1. Demand and Supply Elasticity
Chapter 21
Demand and Supply Elasticity

2. Introduction
The evidence shows that an increase in the price of physician’s services or prescription medications results in a relatively small decrease in the quantity of these goods demanded.
In contrast, an increase in the price of psychiatric services causes a significant reduction in the quantity demanded. Why is there a difference in the price responsiveness of these goods?

3. Learning Objectives Express and calculate price elasticity of demand
Understand the relationship between the price elasticity of demand and total revenues
Discuss the factors that determine the price elasticity of demand

4. Learning Objectives
Describe the cross price elasticity of demand and how it may be used to indicate whether two goods are substitutes or complements
Explain the income elasticity of demand

5. Learning Objectives
Classify supply elasticities and explain how the length of time for adjustment affects the price elasticity of supply

6. Chapter Outline Price Elasticity Price Elasticity Ranges
Elasticity and Total Revenues
Determinants of the Price Elasticity of Demand

7. Chapter Outline Cross Price Elasticity of Demand
Income Elasticity of Demand
Elasticity of Supply

8. Did You Know That...
Lower beer prices are associated with an increase in the number of violent incidents on campus?
A reduction in the price of a good can cause either an increase or a decrease in total sales revenue collected?

9. Price Elasticity Price Elasticity of Demand (Ep)
The responsiveness of quantity demanded of a commodity to changes in its price

10. Price Elasticity Price Elasticity of Demand (Ep)
percentage change in quantity demanded
percentage change in price

11. Price Elasticity Example Price of oil increases 10 percent
Quantity demanded decreases 1 percent
Ep =
-1%
+10%
= -.1

12. Price Elasticity Question Answer
How would you interpret an elasticity of -0.1?
Answer
A ten percent increase in the price of oil will lead to a one percent decrease in quantity demanded

13. Price Elasticity Relative quantities only Always negative
Elasticity is measuring the change in quantity relative to the change in price
Always negative
An increase in price decreases the quantity demanded, ceteris paribus

14. Calculating Elasticity
Elasticity formula:
change in Q
sum of quantities/2
Ep =
change in P or
change in Q
(Q1 + Q2)/2
Ep =
change in P
(P1 + P2)/2

15. Example: The Price Elasticity of Demand for Beer
Lowenbrau, a beer imported from Germany, recently increased in price from $4.67 to $7.00 per six-pack.
In response, annual sales of six-packs fell from 25 million to million.
What is the elasticity of demand?

16. Example: The Price Elasticity of Demand for Beer
Use the elasticity formula:
÷ $7.00 – ( )/ ($7.00 +$4.67)/2
Solve the formula, and you will find that elasticity equals 1.

17. Price Elasticity Ranges
Elastic Demand
Percentage change in quantity demanded is larger than the percentage change in price
Ep > 1

18. Price Elasticity Ranges
Unit Elasticity of Demand
Percentage change in quantity demanded is equal to the percentage change in price
Ep = 1

19. Price Elasticity Ranges
Inelastic Demand
Percentage change in quantity demanded is smaller than the percentage change in price
Ep < 1

20. Price Elasticity Ranges
Elastic demand
% change in Q > % change in P; Ep > 1
Unit elastic
% change in Q = % change in P; Ep = 1
Inelastic demand
% change in Q < % change in P; Ep < 1

21. Price Elasticity Ranges
Extreme elasticities
Perfectly Inelastic Demand
A demand curve that is a vertical line
It has only one quantity demanded for each price
No matter what the price, quantity demanded does not change

22. Extreme Price ElasticitiesD
Perfect inelasticity, or zero elasticity
Price 8
Quantity Demanded per Year (millions of units)
Figure 21-1, Panel (a)

23. Extreme Price ElasticitiesD P1
Price
Perfect inelasticity, or zero elasticity P0 8
Quantity Demanded per Year (millions of units)
Figure 21-1, Panel (a)

24. Price Elasticity Ranges
Extreme elasticities
Perfectly Elastic Demand
A demand curve that is a horizontal line
It has only one price for every quantity
The slightest increase in price leads to zero quantity demanded

25. Extreme Price Elasticities30 D
Price (cents)
Perfect elasticity, or infinite elasticity
Quantity Demanded per Year (millions of units)
Figure 21-1, Panel (b)

26. Policy Example: Who Pays Gasoline Taxes?
State and federal governments impose gasoline taxes that are assessed as a flat amount per gallon.
Who pays the tax depends on price elasticity of demand.

27. Policy Example: Who Pays Gasoline Taxes?
Figure 21-2, Panels (a) and (b)

28. Policy Example: Who Pays Gasoline Taxes?
Figure 21-2, Panel (c)

29. Elasticity and Total Revenues
When demand is elastic, a negative relationship exists between small changes in price and changes in total revenue.
When demand is unit-elastic, changes in price do not change total revenue.
When demand is inelastic, a positive relationship exists between changes in price and total revenues.

30. Determinants of Price Elasticity of Demand
Existence of substitutes
The closer the substitutes and the more substitutes there are, the more elastic is demand.
Share of the budget
The greater the share of the consumer’s total budget spent on a good, the greater is the price elasticity.

31. Determinants of Price Elasticity of Demand
The length of time allowed for adjustment
The longer any price change persists, the greater is the price elasticity of demand.
Price elasticity is greater in the long-run than in the short-run.

32. Determinants of Price Elasticity of Demand
How to define the short run and the long run
The short run is a time period too short for consumers to fully adjust to a price change.
The long run is a time period long enough for consumers to fully adjust to a change in price other things constant.

33. Short-Run and Long-Run Price Elasticity of Demand
In the short run, quantity
demanded falls slightly.
However, with more time
for adjustment the
demand curve becomes
more elastic and quantity
demanded falls by a
greater amount. P1 E
Price per Unit Pe D2 D1 Q2 Q1 Qe
Quantity Demanded per Period
Figure 21-4

34. Short-Run and Long-Run Price Elasticity of Demand
In the short run, quantity
demanded falls slightly.
However, with more time
for adjustment the
demand curve becomes
more elastic and quantity
demanded falls by a
greater amount. P1 E
Price per Unit Pe D3 D2 D1 Q3 Q2 Q1 Qe
Quantity Demanded per Period
Figure 21-4

35. Example: Real-World Elasticities of Demand
Table 21-2

36. Cross Price Elasticity of Demand
Cross Price Elasticity of Demand (Exy)
The percentage change in the demand for one good (holding its price constant) divided by the percentage change in the price of a related good
The responsiveness of change in demand of one good to the change in prices of related goods

37. Cross Price Elasticity of Demand
Formula for computing cross elasticity of demand
% change in demand for good X
% change in price of good Y
Exy =

38. Cross Price Elasticity of Demand
Substitutes
Exy would be positive
An increase in the price of X would increase the quantity of Y demanded at each price.
Complements
Exy would be negative
An increase in the price of X would decrease the quantity of Y demanded at each price.

39. E-Commerce Example: Cross-Price Elasticity of Telescopes
Economic researchers have estimated the cross-price elasticity of demand for different types of telescopes.
The finding was that the cross-price elasticity of demand between 3.5-inch and 5-inch telescopes was
In contrast, the cross-price elasticity of demand between 5-inch and 8-inch telescopes was close to zero.

40. E-Commerce Example: Cross-Price Elasticity of Telescopes
The conclusion is that 3.5-inch telescopes and 5-inch telescopes are substitutes for one another. But consumer behavior shows that the 5-inch telescope is not a substitute for the 8-inch one.

41. Income Elasticity of Demand
Income Elasticity of Demand (Ei)
The percentage change in demand for any good, holding its price constant, divided by the percentage change in income
The responsiveness of demand to changes in income, holding the good’s relative price constant

42. Income Elasticity of Demand
percentage change in demand
percentage change in income
Ei =

43. Income Elasticity of Demand
refers to a horizontal shift in the demand curve in response to changes in income
Price elasticity of demand
refers to a movement along the curve in response to price changes

44. Income Elasticity of Demand
Formula:
Change in Quantity ÷ Change in Income Average Quantity Average Income
The income elasticity of demand can be either negative or positive.
Remember that, in calculating the income elasticity of demand, the price of the good is assumed to be constant.

45. Elasticity of Supply Price Elasticity of Supply (Ei)
The responsiveness of the quantity supplied of a commodity to a change in its price
The percentage change in quantity supplied divided by the percentage change in price

46. Elasticity of Supply Formula for computing price elasticity of supply
percentage change in quantity supplied
percentage change in price
ES =

47. Elasticity of Supply Classifying supply elasticities
Perfectly Elastic Supply
Quantity supplied falls to zero when there is any decrease in price.
The supply curve is horizontal at a given price.

48. Elasticity of Supply Classifying supply elasticities
Perfectly Inelastic Supply
Quantity supplied is constant no matter what happens to price.
The supply curve is vertical at a given price.

49. The Extremes in Supply CurvesQ1 S’
Perfect inelasticity
Price per Unit
Quantity Supplied per Period
Figure 21-5

50. The Extremes in Supply Curves
Perfect inelasticity P1 S
Price per Unit
Perfect elasticity Q1
Quantity Supplied per Period
Figure 21-5

51. Elasticity of Supply
Price elasticity of supply and length of time for adjustment
The longer the time allowed for adjustment, the more elastic is supply.
Firms can find ways to increase (or decrease) output.
Resources can flow into (or out of) an industry through expansion (or contraction) of existing firms.

52. Short-Run and Long-Run Price Elasticity of SupplyQ1
As time passes the supply curve rotates from S1 to S2 and quantity supplied rises first to Q1. Pe
Price per Unit E Qe
Quantity Supplied per Period
Figure 21-6

53. Short-Run and Long-Run Price Elasticity of SupplyPe
Price per Unit E
As time passes the supply curve rotates to S2 then to S3 and quantity supplied rises first to Q1 and then to Q2. Qe Q1 Q2
Quantity Supplied per Period
Figure 21-6

54. International Example: French Truffle Production Takes a Nosedive
Chinese competition caused the price of French truffles to fall 30 percent in
Accordingly French production decreased by 25%.
Short-run ES = .83

55. Issues and Applications: The Inelastic Demand for Health Care
Evidence shows that the price elasticities of demand for physician services, hospital stays, and prescription medications are all or less.
Yet the elasticity of demand for psychiatric services is about 1.20, six times greater than the price responsiveness for these other health care categories.

56. Issues and Applications: The Inelastic Demand for Health Care
The explanation is found in the fact that there are more substitutes available for psychiatric services.
Someone seeking help for emotional distress might consult a clergy member or a family counselor, rather than a psychiatrist.

57. Summary Discussion of Learning Objectives
Expressing and calculating the price elasticity of demand
Percentage change in quantity demanded divided by the percentage change in price

58. Summary Discussion of Learning Objectives
The relationship between the price elasticity of demand and total revenues
When demand is elastic, price and total revenue are inversely related
When demand is inelastic, price and total revenue are positively related
When demand is unit elastic, total revenue does not change when price changes

59. Summary Discussion of Learning Objectives
Factors that determine price elasticity of demand
Availability of substitutes
Percentage of a person’s budget spent on the good
The length of time allowed for adjustment to a price change

60. Summary Discussion of Learning Objectives
The cross price elasticity of demand and using it to determine whether two goods are substitutes or complements
Percentage change in the demand for one good divided by the percentage change in the price of another
If cross elasticity is positive, the goods are substitutes
If cross elasticity is negative, the goods are complements

61. Summary Discussion of Learning Objectives
Income elasticity of demand
Percentage change in the demand for a good divided by the percentage in income

62. Summary Discussion of Learning Objectives
Classifying supply elasticities and how the length of time for adjustment affects price elasticity of supply
Elastic supply: price elasticity of supply is greater than 1
Inelastic supply: price elasticity of supply is less than 1
Unit-elastic supply: price elasticity of supply is equal to 1
The longer the time period for adjustment, the more elastic is supply

63. Demand and Supply Elasticity
End of Chapter 21
Demand and Supply Elasticity