1. Chapter 4: Elasticity Price elasticity of demand – An Example:
The percentage change in quantity demanded in response to one percent change in price;
Measure of sensitivity of quantity demanded to changes in price.
An Example:
When the price of gasoline increases by 1%, the quantity demanded of gasoline decreases by 0.5%. Therefore, the price elasticity of demand of gasoline is –0.5.
To what extent would a tax on gasoline help reduce environmental pollution?

2. Price Elasticity of Demand
Calculate price elasticity of demand –
ε =
Percentage change in quantity demanded
Percentage change in price
Price elasticity of demand is always negative;
In practice, we take the absolute value of .

3. Price Elasticity of Demand
 > 1
=1
 < 1
Demand
Elastic
Unit elastic
Inelastic
An example: Demand for season ski passes
Old
New
% Change
Price
$400
$380 5%
Quantity
10,000
12,000
20%
ε =
20% 5%
= 4
Demand is elastic

4. Determinants of Price Elasticity of Demand
Substitution options: more options, more elastic;
Budget share: higher the share, more elastic;
Time horizon: longer the time, more elastic;
Necessity: more necessary, more elastic;
Breadth of definition: broader, less elastic.

5. Price Elasticity of Demand
Green peas
2.80
Restaurant meals
1.63
Beer
1.19
Coffee
0.25
Automobiles
1.35
Foreign air travel
0.77
Movies
0.87
Theater, opera
0.18

6. Price Elasticity: A Graphical View
ε =
ΔQ / Q
ΔP / P
P – Δ P
Price P D A Q
Q + Δ Q
Δ Q
Δ P
Quantity
ε = P Q ΔQ ΔP x
ε = P Q 1
slope x

7. Price Elasticity on A Straight-Line Demand Curve
ε = P Q 1
slope x
The slope is the same at each point;
P/Q increases along the demand curve since when price increases, quantity demanded decreases;
As a result,  is different at each point.

8. Price Elasticity on A Straight-Line Demand Curve
b/2
a/2 a b
Quantity
At high price, quantity demanded is elastic;
At low price, quantity demanded is inelastic.

9. Two Special Cases of Price Elasticity
Perfectly Elastic Demand
Infinite price elasticity of demand
Perfectly Inelastic Demand
Zero price elasticity of demand
Price
Price
Price D D D
Quantity
Quantity
Quantity

10. Elasticity and Total Revenue
R = P x Q
Since price and quantity demanded change in opposite directions, whether revenue increases/decreases when price increases/decreases depends on price elasticity.
Intuitively speaking,
If price elasticity is low, meaning quantity demanded is not sensitive to a price change, revenue increases when price increases;
In contrast, if price elasticity is high, revenue increases when price decreases.

11. Elasticity and Total Revenue
Price
$12
$10 $8 $6 $4 $2 $0
Quantity
1,000
2,000
3,000
4,000
5,000
6,000
Expenditure
$1,000
$1,600
$1,800
1,800
Price ($/ticket)
Total expenditure ($/day) 2 6 10
1,600
1,000 12
Quantity (00s of tickets/day) 1 3 4 5 8

12. Elasticity and Total Revenue

13. Cross-Price Elasticity of Demand
Definition
Percentage change in quantity demanded of A from a 1 percent change in the price of B
Sign of cross-price elasticity shows relationship between the goods
Complements have negative cross-price elasticity
Substitutes have positive cross-price elasticity

14. Income Elasticity of Demand
Definition
Percentage change in quantity demanded from a 1 percent change in income
Income elasticity of demand can be positive or negative
Positive income elasticity is a normal good
Negative income elasticity is an inferior good

15. Price Elasticity of Supply
Definition
Percentage change in quantity supplied in response to a 1 percent change in price 2 8 A 3 10 B
Quantity
Price 4 S
ε =
ΔQ / Q
ΔP / P
ε = P Q 1
slope x

16. Determinants of Price Elasticity of Supply
Input Flexibility
Uses adaptable inputs, more elastic
Mobility of Inputs
Resources move where needed, more elastic
Produce Substitute Inputs
Alternative inputs easy to find, more elastic
Time
Long run, more elastic