1. Economics 10 1 2017 September Lecture 6 Chapter 4 Elasticity
2017 Economics 101 CCC

2. Content
Define, calculate, and explain the factors that influence the price elasticity of demand
Elasticity– inelastic, elastic, along the curve, point, arc, slope
Define, calculate, and explain the factors that influence the income elasticity of demand and the cross elasticity of demand
Complement & Substitutes
Define, calculate, and explain the factors that influence the elasticity of supply

3. What is elasticity?

4. Elasticity . . .
… allows us to analyze supply and demand with greater precision.
… is a measure of how much buyers and sellers respond to changes in market conditions

5. Elasticity . . . Price Elasticity of Supply
= (% change in quantity supplied)
(% change in price)
The elasticity of supply measures the responsiveness of the quantity supplied to a change in the price of a good, with all other factors remaining the same.
How much it increases depends on the elasticity of supply.

6. Healthy red wine
increase red wine demand
Increase price
Switch from white to red grape production
Increased supply
Higher price results in response of more quantity supplied

7. Higher price results in response of more quantity supplied
Also here?
Fixed supply

8. Elasticity . . . Price Elasticity of Demand
= (% change in quantity demanded)
(% change in price)
The elasticity of demand measures the responsiveness of the quantity demanded to a change in the price of a good, with all other factors remaining the same.
How much it increases depends on the elasticity of demand

11. Price Elasticity of Demand

12. Price Elasticity of Demand
Law of Demand
Change occurs then equilibrium price rises and the equilibrium quantity decreases.
But does the price rise by a large amount and the quantity decrease by a little?
The answer depends on the responsiveness of the quantity demanded of a good to a change in its price.

13. Price Elasticity of Demand
Role of Slope of the Demand Curve in assessing responsiveness of price changes
If the demand curve is steep, the price rises and Qd barely changes
if the demand curve is almost flat, the price rises and Qd changes a great deal
To measure responsiveness we need a measure that is independent of units of measurement. –
Elasticity is such a measure.

14. What is the Price Elasticity of Demand?
The price elasticity of demand reviews the percentage change in the quantity demanded resulting from a percentage change in price.
Epsilon (ε) to represent price elasticity of demand.
Firms want to understand the relationship between Qd and Price
They know if they increase the price - Qd will decrease but they want to know how much it will decrease
And vice versa

15. How to calc Price Elasticity of Demand?
Option 1 Point Elasticity
ε =
Price elasticity of demand is computed along a demand curve.
(ΔQ/Q)
(ΔP/P) =

16. How to calculate Price Elasticity of Demand?
Option 1 Point Elasticity (using slope values)
ε = (ΔQ/Q)/(ΔP/P)
where rise/run = ΔP/ΔQ
So can simply use
ε = (P/Q)(1/slope)

17. How to calculate Price Elasticity of Demand?
Option 2 Arc Elasticity
ε =
Where
% change in P = x 100
% change in Q = x 100

18. Price Elasticity of Demand (ε)
Option 1 and 2 are known as point elasticity
Option 3 is arc elasticity

19. Example: If the price of an ice cream cone increases from $2. 00 to $2
Example: If the price of an ice cream cone increases from $2.00 to $ and the amount you buy falls from 10 to 8 cones, then your elasticity of demand would be calculated as:

20. Example: If the price of an ice cream cone increases from $2. 00 to $2
Example: If the price of an ice cream cone increases from $2.00 to $ and the amount you buy falls from 10 to 8 cones, then your elasticity of demand, using the midpoint formula, would be calculated as:

21. Price Elasticity of Demand and the Demand Curve
Figure 4.1 calculates the price elasticity of demand for pizza.
Initially, the price of a pizza is $20.50 and the quantity demanded is 9 pizzas an hour.

22. Price Elasticity of Demand and the Demand Curve
The price of a pizza falls to $19.50 and the quantity demanded increases to pizzas an hour.
The price falls by $1 and the quantity demanded increases by 2 pizzas an hour.

23. Price Elasticity of Demand and the Demand Curve
The percentage change in quantity demanded, %DQ, is calculated as DQ/Qave x 100, which is
(2/10) x 100 = 20%.
The percentage change in price, %DP, is calculated as DP/Pave x 100, which is
($1/$20) x 100 = 5%.
The price elasticity of demand equals
%DQ / %DP = 20% / 5%
= 4.

24. Note this about Price Elasticity of Demand
Average Price and Quantity
By using the average price and average quantity, we get the same elasticity value regardless of whether the price rises or falls.
Percentages and Proportions
The ratio of two proportionate changes is the same as the ratio of two percentage changes.
%DQ / %DP = DQ / DP

25. Note this about Price Elasticity of Demand
A Units-Free Measure
Elasticity is a ratio of percentages, so a change in the units of measurement of price or quantity leaves the elasticity value the same.
Minus Sign and Elasticity
The formula yields a negative value, because price and quantity move in opposite directions.
But it is the magnitude, or absolute value, that reveals how responsive the quantity change has been to a price change.

26. The Variety of Demand Curves
Inelastic Demand
Quantity demanded does not respond strongly to price changes.
Price elasticity of demand is less than one.
Elastic Demand
Quantity demanded responds strongly to changes in price.
Price elasticity of demand is greater than one.

27. The Variety of Demand Curves
Perfectly Inelastic
Quantity demanded does not respond to price changes.
Perfectly Elastic
Quantity demanded changes infinitely with any change in price.
Unit Elastic
Quantity demanded changes by the same percentage as the price.

28. The Variety of Demand Curves
Perfectly Inelastic Demand: Elasticity Equals 0
Price
Demand
100 $5
1. An
increase
in price . . . 4
Quantity
leaves the quantity demanded unchanged.

29. The Variety of Demand Curves
Perfectly Elastic Demand: Elasticity Equals Infinity
Price
1. At any price
above $4, quantity
demanded is zero. $4
Demand
2. At exactly $4,
consumers will
buy any quantity.
3. At a price below $4,
quantity demanded is infinite.
Quantity

30. The Variety of Demand Curves
If ϵp > 1, elastic then
1 % Change in P results in a > 1% Change is Q
If ϵp < 1, inelastic then
1 % Change in P results in a < 1% Change is Q
If ϵp = 1, unitary then
1 % Change in P results = 1% Change is Q

31. Factors that Influence Price Elasticity of Demand
The Factors That Influence the Elasticity of Demand
The elasticity of demand for a good depends on:
The closeness of substitutes
The proportion of income spent on the good
The time elapsed since a price change

32. Factors that Influence Price Elasticity of Demand
Closeness of Substitutes
The closer the substitutes for a good or service, the more elastic is the demand for the good or service.
Necessities, such as food or housing, generally have inelastic demand.
Luxuries, such as exotic vacations, generally have elastic demand.

33. Factors that Influence Price Elasticity of Demand
Proportion of Income Spent on the Good
The greater the proportion of income consumers spend on a good, the larger is the elasticity of demand for that good.
Time Elapsed Since Price Change
The more time consumers have to adjust to a price change, or the longer that a good can be stored without losing its value, the more elastic is the demand for that good.

34. Elasticity Along a Linear Demand Curve
Figure 4.3 shows how the elasticity of demand changes along a linear demand curve.
At the mid-point of the demand curve, demand is unit elastic.

35. Elasticity Along a Linear Demand Curve
At prices above the mid- point of the demand curve, demand is elastic.
At prices below the mid- point of the demand curve, demand is inelastic.

36. Elasticity Along a Linear Demand Curve
For example, if the price falls from $25 to $15, the quantity demanded increases from 0 to 20 pizzas an hour.
The average price is $20 and the average quantity is 10 pizzas.
The price elasticity of demand is (20/10) divided by (10/20), which equals 4.

37. Elasticity Along a Linear Demand Curve
If the price falls from $10 to $0, the quantity demanded increases from 30 to 50 pizzas an hour.
The average price is $5 and the average quantity is 40 pizzas.
The price elasticity is (20/40) divided by (10/5), which equals 1/4.

38. Elasticity Along a Linear Demand Curve
If the price falls from $15 to $10, the quantity demanded increases from 20 to 30 pizzas an hour.
The average price is $12.50 and the average quantity is 25 pizzas.
The price elasticity is (10/25) divided by (5/12.5), which equals 1.

39. Total Revenue and the Price Elasticity of Demand
Total revenue is the amount paid by buyers and received by sellers of a good.
Computed as the price of the good times the quantity sold.
TR = P x Q

40. Total Revenue and the Price Elasticity of Demand
Figure 2 Total Revenue
Price
Demand $4
100 P
P × Q = $400
(revenue)
Quantity Q

41. How Total Revenue Changes When Price Changes: Inelastic Demand
An Increase in price from $1
to $3 …
… leads to an Increase in total revenue from $100 to $240
Demand
Demand $3 80
Revenue = $240 $1
100
Revenue = $100
Quantity
Quantity

42. Elasticity and Total Revenue along a Linear Demand Curve
With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases.

43. How Total Revenue Changes When Price Changes: Elastic Demand
An Increase in price from $4
to $5 …
… leads to an decrease in total revenue from $200 to $100 $5 20
Demand
Demand
Revenue = $100 $4 50
Revenue = $200
Quantity
Quantity
Copyright©2003 Southwestern/Thomson Learning

44. Elasticity of a Linear Demand Curve

45. Price Elasticity of Demand
The change in total revenue due to a change in price depends on the elasticity of demand:
If demand is elastic, a 1 percent price cut increases the quantity sold by more than 1 percent, and total revenue increases.
If demand is inelastic, a 1 percent price cut increases the quantity sold by less than 1 percent, and total revenues decreases.
If demand is unit elastic, a 1 percent price cut increases the quantity sold by 1 percent, and total revenue remains unchanged.

46. Firms use of price elasticity of demand

47. Why is Price Elasticity of Demand useful to firms?
Why is elasticity useful?
We know if we raise a price,
the Qd will decline (law of demand)
but firms want to know how much of a Q change will occur
In Business, we want to know the relationship between Qd and Price.. Put it on sale or not..

48. Suppose a retail gourmet coffee outlet is selling its premium “Cappuccino ” for $3/cup. The store generally is selling 15 cups of “Cappuccino ” per hour, and the store manager is thinking seriously of raising the price to $5/cup.
She knows they will lose some sales but thinks that most of the customers are willing to pay more.
Link the price to total expenditure
also called total revenue for firms
Cappuccino Decisions

49. Firms use price elasticity of Demand to determine price changes
Changes in Price
Changes in Total Revenue
εD < 1
Increases
Decreases
εD = 1
Unchanged
εD > 1
Can you logic these out .. This is important!

50. Product Price Elasticity
Green Beans
Beer
Theatre .18
How do you interpret these? And why?

51. How do Policy makers use ED?
Tobacco or Alcohol
How do Business people use price elasticity of demand?
Branded products
Commodity products
Differentiated products

52. Other Types of Elasticity
Consider the other types of elasticity

53. Income Elasticity of Demand
The percentage amount by which the quantity demanded changes in response to a one-percent change in income
Income Elasticity of Demand
If income elasticity is positive: the good is normal. Why?
If income elasticity is negative: the good is inferior. Why?

54. Cross Price Elasticity of Demand
The percentage amount by which the quantity demanded of one good changes in response to a one-percent change in the price of another good
Cross Price Elasticity of Demand
If cross price elasticity is positive: goods are substitutes. Why?
If cross price elasticity is negative: goods are not substitutes but complements. Why?

55. Cross Price Elasticity of Demand
In Cross Price Elasticity of Demand & Income Elasticity of Demand we do not take the absolute value .. Instead we use them to determine relationships
Why can we then take the absolute value in price elasticity of demand (looking at P & Q of same good) but not in these?

56. Cross Price Elasticity of Demand
Figure 4.5 shows the increase in the quantity of pizza demanded when the price of a burger (a substitute for pizza) rises.
The figure also shows the decrease in the quantity of pizza demanded when the price of a soft drink (a complement of pizza) rises.

57. Elasticity of Supply

58. Elasticity of Supply Percentage change in quantity supplied
The elasticity of supply measures the responsiveness of the quantity supplied to a change in the price of a good, when all other influences on selling plans remain the same.
Calculating the Elasticity of Supply
The elasticity of supply is calculated by using the formula:
Percentage change in quantity supplied
Percentage change in price

59. Elasticity of Supply
Figure 4.6 on the next slide shows three cases of the elasticity of supply.
Supply is perfectly inelastic if the supply curve is vertical and the elasticity of supply is 0.
Supply is unit elastic if the supply curve is linear and passes through the origin. (Note that slope is irrelevant.)
Supply is perfectly elastic if the supply curve is horizontal and the elasticity of supply is infinite.

60. Elasticity of Supply

61. The Variety of Supply Curves
(a) Perfectly Inelastic Supply: Elasticity Equals 0
Price
Supply $5
1. An
increase
in price . . . 4
100
Quantity
leaves the quantity supplied unchanged.
Copyright©2003 Southwestern/Thomson Learning

62. The Variety of Supply Curves
(e) Perfectly Elastic Supply: Elasticity Equals Infinity
Price
1. At any price
above $4, quantity
supplied is infinite. $4
Supply
2. At exactly $4,
producers will
supply any quantity.
3. At a price below $4,
quantity supplied is zero.
Quantity
Copyright©2003 Southwestern/Thomson Learning

63. Factors That Influence the Elasticity of Supply
The Factors That Influence the Elasticity of Supply
The elasticity of supply depends on
Resource substitution possibilities
Time frame for supply decision
Resource Substitution Possibilities
The easier it is to substitute among the resources used to produce a good or service, the greater is its elasticity of supply.

64. Factors That Influence the Elasticity of Supply
Time Frame for Supply Decision
The more time that passes after a price change, the greater is the elasticity of supply.
Momentary supply is perfectly inelastic. The quantity supplied immediately following a price change is constant.
Short-run supply is somewhat elastic.
Long-run supply is the most elastic.

65. Ability of sellers to change the amount of the good they produce.
Beach-front land is inelastic.
Books, cars, or manufactured goods are elastic.
Time period.
Supply is more elastic in the long run.

66. Can good news for farming be bad news for farmers?
What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties?

67. Examine whether the supply or demand curve shifts.
Determine the direction of the shift of the curve.
Use the supply-and-demand diagram to see how the market equilibrium changes.

68. Figure 8 An Increase in Supply in the Market for Wheat
Price of
Wheat
1. When demand is inelastic,
an increase in supply
. . .
leads
to a large fall
in price . . . S1 S2
Demand $3
100 2
110
Quantity of
and a proportionately smaller
increase in quantity sold. As a result,
revenue falls from $300 to $220.
Wheat

69. Compute the Price Elasticity of Supply
Supply is inelastic

70. Table 4.1 provides a glossary of all the elasticity measures.

74. Questions
Define, interpret and compute all three types of elasticity of demand.
Identify shapes of perfectly elastic, perfectly inelastic and unit elastic demand curves and what their shapes imply
Define and interpret values for income elasticity of demand.
Define and interpret cross-price elasticity.
Understand how firms use price elasticity of demand
Understand relationship between price changes and total expenditure and total revenue for firms in elastic, inelastic and unitary

75. Questions Define and compute arc elasticity of demand.
Calculate price elasticity of demand along a linear demand curve.
Identify shapes of perfectly elastic, perfectly inelastic and unit elastic demand curves.
Define and interpret values for income elasticity of demand.
Define and interpret cross-price elasticity.

76. End of slides

77. Extra examples

78. Income
Milk
Milk has a low positive Income Elasticity of Demand value of
Income Elasticity of Demand a product like milk is inelastic because if income increases the quantity consumed of milk remains much the same.
Fillet + 5
Fillet of steak is elastic because if income increases the quantity consumed will rise substantially and it will have a high positive Income Elasticity of Demand value e.g. + 5

79. EXTRA INFO:
Can you interpret these?

80. Income Elasticity of Demand for Chocolate
Which country has the sweeter tooth when it comes to income elasticity for chocolate??
Total consumption
USA 0.79
Germany 0.39
United Kingdom 0.44
France 0.60
Japan 0.08
Switzerland 1.06
Reference: Henri Jason Trends in cocoa and chocolate consumption with particular reference to developments in the major markets. Malaysian International Cocoa Conference, Kuala Lumpur, October 1994 (ICCO, ED(MEM) 686)

81. The Variety of Supply Curves
If the supply curve is flat, the change in price creates a large change in Q S
If the supply curve is fairly flat, the change in price creates a small change in price
What causes these changes in price?
What makes the curve be flat or steep?

82. End of slides