1. Elasticity of Demand and Supply
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2. Price Elasticity of Demand
Responsiveness
Price elasticity of demand
How responsive quantity demanded is to a price change
Percentage change in quantity demanded divided by percentage change in price
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3. Price Elasticity of Demand
%Δq – percentage change in quantity
Δq – change in quantity
%Δp – percentage change in price
Δp – change in price
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4. Price Elasticity of Demand
Price elasticity of demand, ED
Law of demand
Price and quantity demanded are inversely related
ED negative
Absolute value of ED positive
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5. Exhibit 1 Demand Curve for Tacos 0.90 Price per taco $1.10 D a b 10595
Thousands per day
If the price of tacos drops from $1.10 to $0.90, the quantity demanded increases from 95,000 to 105,000.
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6. Categories of ED If %∆q < %∆p If %∆q = %∆p
A change in price has relatively little effect on quantity demanded
ED between 0 and 1
Inelastic demand
If %∆q = %∆p
ED = 1
Unit elastic demand
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7. Categories of ED If %∆q > %∆p
A change in price has a relatively large effect on quantity demanded
ED greater than 1
Elastic demand
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8. Elasticity and Total Revenue
Total revenue = price * quantity demanded at this price
TR= p ˣ q
As price decreases
If demand is elastic, TR increases
If demand is inelastic, TR decreases
If demand is unit elastic, TR constant
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9. Price Elasticity and Linear D Curve
Linear demand curve
Straight line demand curve
Constant slope
Varying elasticity
Demand becomes less elastic as we move downward
Upper half: elastic
Lower half: inelastic
Midpoint: unit elastic
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10. (a) Demand and price elasticity
Exhibit 2
Demand, Price Elasticity, and Total Revenue
(a) Demand and price elasticity 90 60 10 70
Price per unit
$100 80 50 40 30 20 D b a
Where the demand curve is elastic, a lower price increases total revenue. Total revenue reaches a maximum at the rate of output where the demand curve is unit elastic.
Elastic, ED >1
Unit elastic, ED =1 c
Inelastic, ED <1 d e
800
500
200
100
Quantity per period
1,000
900
(b) Total revenue
Total revenue
$25,000
Where the demand curve is inelastic, further decreases in price reduce total revenue.
Total
revenue
500
Quantity per period
1,000
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11. Constant Elasticity Demand Curves
Perfectly elastic demand curve
Horizontal line
Any price increase would reduce quantity demanded to zero
ED = ∞
Consumers don’t tolerate price increases
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12. Constant Elasticity Demand Curves
Perfectly inelastic demand curve
Vertical line
Any price change has no effect on the quantity demanded
ED = 0
‘Price is no object’
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13. Constant Elasticity Demand Curves
Unit-elastic demand curve
Everywhere along the demand curve
% Δp causes an equal but offsetting %Δq
Total revenue remains the same
ED = 1
Constant-elasticity demand curve
Price elasticity is the same everywhere along the curve
Elasticity value is unchanged
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14. Exhibit 3 Constant-Elasticity Demand Curves (a) Perfectly elastic
(b) Perfectly inelastic
(c) Unit elastic
Price per unit p
Price per unit D’
Price per unit
$10 6
ED’’ = 1
D’’
ED’ = 0
ED = ∞ a D b
Quantity
per period
Quantity
per period Q
Quantity
per period 60
100
The three panels show constant-elasticity demand curves, so named because the elasticity value does not change along the demand curve. Along the perfectly elastic, or horizontal, demand curve of panel (a), consumers demand all that is offered for sale at price p, but demand nothing at a price above p. Along the perfectly inelastic, or vertical, demand curve of panel (b), consumers demand amount Q regardless of price. Along the unit-elastic demand curve of panel (c), total revenue is the same for each price-quantity combination.
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15. Exhibit 4 Summary of Price Elasticity of Demand
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16. Determinants of Price Elasticity of D
ED is greater:
The greater the availability of substitutes, and the more similar the substitutes
The more important the good as a share of the consumer’s budget
The longer the period of adjustment (time)
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17. Exhibit 5 Demand Becomes More Elastic Over Time Price per unit $1.25
1.00 Dw Dm Dy e
Quantity per day 95
100 75 50
Dw is the demand curve one week after a price increase from $1.00 to $1.25. Along this curve, quantity demanded per day falls from 100 to 95. One month after the price increase, quantity demanded has fallen to 75 along Dm. One year after the price increase, quantity demanded has fallen to 50 along Dy. At any given price, Dy is more elastic than Dm, which is more elastic than Dw.
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18. Elasticity Estimates Short run Long run
Consumers have little time to adjust
Long run
Consumers can fully adjust to a price change
Demand is more elastic in the long run
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19. Exhibit 6 Selected Price Elasticities of Demand (Absolute Values)
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20. Deterring Young Smokers
Health hazard
Kills 440,000 Americans a year
10 times more than traffic accidents
Lung cancer
Heart disease
Emphysema
Stroke
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21. Deterring Young Smokers
Cost to society
More than $7 per pack sold in
Higher health cost
Lost worker productivity
Total: more than $150 billion a year
More than $3,400 per smoker per year
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22. Deterring Young Smokers
About 80% of adult smokers
Began before the age of 18
Each day
3,500 U.S. teens under 18 try smoking for the first time
One third become regular smokers
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23. Deterring Young Smokers
Discouraging smoking
Prohibit the sale of cigarettes to minors
Higher cigarette tax
ED is higher for teens
Big share of budget
Less peer pressure
Not an addiction yet
Reduces teen smoking
Change consumer tastes
Health warnings
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24. Price Elasticity of Supply
Responsiveness
Price elasticity of supply
Responsiveness of quantity supplied to a price change
Percentage change in quantity supplied divided by percentage change in price
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25. Price Elasticity of Supply
Law of supply
ES positive
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26. Exhibit 7 Price Elasticity of Supply Price per unit p p’ S
Quantity per period q q’
If the price increases from p to p’, the quantity supplied increases from q to q’.
Price and quantity supplied move in the same direction, so the price elasticity of supply is a positive number.
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27. Categories of ES If %∆q < %∆p If %∆q = %∆p
A change in price has relatively little effect on quantity supplied
ES between 0 and 1
Inelastic supply
If %∆q = %∆p
ES = 1
Unit elastic supply
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

28. Categories of ES If %∆q > %∆p
A change in price has a relatively large effect on quantity supplied
ES greater than 1
Elastic supply
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29. Constant Elasticity Supply Curves
Perfectly elastic supply curve
Horizontal line
Any price decrease drops the quantity supplied to zero
ES = ∞
Unit-elastic supply curve, ES=1
%∆p causes an identical %∆q
Straight line from the origin
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30. Constant Elasticity Supply Curves
Perfectly inelastic supply curve
Vertical line
A price change has no effect on the quantity supplied
ES = 0
Goods in fixed supply
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31. Exhibit 8 Constant-Elasticity Supply Curves (a) Perfectly elastic
(b) Perfectly inelastic
(c) Unit elastic
Price per unit p
Price per unit S’
Price per unit
$10 5
S’’
ES’’ = 1
ES’ = 0
ES = ∞ S
Quantity
per period
Quantity
per period Q
Quantity
per period 10 20
In each of the three panels is a constant-elasticity supply curve, so named because the elasticity value does not change along the curve. Supply curve S in panel (a) is perfectly elastic, or horizontal. Along S, firms supply any amount of output demanded at price p, but supply none at prices below p. Supply curve S’ is perfectly inelastic, or vertical. S’ shows that the quantity supplied is independent of the price. In panel (c), S”, a straight line from the origin, is a unit-elastic supply curve. Any percentage change in price results in the same percentage change in quantity supplied.
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32. Determinants of Supply Elasticity
ES is greater:
If the marginal cost rises slowly as output expands
The longer the period of adjustment (time)
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33. Exhibit 9 Supply Becomes More Elastic Over Time Sm Sw Price per unit
1.00
$1.25 Sy
Quantity per day
110
200
100
140
The supply curve one week after a price increase, Sw, is less elastic, at a given price, than the supply curve one month later, Sm, which is less elastic than the supply curve one year later, Sy. Given a price increase from $1.00 to $1.25, quantity supplied per day increases to 110 units after one week, to 140 units after one month, and to 200 units after one year.
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34. Income Elasticity of Demand
Demand responsiveness to a change in consumer income
Percentage change in demand divided by the percentage change in income that caused it
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35. Income Elasticity of Demand
Inferior goods
Negative income elasticity
Normal goods
Positive income elasticity
Income inelastic, necessities
Elasticity between 0 and 1
Income elastic, luxuries
Elasticity > 1
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36. Exhibit 10 Selected Income Elasticities of Demand
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37. Market for Food & the “Farm Problem”
1950: 10 millions family farms
Today: less than 3 millions
Demand
Price inelastic
Total revenue falls when P falls
Income inelastic: D increases
Supply
Technological improvements: S increases
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38. Exhibit 11 The Demand for Grain Price per bushel $5 4 3 2 1 D 5 10 11
Billions of bushels per year
The demand for grain tends to be price inelastic. As the market price falls, so does total revenue.
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39. Exhibit 12
The Effect of Increases in Demand and Supply on Farm Revenue
Price per bushel $8 4 S
Over time, technological advances in farming have sharply increased the supply of grain. In addition, increases in consumer income over time have increased the demand for farm products. But because increases in the supply of grain exceed increases in demand, the combined effect is a drop in the market price and a fall in total farm revenue. D D’ S’ 5 10 14
Billions of bushels per year
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40. Cross-Price Elasticity of Demand
The percentage change in the demand of one good, divided by the percentage change in the price of another good
Positive for substitutes
Negative for complements
Zero for unrelated goods
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41. Price Elasticity and Tax Incidence
Decrease in supply by the amount of tax
Tax incidence
Consumers : high price
Producers: lower net-of-tax receipt
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42. Price Elasticity and Tax Incidence
The more price elastic the demand:
The more tax producers pay
The less tax consumers pay
The more elastic the supply:
The less tax producers pay
The more tax consumers pay
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43. Exhibit 13 Effects of Price Elasticity of Demand on Tax Incidence
(a) Less elastic demand
(b) More elastic demand
Price per ounce
$1.15
1.00
0.95 St D
Price per ounce
$1.05
1.00
0.85 St
$0.20 Tax
$0.20 Tax S D’ S
Millions of
ounces per day 10 9 10 7
Millions of
ounces per day
The imposition of a $0.20-per-ounce tax on tea shifts the supply curve leftward from S to St. In panel (a), which has a less elastic demand curve, the market price rises from $1.00 to $1.15 per ounce and the market quantity falls from 10 million to 9 million ounces. In panel (b), which has a more elastic demand curve, the same tax leads to an increase in price from $1.00 to $1.05; market quantity falls from 10 million to 7 million ounces. The more elastic the demand curve, the more the tax is paid by producers in the form of a lower net-of-tax receipt.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

44. Exhibit 14 Effects of Price Elasticity of Supply on Tax Incidence
(a) More elastic supply
(b) Less elastic supply
Price per ounce
$1.15
1.00
0.95
St’
$0.20 Tax
Price per ounce
$1.05
1.00
0.85
St” S”
D’’
D’’
$0.20 Tax S’
Millions of ounces per day 10 8 10 9
The imposition of a $0.20-per-ounce tax on tea shifts the supply curve leftward from S to St. In panel (a), which has a less elastic demand curve, the market price rises from $1.00 to $1.15 per ounce and the market quantity falls from 10 million to 9 million ounces. In panel (b), which has a more elastic demand curve, the same tax leads to an increase in price from $1.00 to $1.05; market quantity falls from 10 million to 7 million ounces. The more elastic the demand curve, the more the tax is paid by producers in the form of a lower net-of-tax receipt.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.