1. Ch. 4: Elasticity.
Define, calculate, and explain the factors that influence
the price elasticity of demand
the cross elasticity of demand
the income elasticity of demand
the elasticity of supply

2. Price Elasticity of Demand
The slope of the demand curve affects how much equilibrium price and quantity change for a given change in supply.

3. Price Elasticity of Demand
units-free measure of the responsiveness of the quantity demanded of a good to a change in its price, ceteris paribus.

4. Price Elasticity of Demand
%DQ = DQ/Qavg
= 2/10
= .2
%DP = DP/Pavg
= -$1/$20
= -.05
e = .2/.05 =4

5. Price Elasticity of Demand
By using the average price and average quantity, we get the same elasticity value regardless of whether the price rises or falls.
Measuring as % changes leaves the elasticity value the same (“units free”).
Although the formula yields a negative value for elasticity because price and quantity move in opposite directions, we report the absolute value.

6. Price Elasticity of Demand
Inelastic and Elastic Demand
if e>1: elastic
if e=1: unit elastic
if e<1: inelastic
Shape of
Perfectly inelastic demand curve (e=0)
Perfectly elastic demand curve (e= infinite)

7. Price Elasticity of Demand
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.

9. Price Elasticity of Demand
Total Revenue and Elasticity
TR=P*QD
When P changes, TR could rise or fall because QD moves in opposite direction.
But a higher price doesn’t always increase total revenue.

10. Price Elasticity of Demand
%D TR = % D P + % D Q
= % D P - % D P(e)
= % D P(1-e)
If demand is elastic (e>1),
P increase  TR decreases
P decrease  TR increases
If demand is inelastic (e<1),
P increase  TR increases
P decrease  TR decreases
If demand is unitary elastic,
P increase or decrease  TR unchanged.

11. Price Elasticity of Demand
As P falls from $25 to $12.50, D is elastic, and TR rises.
At $12.50, D is unit elastic and TR stops increasing.
As P falls from $12.50 to 0, D is inelastic, and TR decreases.

12. Price Elasticity of Demand

13. Price Elasticity of Demand
The elasticity of demand for a good depends on:
The number & closeness of substitutes
The proportion of income spent on the good
The time elapsed since a price change

14. More Elasticities of Demand
Cross Elasticity of Demand
measures responsiveness of demand for a good to a change in the price of another good.
exy= %D quantity demanded for x
%D change in price of y
exy > 0  substitutes
exy <0  complements

15. More Elasticities of Demand
Income Elasticity of Demand
measures how the quantity demanded of a good responds to a change in income, ceteris paribus. eI = %D in quantity demanded
% D in income
eI >0  normal good
eI >1 luxury good
eI <0 inferior good

16. Price Elasticity of Supply
A change in demand causes
A larger change in equilibrium price if supply is supply is steeper,
A smaller change in equilibrium quantity if supply is steeper.

17. Elasticity of Supply 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.

18. Elasticity of Supply

19. Elasticity of Supply Factors That Influence the Elasticity of Supply
Elasticity of supply for inputs
Substitution possibilities for inputs
The time frame for supply decisions
Storage costs