1. ECONOMICS
Elasticity

2. Learning Objectives
Define and calculate the price elasticity of demand
Use a total revenue test and an expenditure test to estimate the price elasticity of demand
Explain the factors that influence the price elasticity of demand

3. Learning Objectives (cont.)
Define and calculate the cross elasticity of demand
Define and calculate the income elasticity of demand
Define and calculate the elasticity of supply

4. Learning Objectives
Define and calculate the price elasticity of demand
Use a total revenue test and an expenditure test to estimate the price elasticity of demand
Explain the factors that influence the price elasticity of demand

5. The Price Elasticity of Demand
You know that when supply increases, the equilibrium price falls and the equilibrium quantity increases.
But does the price fall by a large amount and the quantity increase by a little?
Or does the price barely fall and the quantity increase by a large amount?

6. The Price Elasticity of Demand
The price elasticity of demand is a units- free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buyers’ plans remain the same.

7. How a Change in Supply Changes Price and Quantity
40.00 S0 S1
An increase
in supply
brings ...
30.00
… a large
fall in price...
Large price change and
small quantity change
Price (dollars per pizza)
20.00
10.00
… and a small
increase in quantity...
5.00 Da 5 10 13 15 20 25
Quantity (pizza per hour)

8. How a Change in Supply Changes Price and Quantity
An increase
in supply
brings ...
40.00 S0 S1
30.00
… a small
fall in price...
Price (dollars per pizza)
Small price change and
large quantity change
20.00
15.00 Db
10.00
… and a large
increase in quantity... 5 10 15 17 20 25
Quantity (pizza per hour)

9. The Price Elasticity of Demand
Calculating Elasticity
Percent change in quantity demanded
Price elasticity of demand =
Percent change in price
Express the changes in price and quantity demanded
as percentages of the average price and the
average quantity.

10. The Price Elasticity of Demand
Calculating Elasticity (cont.)
The original price is $20.50 and the new price is $19.50,
so the average price is $20.
The $1.00 price decrease is 5 percent of the average price.
P/Pavg
= ($1/$20) x 100 = 5%

11. The Price Elasticity of Demand
Calculating Elasticity (cont.)
The original quantity demanded is 9 pizzas and the new
quantity demanded is 11 pizzas.
The 2 pizza increase in the quantity demanded is 20 percent
of the average quantity.
Q/Qavg
= (2/10) x 100 = 20%

12. The Price Elasticity of Demand
Calculating Elasticity (cont.)
Price elasticity of demand
20% = = 4 5%

13. Calculating the Elasticity of Demand
Original
point
20.50
= $1
Elasticity = 4
Price (dollars per pizza)
20.00
Pavg = $20
New
point
19.50
= 2 D
Qavg = 10
Quantity (pizza per hour)

14. The Price Elasticity of Demand
Average Price and Quantity
We use the average price and average quantity to avoid having two values for the elasticity of demand at a single point on the demand curve, depending whether the price falls or rises.

15. The Price Elasticity of Demand
Percentages and Proportions
Elasticity is the ratio of the percentage change in the quantity demanded to the percentage change in the price.
Equivalently, the proportionate change in the quantity demanded divided by the proportionate change in price.

16. The Price Elasticity of Demand
A Units-Free Measure
Elasticity is a units-free measure because the percentage change in each variable is independent of the units in which the variable is measured.
And the ratio of the two percentages is a number without units.

17. The Price Elasticity of Demand
Minus Sign and Elasticity
The price elasticity of demand is a negative number.
But, it is the magnitude, or absolute value, of the price elasticity of demand that tells us how elastic demand is.
We use the magnitude and ignore the minus sign.

18. The Price Elasticity of Demand
Inelastic and Elastic Demand
Perfectly inelastic demand
Implies that quantity demanded remains constant when price changes occur.
Price elasticity of demand = 0

19. The Price Elasticity of Demand
Inelastic and Elastic Demand (cont.)
Unit elastic demand
Implies that the percentage change in quantity demanded equals the percentage change in price.
Price elasticity of demand = 1

20. Inelastic and Elastic Demand
Inelastic and Elastic Demand (cont.)
Perfectly elastic demand
Implies that if price changes by any percentage, quantity demanded will fall to 0.
Price elasticity of demand =

21. Inelastic and Elastic Demand
Inelastic and Elastic Demand (cont.)
Inelastic demand
Implies the percentage change in quantity demanded is less than the percentage change in price.
Price elasticity of demand > 0 and < 1.

22. Inelastic and Elastic Demand
Inelastic and Elastic Demand (cont.)
Elastic demand
Implies the percentage change in quantity demanded is greater than the percentage change in price.
Price elasticity of demand > 1.

23. Inelastic and Elastic Demand
Perfectly inelastic demand D1
Price
Elasticity = 0 12 6
Quantity

24. Inelastic and Elastic Demand
Unit elastic demand
Price
Elasticity = 1 12 6 D2
Quantity

25. Inelastic and Elastic Demand
Perfectly elastic demand
Price
Elasticity = 12 D3 6
Quantity

26. Inelastic and Elastic Demand
Elasticity Along a Straight-Line Demand Curve
Along a straight-line demand curve, the elasticity varies.
At high prices and small quantities, the elasticity is large and at low prices and large quantities, the elasticity is small.

27. Elasticity Along a Straight-Line Demand Curve
25.00
Elasticity = 4
Elastic
20.00
Elasticity = 1
Price (dollars per pizza)
15.00
12.50
Inelastic
10.00
Elasticity = 1/4
5.00
Quantity (pizza per hour)

28. Learning Objectives
Define and calculate the price elasticity of demand
Use a total revenue test and an expenditure test to estimate the price elasticity of demand
Explain the factors that influence the price elasticity of demand

29. Total Revenue and Elasticity
When a price changes, the change in producers’ total revenue depends on the elasticity of demand.

30. Total Revenue and Elasticity
Elastic demand: a 1 percent price cut increases the quantity sold by more than 1 percent and total revenue increases.
Unit elastic demand: a 1 percent price cut increases the quantity sold by 1 percent and so total revenue does not change.
Inelastic demand: a 1 percent price cut increases the quantity sold by less than 1 percent and total revenue decreases.

31. Total Revenue and Elasticity
Total Revenue Test
Price elasticity of demand can be estimated by observing the change in total revenue that results from a price change (ceteris paribus).

32. Total Revenue and Elasticity
Total Revenue Test
If a price cut increases total revenue, demand is elastic.
If a price cut decreases total revenue, demand is inelastic.
If a price cut leaves total revenue unchanged, demand is unit elastic.

33. 0 25 50 25.00 Elastic demand 20.00 15.00 Unit elastic
Price (dollars per pizza)
12.50
10.00
Inelastic
demand
5.00
350.00
312.50
Maximum
total revenue
300.00
250.00
When demand
is inelastic,
price cut decreases
total revenue
When demand
is elastic,
price cut
increases
total revenue
Total Revenue (billions of dollars)
200.00
150.00
100.00
50.00
Quantity (pizza per hour)

34. Total Revenue and Elasticity
Your Expenditure and Your Elasticity
If your demand is elastic, a 1 percent price cut increases the quantity you buy by more than 1 percent and your expenditure on the item increases.

35. Total Revenue and Elasticity
Your Expenditure and Your Elasticity (cont.)
If your demand is unit elastic, a 1 percent price cut increases your quantity bought by 1 percent and so your expenditure on the item does not change.

36. Total Revenue and Elasticity
Your Expenditure and your Elasticity (cont.)
If your demand is inelastic, a 1 percent price cut increases your quantity bought by less than 1 percent and so your expenditure on the item decreases.

37. Some Real-World Price Elasticities of Demand
Good or Service Elasticity
Elastic Demand
Metals 1.52
Electrical engineering products 1.30
Mechanical engineering products 1.30
Furniture 1.26
Motor vehicles 1.14
Instrument engineering products 1.10
Professional services 1.09
Transportation services 1.03
Inelastic Demand
Gas, electricity, and water 0.92
Oil 0.91
Chemicals 0.89
Beverages (all types) 0.78
Clothing 0.64
Tobacco 0.61
Banking and insurance services 0.56
Housing services 0.55
Agricultural and fish products 0.42
Books, magazines, and newspapers 0.34
Food 0.12

38. Learning Objectives
Define and calculate the price elasticity of demand
Use a total revenue test and an expenditure test to estimate the price elasticity of demand
Explain the factors that influence the price elasticity of demand

39. Factors That Influence Elasticity the Elasticity of Demand
Closeness of Substitutes.
The closer the substitutes, the more elastic the demand.
necessities
luxuries
Instructor Notes:
The next slide will illustrate the relationship between income and price elasticity of demand.

40. Factors That Influence Elasticity the Elasticity of Demand
Proportion of Income Spent on the Good
The greater the proportion of income spent on food, the more elastic the demand.
Time Elapsed Since Price Change
The longer the time, the more elastic the demand.
Short-run demand
Long-run demand
Instructor Notes:
The next slide will illustrate the relationship between income and price elasticity of demand.

41. Price Elasticities in 20 Countries

42. Learning Objectives
Define and calculate the cross elasticity of demand
Define and calculate the income elasticity of demand
Define and calculate the elasticity of supply

43. More Elasticities of Demand
Cross elasticity of demand
Measures the responsiveness of the demand for a good to a change in the price of a substitute or complement good.
Cross elasticity
of demand =
Percentage change
in quantity demanded
Percentage change in price of
a substitute or complement

44. Cross Elasticity of Demand
Price of soda,
a complement,
falls. Negative
cross elasticity.
Price of pizzas D1
Price of a burger,
a substitute, falls.
Positive cross elasticity. D0
Quantity of pizzas

45. Learning Objectives
Define and calculate the cross elasticity of demand
Define and calculate the income elasticity of demand
Define and calculate the elasticity of supply

46. Income Elasticity of Demand
Measures the responsiveness of the demand to a change in income.
Income elasticity
of demand =
Percentage change
in quantity demanded
Percentage change in income

47. Income Elasticity of Demand
Income elasticity can be:
) Greater than 1 (normal good, income elastic)
) Between zero and 1 (normal good, income inelastic)
) Less than zero (inferior good)

48. Income Elasticity of Demand
Elasticity greater
than 1
Elasticity between
zero and 1
Elasticity less than 1
and becomes negative
Income
inelastic
Income
elastic
Quantity demanded
Quantity demanded
Quantity demanded m
Positive
income
elasticity
Negative
income
elasticity
Income
Income
Income
Income

49. Some Real-World Income Elasticities of Demand
Elastic Demand
Airline Travel 5.82
Movies 3.41
Foreign Travel 3.08
Electricity 1.94
Restaurant meals 1.61
Local buses and trains 1.38
Haircutting 1.36
Cars 1.07
Inelastic Demand
Tobacco 0.86
Alcoholic beverages 0.62
Furniture 0.53
Clothing 0.51
Newspapers and magazines 0.38
Telephone 0.32
Food 0.14

50. Income Elasticities in 15 Countries

51. Learning Objectives
Define and calculate the cross elasticity of demand
Define and calculate the income elasticity of demand
Define and calculate the elasticity of supply

52. Elasticity of Supply
Elasticity of supply measures the responsiveness of quantity supplied to a change in price.
Percentage change in quantity supplied
Elasticity
of supply =
Percentage change in price

53. How a Change in Demand Changes Price and Quantity
An increase
in demand
brings ...
40.00 Sa D1
Large price change and
small quantity change
30.00
Price (dollars per pizza)
20.00
… a large
price rise...
10.00
… and a small
quantity increase... D0 5 10 13 15 20 25
Quantity (pizza per hour)

54. How a Change in Demand Changes Price and Quantity
An increase
in demand
brings ... D1
40.00
Small price change and
large quantity change
30.00
Price (dollars per pizza) Sb
21.00
20.00
… a small
price rise...
10.00
… and a large
quantity increase... D0 5 10 15 20 25
Quantity (pizza per hour)

55. Elasticity of Supply Supply elasticity depends on:
Resource substitution possibilities
Time frame for the supply decision

56. Inelastic and Elastic Demand
Perfectly inelastic supply S1
Price
Elasticity of supply = 0
Quantity

57. Inelastic and Elastic Demand
Unit elastic supply S1
Price
Elasticity of supply = 1
Quantity

58. Inelastic and Elastic Demand
Perfectly elastic supply
Price
Elasticity of supply = S3
Quantity

59. Elasticity of Supply Resource Substitution Possibilities
The more unique the resource, the more inelastic the supply.
Van Gogh painting - Van Gogh
Wheat/corn — farmland

60. Elasticity of Supply Time Frame for Supply Decisions Momentary supply
Long-run supply
Short-run supply
The longer producers have to adjust to a price change, the more elastic is supply.

61. A Compact Glossary of Elasticities
PRICE ELASTICITIES OF DEMAND
A relationship is
described as
Which means that
When its
magnitude is
Perfectly elastic
or infinitely elastic
Infinity
The smallest possible increase in price causes
an infinitely large decrease in quantity demanded
Elastic
Less than infinity
but greater than 1
The percent decrease in the quantity demanded
exceeds the percent increase in price
Unit elastic 1
The percent decrease in the quantity demanded
equals the percent increase in price
In elastic
Greater than zero
but less than 1
The percentage decrease in the quantity demanded
is less than the percent increase in price.
Perfectly inelastic
or completely inelastic
Zero
The quantity demanded is the same at all prices

62. A Compact Glossary of Elasticities
CROSS ELASTICITIES OF DEMAND
A relationship is
described as
When its
magnitude is
Which means that
Perfect substitutes
Infinity
The smallest possible increase in price of one
good causes an infinitely large in the demand
of the other good.
Substitutes
Positive, less
than infinity
If the price of one good increases, the quantity
demanded of the other good also increases.
Independent
Zero
The demand for one good remains constant,
regardless of the price of the other good.
Complements
Less than zero
The demand for one good decreases when the
price of the other good increases.

63. A Compact Glossary of Elasticities
INCOME ELASTICITIES OF DEMAND
A relationship is
described as
When its
magnitude is
Which means that
Income elastic
(normal good)
Greater than 1
The percent increase in the quantity demanded
is greater than the percentage increase in income.
Income inelastic
(normal good)
Less than 1 but
greater than zero
The percent increase in the quantity demanded
is less than the percentage increase in income.
Negative income elastic
(inferior good)
Less than zero
When income increases, quantity demanded
decreases.

64. A Compact Glossary of Elasticities
ELASTICITIES OF SUPPLY
A relationship is
described as
When its
magnitude is
Which means that
Perfectly elastic
Infinity
The smallest possible increase in price causes an
infinitely large increase in the quantity supplied.
Elastic
Less than infinity
but greater than 1
The percent increase in the quantity supplied
exceeds the percentage increase in the price.
Inelastic
Greater than zero
but less than 1
The percentage increase in the quantity supplied
is less than the percentage increase in price.
Perfectly inelastic
Zero
The quantity supplied is the same at all prices.