1. Economics Today Chapter 20 Demand and Supply Elasticity
Roger LeRoy Miller
Economics Today
Chapter 20
Demand and Supply Elasticity

2. Introduction
Starting in the 1980s cities began to experience an over abundance of trash. In the future local landfills will be full, requiring cities to transport trash to remote areas.
How could charging people an explicit price to haul trash away stem this flow of trash?

3. Learning Objectives Express and calculate price elasticity of demand
Understand the relationship between the price elasticity of demand and total revenues
Discuss the factors that determine the price elasticity of demand

4. Learning Objectives
Describe the cross price elasticity of demand and how it may be used to indicate whether two goods are substitutes or complements
Explain the income elasticity of demand

5. Learning Objectives
Classify supply elasticities and explain how the length of time for adjustment affects the price elasticity of supply

6. Chapter Outline Price Elasticity Price Elasticity Ranges
Elasticity and Total Revenues
Determinants of the Price Elasticity of Demand

7. Chapter Outline Cross Price Elasticity of Demand
Income Elasticity of Demand
Elasticity of Supply

8. Did You Know That...
The government predicted it would raise $6 million per year in new revenues from a new 10 percent luxury tax on private airplane and yacht sales a few years ago?
It actually collected only $53,000?
How can that be?

9. Price Elasticity Price Elasticity of Demand (Ep)
The responsiveness of quantity demanded of a commodity to changes in its price

10. Price Elasticity Price Elasticity of Demand (Ep)
percentage change in quantity demanded
percentage change in price
Ep =
%DQd
%DP

11. Price Elasticity Example Price of oil increases 10%
Quantity demanded decreases 1%
Ep =
-1%
+10%
= -.1

12. Price Elasticity Question Answer
How would you interpret an elasticity of -0.1?
Answer
A one percent increase in the price of oil will lead to a one percent decrease in quantity demanded

13. Price Elasticity Relative quantities only Always negative
Elasticity is measuring the change in quantity relative to the change in price
Always negative
An increase in price decreases the quantity demanded, ceteris paribus

14. Policy Example: To Cut Teen Drug Use, Make the Price of a “High” Higher
Youthful cocaine abusers are three times as sensitive to price changes compared to adults.
Legal crackdowns on cocaine dealers to decrease supply and raise prices may be an appropriate strategy in the war on drugs.

15. Calculating Elasticity
% change in Qd =
change in Qd
original Qd
% change in price =
change in price
original price

16. Price Elasticity The basics of measuring percentage changes
If price increases from $1 to $2 the percent change in price is:
%DP = 1
= 100%

17. Price Elasticity The basics of measuring percentage changes
If price falls from $2 to $1 the percent change in price is:
%DP = 1 2
= 50%

18. Price Elasticity The basics of measuring percentage changes
The percentage is influenced by the base of the original value.

19. Calculating Elasticity
Adjusting for the percent change bias
change in Q
sum of quantities/2
Ep =
change in P or
change in Q
(Q1 + Q2)/2
Ep =
change in P
(P1 + P2)/2
D Q
Avg. Q
Ep =
D P
Avg. P or

20. Calculating Elasticity
Example
If the price increases from 1 to 2: 1
3/2
%DP =
= .67

21. Calculating Elasticity
Example
If the price decreases from 2 to 1: 1
3/2
%DP =
= .67

22. International Example: The Price Elasticity of Demand for Newspapers
Price of Today was lowered 25 pence to 10 pence
Circulation increased from 590,000 to 1.05 million copies

23. International Example: The Price Elasticity of Demand for Newspapers
D Q
(Q1 + Q2)/2
Ep =
D P
(P1 + P2)/2
Ep =
1,050, ,000
(590, ,050,000)/2
( )/2

24. International Example: The Price Elasticity of Demand for Newspapers
460,000
820,000
Ep = 15
17.5
= .66
Interpretation
A 1% decrease in price will increase quantity demanded by .66 percent.

25. Price Elasticity Ranges
Elastic Demand
Percentage change in quantity demanded is larger than the percentage change in price
Ep > 1

26. Price Elasticity Ranges
Unit Elasticity of Demand
Percentage change in quantity demanded is equal to the percentage change in price
Ep = 1

27. Price Elasticity Ranges
Inelastic Demand
Percentage change in quantity demanded is smaller than the percentage change in price
Ep < 1

28. Price Elasticity Ranges
Elastic demand
%DQ > %DP; Ep > 1
Unit elastic
%DQ = %DP; Ep = 1
Inelastic demand
%DQ < %DP; Ep < 1

29. Price Elasticity Ranges
Extreme elasticities
Perfectly Inelastic Demand
A demand curve that is a vertical line
It has only one quantity demanded for each price
No matter what the price, quantity demanded does not change

30. Extreme Price Elasticities
Quantity Demanded per Year (millions of units)

31. Extreme Price ElasticitiesD
Perfect inelasticity, or zero elasticity
Price 8
Quantity Demanded per Year (millions of units)
Figure 20-1, Panel (a)

32. Extreme Price ElasticitiesD P1
Price
Perfect inelasticity, or zero elasticity P0 8
Quantity Demanded per Year (millions of units)

33. Price Elasticity Ranges
Extreme elasticities
Perfectly Elastic Demand
A demand curve that is a horizontal line
It has only one price for every quantity
The slightest increase in price leads to zero quantity demanded

34. Extreme Price Elasticities
Price (cents)
Quantity Demanded per Year (millions of units)

35. Extreme Price Elasticities30 D
Price (cents)
Perfect elasticity, or infinite elasticity
Quantity Demanded per Year (millions of units)
Figure 20-1, Panel (b)

36. Extreme Price Elasticities
P1 never touches the demand curve P1 30 D
Price (cents)
Perfect elasticity, or infinite elasticity
Quantity Demanded per Year (millions of units)

37. Policy Example: Who Pays Higher Cigarette Taxes?
In recent years Congress and state legislatures have increased cigarette taxes.
These taxes are a flat amount per pack
Sellers pay the tax but supply the same quantity only at the old price plus the tax
Supply decreases
Who pays the tax depends on price elasticity of demand

38. Price Elasticity: A Cigarette Tax
Figure 20.2, Panels (a) and (b)

39. Policy Example: Who Pays Higher Cigarette Taxes?
Figure 20.2, Panel (c)

40. The Relationship Between Price Elasticity of Demand and Total Revenues for Cellular Phone Service
Figure 20.3, Panel (a)

41. Quantity per period (billions of minutes)
The Relationship Between Price Elasticity of Demand and Total Revenues for Cellular Phone Service
1.10
1.00
.90
.80
.70
Price per Minute ($)
.60
.50
.40
.30
.20
.10 1 2 3 4 5 6 7 8 9 10 11
Quantity per period (billions of minutes)

42. Quantity per period (billions of minutes)
The Relationship Between Price Elasticity of Demand and Total Revenues for Cellular Phone Service
1.10
Elastic (Ep > 1)
Unit-Elastic (Ep = 1)
Inelastic (Ep < 1)
1.00
.90
.80
.70
Demand, or average revenue curve
Price per Minute ($)
.60
.50
.40
.30
.20
.10 D 1 2 3 4 5 6 7 8 9 10 11
Figure 20-3, Panel (b)
Quantity per period (billions of minutes)

43. The Relationship Between Price Elasticity of Demand and Total Revenues for Cellular Phone Service
3.0
2.5
2.0
Total Revenue ($ billions)
1.5
1.0
0.5 1 2 3 4 5 6 7 8 9 10 11
Quantity per period (billions of minutes)

44. The Relationship Between Price Elasticity of Demand and Total Revenues for Cellular Phone Service
3.0
Elastic
Unit-Elastic
Inelastic
2.5
2.0
Total Revenue ($ billions)
1.5
Total revenue curve
1.0 D
0.5 1 2 3 4 5 6 7 8 9 10 11
Figure 20-3, Panel (c)
Quantity per period (billions of minutes)

45. Elasticity and Total Revenues
Elastic Demand
A negative relationship exists between small changes in price and changes in total revenue

46. Elasticity and Total Revenues
Unit-Elastic Demand
Changes in price do not change total revenue

47. Elasticity and Total Revenues
Inelastic Demand
A positive relationship exists between changes in price and total revenues

48. Relationship Between Price Elasticity of Demand and Total Revenues
Price Elasticity Effect of Price Change
of Demand on Total revenues (TR)
Price Price
Decrease Increase
Inelastic (Ep < 1) TR TR
Unit-elastic (Ep = 1) No change in TR No change in TR
Elastic (Ep > 1) TR TR

49. International Example: A Pricing Decision at Disneyland Paris
1995
Prices were lowered from 250 francs to 195 francs
Quantity demanded increased by 700,000
Total revenue increase by 22%
Was the demand elastic or inelastic?

50. Determinants of Price Elasticity of Demand
Existence of substitutes
The closer the substitutes and the more substitutes there are, the more elastic is demand.
Share of the budget
The greater the share of the consumer’s total budget spent on a good, the greater is the price elasticity.

51. Determinants of Price Elasticity of Demand
The length of time allowed for adjustment
The longer any price change persists, the greater is the price elasticity of demand.
Price elasticity is greater in the long-run than in the short-run.

52. Determinants of Price Elasticity of Demand
How to define the short run and the long run
The short run is a time period too short for consumers to fully adjust to a price change.
The long run is a time period long enough for consumers to fully adjust to a change in price other things constant.

53. Short-Run and Long-Run Price Elasticity of Demand
In the short run, quantity
demanded falls slightly.
However, with more time
for adjustment the
demand curve becomes
more elastic and quantity
demanded falls by a
greater amount. P1 E
Price per Unit Pe D2 D1 Q2 Q1 Qe
Quantity Demanded per Period

54. Short-Run and Long-Run Price Elasticity of Demand
In the short run, quantity
demanded falls slightly.
However, with more time
for adjustment the
demand curve becomes
more elastic and quantity
demanded falls by a
greater amount. P1 E
Price per Unit Pe D3 D2 D1 Q2 Q2 Q1 Qe
Quantity Demanded per Period
Figure 20-4

55. Demand Elasticity for Selected Goods
Estimated Elasticity
Category Short Run Long Run
Lamb 2.75 —— Bread .2 ——
Tires and related items
Auto repair and related services
Radio and television repair
Legitimate theater and opera .2 .3
Motion pictures
Foreign travel by U.S. residents
Taxicabs .6 ——
Local public transportation
Intercity bus
Electricity
Jewelry and watches .4 .6

56. Cross Price Elasticity of Demand
Cross Price Elasticity of Demand (Exy)
The percentage change in the demand for one good (holding its price constant) divided by the percentage change in the price of a related good
The responsiveness of change in demand of one good to the change in prices of related goods

57. Cross Price Elasticity of Demand
Formula for computing cross elasticity of demand
%D in demand for good X
%D in price of good Y
Exy =

58. Cross Price Elasticity of Demand
Substitutes
Exy would be positive
An increase in the price of X would increase the quantity of Y demanded at each price.
Complements
Exy would be negative
An increase in the price of X would decrease the quantity of Y demanded at each price.

59. Income Elasticity of Demand
Income Elasticity of Demand (Ei)
The percentage change in demand for any good, holding its price constant, divided by the percentage change in income
The responsiveness of demand to changes in income, holding the good’s relative price constant

60. Income Elasticity of Demand
percentage change in demand
percentage change in income
Ei =

61. Income Elasticity of Demand
refers to a horizontal shift in the demand curve in response to changes in income
Price elasticity of demand
refers to a movement along the curve in response to price changes

62. How Income Affects Quantity of CDs Demanded
Number of CDs
Period Demanded per Month Income per Month
1 6 $400

63. How Income Affects Quantity of CDs Demanded
Income increases from $400 to $600/month
(8 - 6)/6
( )/400
Ei = =
1/3
1/2 2 3
= .667

64. How Income Affects Quantity of CDs Demanded
Income decreases from $600 to $400/month
(6 - 8)/8
( )/600
Ei = =
-1/4
-1/3 3 4
= .75

65. Income Elasticity of Demand
Eliminating the bias of the base
DQuantity
sum of quantities/2
Ei =
DIncome
sum of income/2

66. Income Elasticity of Demand
Demand and elasticities
Accurate estimates of Ep and Ei can yield accurate forecasts of the demand for goods and services.

67. Elasticity of Supply Price Elasticity of Supply (Ei)
The responsiveness of the quantity supplied of a commodity to a change in its price
The percentage change in quantity supplied divided by the percentage change in price

68. Elasticity of Supply Formula for computing price elasticity of supply
percentage change in quantity supplied
percentage change in price
ES =

69. Elasticity of Supply Classifying supply elasticities
Perfectly Elastic Supply
Quantity supplied falls to 0 when there as any decrease in price.
The supply curve is horizontal at a given price.

70. Elasticity of Supply Classifying supply elasticities
Perfectly Inelastic Supply
Quantity supplied is constant no matter what happens to price.
The supply curve is vertical at a given price.

71. The Extremes in Supply CurvesQ1 S’
Perfect inelasticity
Price per Unit
Quantity Supplied per Period

72. The Extremes in Supply Curves
Perfect inelasticity P1 S
Price per Unit
Perfect elasticity Q1
Quantity Supplied per Period
Figure 20-5

73. Elasticity of Supply
Price elasticity of supply and length of time for adjustment
The longer the time allowed for adjustment, the more elastic is supply.
Firms can find ways to increase (or decrease) output.
Resources can flow into (or out of) an industry through expansion (or contraction) of existing firms.

74. The Extremes in Supply Curves
Price per Unit
Quantity Supplied per Period

75. The Extremes in Supply Curves
In the short run the supply curve, S1, is vertical with price Pe and quantity supplied of Qe. Pe E
Price per Unit Qe
Quantity Supplied per Period

76. Short-Run and Long-Run Price Elasticity of Supply
If price increases to S3 quantity stays unchanged P1 Pe
Price per Unit E Qe
Quantity Supplied per Period

77. Short-Run and Long-Run Price Elasticity of SupplyQ1
As time passes the supply curve rotates to S1 then to S2 and quantity supplied rises first to Q1. Pe
Price per Unit E Qe
Quantity Supplied per Period

78. Short-Run and Long-Run Price Elasticity of SupplyQ2 S3 P1 Pe
Price per Unit E
As time passes the supply curve rotates to S2 then to S3 and quantity supplied rises first to Q1 and then to Q2. Qe Q1
Quantity Supplied per Period
Figure 20-6

79. International Example: French Truffle Production Takes a Nosedive
Chinese competition caused the price of French truffles to fall 30 percent in 1996.
Accordingly French production decreased by 25%.
Short-run ES = .83

80. Issues and Applications: Discovering the Value of Garbage
Charlottesville, Virginia recently experimented with a per-unit price for trash collection
Previously trash collection was financed from property taxes
Per unit cost was zero
The cost of trash disposal became high for the city

81. Issues and Applications: Discovering the Value of Garbage
Consequences of the $0.80 charge per 32 gallon bag of garbage
The quantity of trash-collection services declined by 37 percent
The town’s revenues increased
Some illegal dumping occurred
Revenues from the program did not cover costs

82. Web Links
The following Web links appear in the margin of this chapter in the textbook:
TheFirm/ProductionFunct.html
elasticity/Elastic1.html
Elast/Elast.html

83. Summary Discussion of Learning Objectives
Expressing and calculating the price elasticity of demand
Percentage change in quantity demanded divided by the percentage change in price

84. Summary Discussion of Learning Objectives
The relationship between the price elasticity of demand and total revenues
When demand is elastic, price and total revenue are inversely related
When demand is inelastic, price and total revenue are positively related
When demand is elastic total revenue does not change when price changes

85. Summary Discussion of Learning Objectives
Factors that determine price elasticity of demand
Availability of substitutes
Percentage of a person’s budget spent on the good
The length of time allowed for adjustment to a price change

86. Summary Discussion of Learning Objectives
The cross price elasticity of demand and using it to determine whether two goods are substitutes or complements
Percentage change in the demand for one good divided by the percentage change in the price of another
If cross elasticity is positive, the goods are substitutes
If cross elasticity is negative, the goods are complements

87. Summary Discussion of Learning Objectives
Income elasticity of demand
Percentage change in the demand for a good divided by the percentage in income

88. Summary Discussion of Learning Objectives
Classifying supply elasticities and how the length of time for adjustment affects price elasticity of supply
Elastic supply: price elasticity of supply is greater than 1
Inelastic supply: price elasticity of supply is less than 1
Unit-elastic supply: price elasticity of supply is equal to 1
The longer the time period for adjustment, the more elastic is supply

89. End of Chapter
Chapter 20
Demand and Supply Elasticity