1. Elasticity and Its Application5
Elasticity and Its Application

2. The Elasticity of Demand (own)
Computing the price elasticity of demand
Percentage change in quantity demanded
Divided by percentage change in price
Use absolute value (drop the minus sign)
It’s always negative (own-price)
Midpoint method
Two points: (Q1, P1) and (Q2, P2)

3. The Elasticity of Demand
Cigarettes (US)[41]
-0.3 to -0.6 (General)
-0.6 to -0.7 (Youth) – proportion of income?
Soft drinks
-0.8 to -1.0 (general)[51] (broadly defined)
-3.8 (Coca-Cola)[52] (narrow)
-4.4 (Mountain Dew)[52] (narrow)
Car fuel[45]
-0.25 (Short run) (same car – reduce trips)
-0.64 (Long run) (new car?)

4. The Elasticity of Demand
Cross-price elasticity of demand
Measure of how much the quantity demanded of one good responds
To a change in the price of another/different good
[∆Qx/Qx] / [∆Py/Py ]
Sign matters -> tells whether substitute or complement
Magnitude (<1 or >1) -> how “good” a substitute/essential a complement
Substitutes: Positive cross-price elasticity
>1 -> “close” or good substitute as big shift with small price change
Complements: Negative cross-price elasticity
>1 -> “essential” to be used/consumed together (cars and gas)

5. Good
Good with Price Change
XED
Butter
Margarine
+0.81
Beef
Pork
+0.28
Entertainment
Food
-0.72

6. The Elasticity of Supply
Price elasticity of supply
Measure of how much the quantity supplied of a good responds
To a change in the price of that good
Percentage change in quantity supplied
Divided by the percentage change in price
Depends on the flexibility of sellers to change the amount of the good they produce

7. The Elasticity of Supply
Price elasticity of supply
Elastic supply
Quantity supplied responds substantially to changes in the price
Inelastic supply
Quantity supplied responds only slightly to changes in the price
Determinant of price elasticity of supply
Time period
Supply is more elastic in long run

8. The Elasticity of Supply
Computing price elasticity of supply
Percentage change in quantity supplied
Divided by percentage change in price
Variety of supply curves
Supply is perfectly inelastic
Elasticity =0
Supply curve – vertical
Supply is perfectly elastic
Elasticity = infinity
Supply curve – horizontal

9. The Elasticity of Supply
Variety of supply curves
Unit elastic supply
Elasticity =1
Elastic supply
Elasticity >1
Inelastic supply
Elasticity < 1

10. The price elasticity of supply (a, b)5
The price elasticity of supply (a, b)
Perfectly inelastic supply:
Elasticity = 0
(b) Inelastic supply:
Elasticity < 1
1. an
Price
1. an
Price
Supply
100
Supply An
increase
in price…
A 22%
increase
in price…
2. … leads to
a 10% increase
in quantity
supplied $5 $5
110 4 4
100
2. …leaves
the quantity
supplied
unchanged
Quantity
Quantity
The price elasticity of supply determines whether the supply curve is steep or flat.
Note that all percentage changes are calculated using the midpoint method.

11. Applications of Supply, Demand, & Elasticity
Why did OPEC fail to keep the price of oil high?
1970s: OPEC reduced supply of oil
Increase in prices and
Short-run: supply is inelastic
Decrease in supply: large increase in price
– price of oil decreased
Long-run: supply is elastic
Decrease in supply: small increase in price

12. A reduction in supply in the world market for oil8
A reduction in supply in the world market for oil
(a) The Oil Market in the Short Run
(b) The Oil Market in the Long Run
1. an
Price
1. In the short run, when supply and demand are inelastic, a shift in supply. . .
1. an
Price
1. In the long run, when supply and demand are elastic, a shift in supply. . . S2 S1
Demand S2 S1 P2
Demand
2. … leads to a
large increase
in price P2 P1 P1
2. … leads to a
small increase
in price
Quantity
Quantity
When the supply of oil falls, the response depends on the time horizon. In the short run, supply and demand are relatively inelastic, as in panel (a). Thus, when the supply curve shifts from S1 to S2, the price rises substantially. By contrast, in the long run, supply and demand are relatively elastic, as in panel (b). In this case, the same size shift in the supply curve (S1 to S2) causes a smaller increase in the price.