1. Chapter 10 Price elasticity of Demand and Supply
Economics
Chapter 10
Price elasticity of
Demand and Supply

2. Law of demand ∆P  ∆Qd , ceteris paribus* P  Qd  or P   Qd 

3. Given Qd (unit /day) 1. When price , Qd ? Qd of toy car 
Doll
Qd (unit /day)
$100
100 20
$90
110 40
1. When price , Qd ?
Qd of toy car 
Qd of doll 
2. Which one shows greater effect when P  by 10%?
Qd of toy car: 10 units /  10%
Qd of doll: 20 units /  100%
∴ Doll reflects greater respond to ∆P

4. Price elasticity of demand
Measures the responsiveness of quantity demanded to a change in price
Percentage change in quantity demanded over one percent change in price
% ∆ Qd
Ed =
% ∆ P

5. Price elasticity of demand
Example (p.75)
When P

6. Price elasticity of demand
Example (p.76)
When P

7. Price elasticity of demand
Example (p.76)
Midpoint formula

8. Price elasticity of demand
Toy Car
Doll
Qd (unit /day, P=$100)
100 20
Qd (unit /day, P=$90)
110 40
Calculate Ed of toy car and doll when
Prices drop
Prices rise
By using midpoint formula

9. Price elasticity of demand
Given a straight line demand curve :
Slope of demand curve = 6-0 / 0-6 = -1
Slope = 1, with negative relationship between P and Qd
Price elasticity:
If ∆P = $6$0,
∆ Qd = 0 unit 6 units
Ed = %∆ Qd / %∆P
= (∆ Qd / Average Qd ) / (∆P / Average P)
= [(6-0) / ((6+0)/2)] / [(0-6) / ((6+0)/2))]
= -1
Is Ed = Slope of straight line demand curve?

10. Price elasticity of demand
If ∆P = $5$4, ∆ Qd = 1 unit 2 units
Ed = %∆ Qd / %∆P
= (∆ Qd / Average Qd ) / (∆P / Average P)
= [(2-1) / ((2+1)/2)] / [(5-4) / ((4+5)/2)]
= (1/1.5) / (1/4.5) = 3
Slope of demand curve = 1
Ed ≠Slope of demand curve?

11. Price elasticity of demand
If ∆P = $4$3, ∆ Qd = 2 unit 3 units
Ed = %∆ Qd / %∆P
= (∆ Qd / Average Qd ) / (∆P / Average P)
= [(3-2) / ((3+2)/2)] / [(4-3) / ((4+3)/2)]
= (1/2.5) / (1/3.5) = 1.4
Slope of demand curve = 1
Ed ≠Slope of demand curve?

12. Price elasticity of demand
If ∆P = $3$2, ∆ Qd = 3 unit 4 units
Ed = %∆ Qd / %∆P
= (∆ Qd / Average Qd ) / (∆P / Average P)
= [(4-3) / ((4+3)/2)] / [(3-2) / ((3+2)/2)]
= (1/3.5) / (1/2.5) = 0.714
Slope of demand curve = 1
Ed ≠Slope of demand curve?

13. Price elasticity of demand
If ∆P = $2$1, ∆ Qd = 4 unit 5 units
Ed = %∆ Qd / %∆P
= (∆ Qd / Average Qd ) / (∆P / Average P)
= [(5-4) / ((5+4)/2)] / [(2-1) / ((2+1)/2)]
= (1/4.5) / (1/1.5) = 0.33
Slope of demand curve = 1
Ed ≠Slope of demand curve?

14. Price elasticity of demand
Ed > 1
Ed = 1
Ed < 1 Q

15. 5 Types of elasticity of demand
Elastic demand
Elasticity is greater than 1 (Ed > 1)
Percentage change in quantity demanded is greater than percentage change in price (%∆ Qd > %∆P)
Example
Toys
P ($) D Q

16. 5 Types of elasticity of demand
Inelastic demand
Elasticity is smaller than 1 (Ed < 1)
Percentage change in quantity demanded is smaller than percentage change in price (%∆ Qd < %∆P)
Example
Transportation
P ($) D Q

17. 5 Types of elasticity of demand
Unitary elastic demand
Elasticity equals 1 (Ed = 1)
Percentage change in quantity demanded equals the percentage change in price (%∆ Qd = %∆P)
P ($)
D (regular hyperbola) Q

18. 5 Types of elasticity of demand
Perfectly elastic demand
Elasticity equals infinity (Ed = ∞)
A slightly rise in price will cause quantity demanded fall to 0. i.e. %∆P
Example: Lucky draw ticket
P ($)
D (horizontal) Q

19. 5 Types of elasticity of demand
Perfectly inelastic demand
Elasticity equals 0 (Ed = 0)
Price change has no effect on the quantity demanded. (i.e. %∆Qd = 0)
Example: HKID card
P ($)
D (vertical) Q

20. Factors affecting price elasticity of demand
Substitutes
Quantity
More substitutes  Easier to be replaced  Price elasticity 
E.g.
When MTR started operation  Ed of bus service 
(MTR South Island Line)
When 3DTV launched  Ed of TV sets 
Technology of recycled energy   Ed of traditional energy sources 

21. Factors affecting price elasticity of demand
Substitutes
Substitutability
Similar goods have high substitutability
Higher substitutability  Price elasticity
E.g.
Snacks and soft drinks: Many brands  Ed 
Laptop (similar function): Many brands  Ed 
Bank services: Many banks in the market  Ed 
MTR service: Less choice  Ed
University programmes: A few choice only  Ed

22. Factors affecting price elasticity of demand
What one has higher price elasticity of demand, hamburger or water? Why?
Hamburger is more elastic
as a kind of food more substitutes  Ed 
as a brand  many other brands  Ed 
Water is not elastic
as a kind of element (functional): no close substitutes  Ed
as a brand  comparatively less brands  Ed is not high

23. Factors affecting price elasticity of demand
The way of determining a good
1. Salt
As an element (NaCl) :
No close substitute  Very inelastic
As different brands, e.g. Taikoo Salt, First choice, No frills:
Many brands  Very elastic
2. Water
As an element(H2O) :
As different brands, e.g. Watsons, Bonaqua, Vita
As different packages, e.g. 500mL, 1L, 2L, 5L, 10L, 1Lx6
Many packages  Very elastic

24. Factors affecting price elasticity of demand
Types
Necessities
Lower price elasticity, Price  Less change in Qd
E.g. electricity, tap water, public transports
Luxuries
Higher price elasticity, Price  Greater response in Qd
E.g. visiting Disneyland, travelling overseas
Think about:
Go to school
Dating
Wedding
Wedding banquet
Fish fin

25. Factors affecting price elasticity of demand
Time
Longer time after ∆P
Easier to find substitutes Ed  Less change in Qd
E.g.
1. Price of oil 
 People take time to develop new technology
 More substitutes
 Less relying on oil
 Ed 
2. Price of washing powder 
 Shortly, no close substitutes  Low Ed
 People take time to develop new technology: washing ball
 No need to use washing powder
 Ed of washing powder

26. Factors affecting price elasticity of demand
Exceptional cases
Case of Cross-Harbour Tunnel (1984, Dr. T.D.Hau)
Toll
 Usage 15% , shift to vehicle ferry
 Inconvenient, and no way to find substitutes
 Go back to 98% of normal usage before P
Case of Cross-Harbour Tunnel (Now)
 Usage , shift to Eastern and Western Harbour Tunnels
 Time cost (Inconvenient) + higher tolls (EHT & WHT)
 Go back to similar usage before P

27. Factors affecting price elasticity of demand
Proportion of income spent on good
Small proportion  More inelastic
Large proportion  More elastic
Soy sauce
Travelling
Monthly expenditure
$10
$600
Expenditure after P by 10% (Qd unchanged)
$11
$660
Additional expenditure $1
$60
Incentive to find substitute
Low
High
Therefore, price elasticity is…

28. Factors affecting price elasticity of demand
Question (p.84)
Suppose the cost of finding substitutes for soy sauce and bus service are both $5. Explain whether you would find substitute for them.
Answer:
The benefit of finding substitutes for soy sauce is low relative to the cost. Therefore, consumers may not find substitutes for it.
However, for bus service, the benefit is relatively high when compared to the cost, consumers may search for its substitutes.

29. Relationship between Ed and total revenue
Total revenue (R) = Total expenditure = Total market value = Price x Quantity transacted
= P x Q
E.g. PA = $10 per unit, Q = 50 units
Total revenue of Good A = $10 x 50 = $500

30. Elasticity and change of total revenue
1. Elastic demand and revenue
Rise in price
At P1 and Q1: R = P1xQ1 = Area (A+B)
When P (from P1 to P2), Q (from Q1 to Q2)
R = P2xQ2 = Area (A+C)
Loss (Area B) > Gain (Area C)
R 
Elastic (Ed>1):
%∆Qd > %∆P
R () = P() x Q() D
P ($) Q C
gain B
Loss A P2 P1 Q1 Q2
more

31. Elasticity and change of total revenue
1. Elastic demand and revenue
Fall in price
At P1 and Q1: R = P1xQ1 = Area (A+C)
When P (from P1 to P2), Q  (from Q1 to Q2)
R = P2xQ2 = Area (A+B)
Gain (Area B) > Loss (Area C)
R 
Elastic (Ed>1):
%∆Qd > %∆P
R () = P () x Q()
P ($) P1 C
Loss P2 D
more B
Gain A Q Q1 Q2

32. Elasticity and change of total revenue
2. Inelastic demand and revenue
Rise in price
At P1 and Q1: R = P1xQ1 = Area (A+B)
When P (from P1 to P2), Q (from Q1 to Q2)
R = P2x Q2 = Area (A+C)
Loss (Area B) < Gain (Area C)
R 
Elastic (Ed<1):
%∆Qd < %∆P
R () = P() x Q()
P ($) P2 C
gain P1
more B
Loss A D Q Q2 Q1

33. Elasticity and change of total revenue
2. Inelastic demand and revenue
Fall in price
At P1 and Q1: R = P1xQ1 = Area (A+C)
When P  (from P1 to P2), Q  (from Q1 to Q2)
R = P2 x Q2 = Area (A+B)
Gain (Area B) < Loss (Area C)
R 
Elastic (Ed<1):
%∆Qd < %∆P
R () = P () x Q()
P ($) P1 C
Loss P2
more B
Gain A D Q Q1 Q2

34. Elasticity and change of total revenue
3. Unitary elastic demand and revenue
Rise in price
At P1 and Q1: R = P1xQ1 = Area (A+B)
When P (from P1 to P2), Q (from Q1 to Q2)
R = P2x Q2 = Area (A+C)
Loss (Area B) = Gain (Area C)
R remains unchanged
Elastic (Ed=1):
%∆Qd = %∆P
R (remains unchanged) = P() x Q()
P ($) P2 C
gain P1
more A B
Loss Q Q2 Q1

35. Unitary elastic demand
Summary
∆P vs. ∆Revenue
Reason
Elastic demand
P  R 
P  R 
%∆Qd > %∆P
Inelastic demand
P  R 
P  R 
%∆Qd < %∆P
Unitary elastic demand
P 
R remains unchanged
%∆Qd = %∆P
Question (p.90)
Pam’s monthly expenditure on apples remains unchanged after a rise in price. What is the elasticity of demand of apples? Explain. (3)
Answer:
Unitary elastic. Expenditure = Price x Quantity. Since her expenditure on apples remains unchanged, the percentage increase in price equals the percentage decrease in quantity demanded. So it is unitary elastic demand.
MC question
What can the elasticity of demand of Good X be if its revenue drops by 10% when its price rises by 5%?
A. 0.5 B. 1 C. 5 D. Infinity

36. Effects on change in supply
Supply curve shifts
1. Increase in supply  P & Q
Elastic demand (Ed>1): P R
Unitary elastic demand (Ed=1): PR unchanged
Inelastic demand (Ed<1): PR S1
P ($) S2 P1 C
Loss P2 D B
Gain A Q Q1 Q2

37. Effects on change in supply
Supply curve shifts
2. Decrease in supply  P & Q 
Elastic demand (Ed>1): P  R
Unitary elastic demand (Ed=1): P R unchanged
Inelastic demand (Ed<1): P R  S2
P ($) S1 P2 C
gain P1 D B
Loss A Q Q2 Q1

38. Effects on change in demand
Demand curve shifts
3. Increase in demand  P & Q 
Elastic demand (Ed>1): R 
Unitary elastic demand (Ed=1): R d
Inelastic demand (Ed<1): R 
4. Decrease in demand  P & Q 
Elastic demand (Ed>1): R 
Unitary elastic demand (Ed=1): R 
Inelastic demand (Ed<1): R 
P ($) S P2 D2 C
gain P1 D1 Q1 Q2 Q

39. Price elasticity of supply
Measures the responsiveness of quantity supplied to a change in price
Percentage change in quantity supplied over one percent change in price
% ∆ QS
Ed =
% ∆ P

40. Price elasticity of supply
Example (p.95)
Midpoint formula

41. Price elasticity of supply
Example (p.95)
Midpoint formula

42. Price elasticity of supply
Example (p.95)
Taking the case of P

43. Price elasticity of supply
Example (p.95)
Midpoint formula

44. 5 Types of elasticity of supply
Elastic supply
Elasticity is greater than 1 (Es > 1)
%∆ Qs > %∆P
Inelastic supply
Elasticity is smaller than 1 (Es < 1)
%∆ Qs < %∆P S Q
P ($) S Q

45. 5 Types of elasticity of supply
Unitary elastic supply
Elasticity equals 1 (Ed = 1)
%∆ Qs = %∆P
P ($) S Q

46. 5 Types of elasticity of supply
Perfectly elastic supply
Elasticity equals infinity (Ed = ∞)
A slightly rise in price will cause quantity supplied fall to 0. i.e. %∆P
P ($)
S (horizontal) Q

47. 5 Types of elasticity of supply
Perfectly inelastic supply
Elasticity equals 0 (Ed = 0)
Price change has no effect on the quantity supplied. (i.e. %∆Qs = 0)
P ($)
S (vertical) Q

48. Factors affecting price elasticity of supply
1. Factors of production
a. Values of factors of production different uses
Products required non-specialized factors  Price elasticity 
E.g.
Garment
P   Qs   no need to hire many factors  non-specialized factors (e.g. low-skilled workers) leave the product and go to another industry  Greater fall in Qs
Products required specialized factors  Price elasticity 
Medical service (factor: equipment)
 P  temporary, no increase in equipment because too specialized
 Qs has less effect on price change Or
Demand 
 P 
 Existing equipment can’t be used for other purposes
 Change of Qs has less response

49. Factors affecting price elasticity of supply
1. Factors of production
b. Adjustment cost of the cost of production
Production with non-specialized factors  Es 
E.g. Clerk, easier to hire when needed
Production with specialized factors  Es 
University principal, need to go through many procedures

50. Factors affecting price elasticity of supply
Factors of production
Availability of information
More information  Es 
Reserve capacity of equipment
More reserve  Es 
Idle resources in the economy
More resources  Es 
Occupational/Geographical Mobility
Higher mobility  Es 

51. Factors affecting price elasticity of supply
Nature of products
Easily perishable  Es 
E.g. flowers at flower market: worthless if unsold
Market structure and entry barrier
Restriction on output  Es 
How to restrict?
Entry barrier (e.g. registration is needed to become a doctor)
Monopoly (e.g. water supply)
Quota on imported goods

52. Factors affecting price elasticity of supply
4. Time
Long the time  Es 
More time to hire/release factors of production
When P 
 High cost to increase output shortly  Longer the time, more firms join the market, output 
P ($) S1 S2 Q

53. Cases of perfectly inelastic supply
1. Output limitation
Qs cannot be increases shortly
E.g.
Cross Harbour Tunnel at peak hours
Public Hospital (esp. maternity services) in HK
Application of China Visa Q

54. Cases of perfectly inelastic supply
Output limitation
Qs cannot be increases shortly
E.g.
Cross Harbour Tunnel at peak hours
Public Hospital (esp. maternity services) in HK
Application of China Visa
Goods or services of non-profit making bodies
Qs cannot be changed in accordance to price change
Public housing (gov’t policy)
Police service
Social welfare service by NGO

55. Cases of perfectly inelastic supply
3. Government control
Quotas
E.g.
Taxi license
Broadcasting license
4. Land supply
Qs is fixed
In terms of natural resources, but not the ownership of a piece of land by the gov’t