Demand,
and Supply
Lecture #4:
Elasticity of Demand and Supply
ELASTICITY OF DEMAND
(Price Elasticity of Demand)
• The degree to which a change in price affects the
quantity demanded
• ED =
% change in quantity demanded
% change in price
MIDPOINT FORMULA FOR
ELASTICITY OF DEMAND
ED=
(Q2 – Q1)
(Q2 + Q1)/2
____________________________
(P2 – P1)
(P2 + P1)/2
The Midpoint Method: A Better Way to
Calculate Percentage Changes and
Elasticities
• Example: If the price of an ice cream cone increases
from $2.00 to $2.20 and the amount you buy falls
from 10 to 8 cones, then your elasticity of demand,
using the midpoint formula, would be calculated as:
(10  8)
22%
(10  8) / 2

 2.32
(2.20  2.00)
9.5%
(2.00  2.20) / 2
ELASTIC DEMAND
• When a small change in price leads to a relatively large
change in the quantity demanded
• Ex. A 10 % increase in price leads to a 20% reduction in
the quantity demanded
ED > 1
Elastic Demand
• Reasons why demand for a good is elastic:
• The product is not necessary
• There are substitutes available
• The product takes a large portion of the consumer’s income
• The market is narrowly defined (like a particular brand name)
• The longer the time period to purchase the good
• Examples of goods with elastic demand
• Fresh peas 2.83
• Lamb and mutton 2.65
• Restaurant meals 2.27
• Residential land 1.60
• Beef 1.27
Figure 1 The Price Elasticity of Demand
(e) Perfectly Elastic Demand: Elasticity Equals Infinity
Price
1. At any price
above $4, quantity
demanded is zero.
$4
Demand
2. At exactly $4,
consumers will
buy any quantity.
0
3. At a price below $4,
quantity demanded is infinite.
Quantity
INELASTIC DEMAND
• When a change in price leads to little or no change in the
quantity demanded
• Ex. A 20% decrease in price leads to a 10% increase in the
quantity demanded
ED < 1
INELASTIC DEMAND
• Reasons why demand for a good is inelastic:
• The product is necessary with few/no substitutes
• Product takes a small portion of the consumer’s income
• The market is widely defined (in general, not a brand name, etc.)
• There is a short time period to buy the good
• Examples of goods with inelastic demand
• Electricity .13
• Bread .15
• Telephone service .26
• Gasoline .6
• Milk .63
Figure 1 The Price Elasticity of Demand
(a) Perfectly Inelastic Demand: Elasticity Equals 0
Price
Demand
$5
4
1. An
increase
in price . . .
0
100
Quantity
2. . . . leaves the quantity demanded unchanged.
Copyright©2003 Southwestern/Thomson Learning
UNIT ELASTIC DEMAND
• When the change quantity demanded is proportional
to the change in price
• Ex. 20% change in price leads to 20% change in
quantity demanded
ED = 1
Figure 1 The Price Elasticity of Demand
(c) Unit Elastic Demand: Elasticity Equals 1
Price
$5
4
Demand
1. A 22%
increase
in price . . .
0
80
100
Quantity
2. . . . leads to a 22% decrease in quantity demanded.
Copyright©2003 Southwestern/Thomson Learning
The Variety of Demand Curves
• Perfectly Inelastic
• Quantity demanded does not respond to price changes.
• Perfectly Elastic
• Quantity demanded changes infinitely with any change in
price.
• Unit Elastic
• Quantity demanded changes by the same percentage as the
price.
TOTAL REVENUE TEST FOR
ELASTICITY OF DEMAND
• Total Revenue (TR) = P x Q
• Elastic Demand
• Price goes up, total revenue goes down
• Price goes down, total revenue goes up
• Inelastic Demand
• Price goes up, total revenue goes up
• Price goes down, total revenue goes down
• Unit Elastic Demand
• Price goes up, total revenue remains unchanged
• Price goes down, total revenue remains unchanged
Figure 2 Total Revenue
Price
$4
P × Q = $400
(revenue)
P
0
Demand
100
Quantity
Q
Copyright©2003 Southwestern/Thomson Learning
Figure 3 How Total Revenue Changes When Price Changes:
Inelastic Demand
Price
Price
… leads to an Increase in
total revenue from $100 to
$240
An Increase in price from $1
to $3 …
$3
Revenue = $240
$1
Demand
Revenue = $100
0
100
Quantity
Demand
0
80
Quantity
Copyright©2003 Southwestern/Thomson Learning
Figure 4 How Total Revenue Changes When Price Changes:
Elastic Demand
Price
Price
… leads to an decrease in
total revenue from $200 to
$100
An Increase in price from $4
to $5 …
$5
$4
Demand
Demand
Revenue = $200
0
50
Revenue = $100
Quantity
0
20
Quantity
Copyright©2003 Southwestern/Thomson Learning
Elasticity of a Linear Demand Curve
Elasticity of a Linear Demand Curve
A downward-sloping demand curve will have elastic, unit elastic,
and inelastic segments. Elasticity does not equal slope.
At the higher prices and lower quantities, the percent change in
quantity will exceed the percent change in price and demand will be
elastic
At the lower prices and higher quantities, the percent change in
price will exceed the percent change in quantity and demand will be
inelastic
ELASTICITY OF SUPPLY
(Price Elasticity of Supply)
• The degree of responsiveness to a change in price by
suppliers
• Is calculated the same way as elasticity of demand
• Time periods are important to elasticity of supply
• In the market period, elasticity of supply is very inelastic
• In the short-run, supply is more elastic than in the market
period and depends on the ability of producers to respond to
changes in price
• In the long-run, supply is the most elastic because adjustments
can be made by producers over time
ELASTICITY OF SUPPLY
MEASURES
ES > 1
 Elastic
ED = 1
 Unit Elastic
ED > 1
 Inelastic
MIDPOINT FORMULA FOR
ELASTICITY OF SUPPLY
ES=
(Q2 – Q1)
(Q2 + Q1)/2
____________________________
(P2 – P1)
(P2 + P1)/2
Figure 6 The Price Elasticity of Supply
(e) Perfectly Elastic Supply: Elasticity Equals Infinity
Price
1. At any price
above $4, quantity
supplied is infinite.
$4
Supply
2. At exactly $4,
producers will
supply any quantity.
0
3. At a price below $4,
quantity supplied is zero.
Quantity
Copyright©2003 Southwestern/Thomson Learning
Figure 6 The Price Elasticity of Supply
(a) Perfectly Inelastic Supply: Elasticity Equals 0
Price
Supply
$5
4
1. An
increase
in price . . .
0
100
Quantity
2. . . . leaves the quantity supplied unchanged.
Copyright©2003 Southwestern/Thomson Learning
CROSS ELASTICITY OF
DEMAND
• Refers to the effect of a change in a
product’s price on the quantity demanded
for another product
• Exy= % change in quantity of X
% change in price of Y
CROSS ELASTICITY OF
DEMAND (continued)
• Cross Elasticity > 0, Good X and Good Y are Substitute
Goods
• Cross Elasticity is < 0, X and Y are Complementary Goods
• If Cross Elasticity is = 0, X and Y are unrelated,
independent products
INCOME ELASTICITY OF
DEMAND
• Refers to the % change in quantity demanded
which results from some % change in
consumer incomes
• Ei = % change in quantity demanded
% change in income
INCOME ELASTICITY OF
DEMAND (continued)
• Income Elasticity > 0 indicates a Normal Good
• Income Elasticity < 0 indicates an Inferior Good
Elasticity Scenarios
1)
Price Coke up 20%
QD Pepsi up 40%
2)
Price hot dogs up 40%
QD relish down 30%
3)
Price econ up 30%
QD fun unchanged
Elasticity Scenarios
4) Income up 20%
QD for New York Mets, Pittsburgh Pirates,
Houston Astros, Los Angeles Dodgers, tickets up
40%
5) Income up 20%
QD for Atlanta Brave, Florida Marlins, Tampa Bay
Rays, Minnesota Twins, Colorado Rockies tickets
down 60%