1. Elasticity
©1999 South-Western College Publishing

2. What is Elasticity?
A term economists use to describe sensitivity of quantity demanded or supplied to a change in price.

3. How do we measure the Price Elasticity of Demand?
The percentage change in quantity demanded divided by the percentage change in price

4. Price Elasticity of Demand
Ed = % change in Qd
% change in P
Ed = % in Qd
% in P

5. Classifying Ed Ed = 1 Unitary elasticity Ed > 1 Elastic demand
Ed < 1 Inelastic demand

6. Extreme elasticities
Ed = 0 Perfectly inelastic (vertical demand curve)
Ed =  Perfectly elastic (horizontal demand curve)

7. Perfectly inelastic demand Perfectly elastic demandQ D
Perfectly elastic demand D P Q

8. When consumers are very sensitive to a price change what does the demand curve look like?
Very horizontal

9. When consumers are less sensitive to a price change what does the demand curve look like?
Very vertical

10. Price Elasticity of Demand
Quantity
% change in Qd
% change in P
Price Elasticity of Demand
Ed = % in Qd
% in P
Initial
New
Initial
New 25 30
100 40
60%
60/100
20%
5/25
3-elastic
.6/.2 40 70
120 90
25%
75%
0.33-inelastic
200
220 80 64
20%
10%
2-elastic 50 75
150
135
10%
50%
.2-inelastic 10

11. When price increases, what two things happen?
more money per unit
fewer units are sold

12. What factors influence Demand Sensitivity (elasticity)?
Number and closeness of Substitute goods
% of income a good makes up
Basic goods or “needs”
Time to adjust

13. What do substitutes have to do with sensitivity?
The more substitutes a good has, the more sensitive consumers are to a price change

14. A B D D
Which demand curve is for spark plugs and which for Coca-Cola?

15. What does % of income a good makes up have to do with sensitivity?
The lower the % of ones budget a good is, the less sensitive consumers are to a price change
SALT!

16. What do basic goods have to do with sensitivity?
The greater the need a good has to the consumer, the less sensitive the consumer is to a price change
WATER!

17. What does time have to do with sensitivity?
The more time to adjust, the more sensitive consumers are to a price change

18. If a college raises tuition, what happens to revenue?
If demand is elastic - revenue goes down
If demand is inelastic - revenue goes up

19. Elasticity and Total Revenue (TR)
TR = PQ (price times quantity)
Ed = % change in Qd
% change in P

20. If total revenue does not change when price increases, the demand curve is unitary elastic, value equals 1

21. If price increases and the revenue gained is less than the revenue lost, the demand curve is price elastic, > 1

22. If price increases and the revenue gained is greater than the revenue lost, the demand curve is price inelastic, < 1

23. Summary, elasticity, price changes, and total revenue
Price increase
Price Decrease
Ed = 1
Total revenue same
Total revenue same
Ed > 1
Total revenue falls
Total revenue rises
Ed < 1
Total revenue rises
Total revenue falls

24. What is Cross Elasticity of Demand?
The percentage change in the quantity demanded of one commodity resulting from a 1 percent change in price of another commodity

25. What is Income Elasticity of Demand?
The ratio of the percentage change in quantity demanded to the percentage change in income

26. E i = %  Quantity % Income
E i > 0 Normal goods
E i < 0 Inferior goods
E i > 1 Luxury goods
0 < E i < 1 Necessities

27. When does a good face an income elastic demand curve?
A 1% change in income generates a greater than 1% change quantity demanded

28. When does a good face an income inelastic demand curve?
A 1% change in income generates a less than 1% change quantity demanded

29. Something that people will buy less of as their incomes increase
What is an
Inferior Good?
Something that people will buy less of as their incomes increase
I bought Mac and Cheese in college, but refuse to buy it now! What’s the difference in my income?

30. Something that people will buy more of as their incomes increase
What is a
Normal Good?
Something that people will buy more of as their incomes increase
I bought bologna in college, but now I buy steak! What’s the difference in my income?

31. What is Price Elasticity of Supply?
The ratio of the percentage change in quantity supplied to the percentage change in price

32. E s = %  Q supplied %  Price
E s = 1 Unitary
E s > 1 Elastic
E s < 1 Inelastic

33. Extreme cases of E s
E s = 0, perfectly inelastic (vertical supply curve
E s = , perfectly elastic (horizontal supply curve) S P Q S P Q

34. Does time effect Supply Elasticities?
Yes!
The more time, the more elastic the supply curve

35. Which type of good would be best to tax to raise the most revenue?
Goods that face a price inelastic demand curve will generate the most revenue