1. Elasticity

2. Price Elasticity of Demand
We know from the law of demand the when the price of a product falls, the QD of the product increases
But the law of demand only tells firms that the demand curves for their products slope downward
A more useful measure of responsiveness of the QD to a change in price is the price elasticity of demand

3. Measuring the Price Elasticity of Demand
We might measure the price elasticity of demand using the slope of the demand curve because it tells us how much quantity changes as price changes
Drawback: the measurement of slope is sensitive to the units chosen for quantity and price

4. Measuring the Price Elasticity of Demand
To avoid confusion over units, economists use percentage changes when measuring the price elasticity of demand
Percentage changes are not dependent on units
No matter what units we use to measure the quantity of wheat, 10 % more wheat is 10% more wheat

5. Measuring the Price Elasticity of Demand
Price Elasticity of Demand is measured by dividing the percentage change in the quantity demanded by the percentage change in the price
It is important to note that the price elasticity of demand is not the same as the slope of the demand curve

6. Measuring the Price Elasticity of Demand
If we calculate the price elasticity of demand for a price cut, the percentage change in price will be negative and the percentage change in quantity demanded will be positive
If we calculate the price elasticity of demand for a price increase, the percentage change in price will be positive and the percentage change in quantity demanded will be negative

7. Measuring the Price Elasticity of Demand
In comparing elasticities we are usually interested in their relative size
Drop the minus sign and compare their absolute values

8. Elastic and Inelastic Demand
If the QD is responsive to changes in price, the % change in QD with be greater than the % change in price
The price elasticity of demand will be greater than 1 in absolute value
Demand is elastic

9. Elastic and Inelastic Demand
When the QD is not very responsive to price, however, the % change in QD will be less than the % change in price
The price elasticity of demand will be less than 1 in absolute value
Demand is inelastic

10. Elastic and Inelastic Demand
In the special case in which the % change in QD is equal to the % change in price, the price elasticity of demand equals 1
Demand is unit-elastic

11. The Arc Midpoint Formula
Used to ensure that we have only one value of the price elasticity of demand between the same two points on the same demand curve
It uses the average of the initial and final quantity and the initial and final price

15. Demand Curves Remember elasticity is not the same thing as slope!
Slope is calculated using changes in quantity and price, whereas elasticity is calculated using percentage changes

16. Demand Curves
But it is true that when two demand curves intersect, the one with the smaller slope (in absolute value) – the flatter demand curve – is more elastic
The one with the larger slope (in absolute value) – the steeper demand curve – is less elastic

17. Polar Cases of Price Elasticity
Polar Cases of price elasticity do not occur often
If a demand curve is a vertical line it is perfectly inelastic
The QD is completely unresponsive to price and the price elasticity of demand = 0

18. Polar Cases of Price Elasticity
If the demand curve is a horizontal line, it is perfectly elastic
The QD is infinitely responsive to price, and the price elasticity of demand = infinity
If a demand curve is perfectly elastic, an increase in price causes the QD to fall to zero

19. Straight Line Demand Curve

20. Determinants of Price Elasticity of Demand
Time Horizon
Availability of Substitutes (Market Definition)
Necessities vs. Luxuries
Importance of the good in relation to one’s budget

21. Determinants of the Price Elasticity of Supply
Time horizon
The short-run supply curve is inelastic
In the long run, significant substitution is possible; the supply curve becomes very elastic
Price elasticity of S depends on flexibility producers have to change the amount of good they produce
In SR, hard for firms to open/close plants, hire/fire workers, etc. to make more/less good in response to price changes
In the long run there are more options for changing production, so it is easier (less costly) for suppliers to subs into the production of another good: can open/close factories, new firms enter a market
 The longer the run (time horizon), the greater the elasticity of S.
The question: very elastic.
Caveat: Suppliers produce goods, so we must take into account how easy (costly) it is to substitute for existing goods in production process and make more of them. We’ll be discussing this throughout the course.

22. Cross Price Elasticity
When two goods are substitutes, cross elasticity of demand will be Positive
When two goods are complements, cross elasticity of demand will be Negative
E > 0
E < 0

23. Income Elasticity
Income elasticity of demand will be Positive for normal goods
Income elasticity of demand will be Negative for inferior goods

26. Elasticity and Total Revenue
** Inelastic – Price and TR move in the same direction**
** Elastic – Price and TR move in opposite directions**
**Unit – TR does not change when price changes**