1. Elasticity: Measures impact of changes in:
Chapter 5: Elasticity
Elasticity: Measures impact of changes in:
Price (own & related goods)
Income
Supply (factors)

2. Own-Price (Demand) Elasiticity
Economist use the (own) price elasticity of demand to summarize how responsive quantity demanded is to price
Demand curves are not always linear; and responsiveness can change with price

3. Movement along the Demand Curve
Variables that affect quantity demanded/movement of the demand curve
Own-Price of the Good (movement along D)
Price of Related Goods and Future Price of the Good
Income
For now:
Focus only movement along the D curve
Due to a change in the good’s price (its own price)

4. Movement along the Demand Curve
First: measuring how much quantity demanded changes when price changes
Why use the percentage change, rather than just the slope:
What if the demand curve is non-linear (curved) - > slope is not constant
What if the way price is measured changes?
Measuring in cents rather than $ -> slope will be 100 x greater in cents
$ or Euros -> slope will be different by exchange ratio

5. A Better Measure: Percentage Change
Price Elasticity of Demand =
- 50% / + 20%  
= (-) 2.5

6. The Elasticity of Demand (Own-Price)
What does the demand elasticity tell us
Demand is elastic
Elasticity > |1| (< -1)
% Change in Qty Demanded is very price responsive
Small increases -> large decreases in Qd and Revenues
Small decreases -> large increases in Qd and Revenues
Demand is unit elastic
Elasticity = |1| (=-1)
% change in Qd = % change in price -> no change in Revenues with price increases or decreases
Demand is inelastic
Elasticity < |1| (-1 < έ < 0)
% Change in Qty Demanded is not very price responsive
Increases in price -> little change in Qd and larger increases in Revenu
Decreases -> little change in Qd and decreases in Revenues

7. Demand Elasticity Own-Price (price of the good)
Always negative
First law of demand
Talk about it in absolute terms
Less than |1| -> inelastic
Not very price responsive
Equal to |1| -> unit elastic
% change in Qd = % change in price
More than |1| -> (highly) elastic
Very price responsive

8. Elasticity of Demand – Econometric Studies Own-price
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?)

9. The price elasticity of demand – steep or flat D curve?1
The price elasticity of demand – steep or flat D curve?
(d) Elastic demand:
Elasticity > 1
(e) Perfectly elastic demand:
Elasticity equals infinity
1. an
Price
1. an
Price
A 22%
increase
in price…
1. At any price
above $4, quantity
demanded is zero
Demand
2. At exactly $4,
consumers will
buy any quantity $5 50 4
Demand $4
100
3. At any price
below $4, quantity
demanded is infinite
2. … leads to
a 67% decrease
in quantity
demanded
Quantity
Quantity
The price elasticity of demand determines whether the demand curve is steep or flat.
Note that all percentage changes are calculated using the midpoint method.

10. What Determines Demand Elasticity?
Own-price demand elasticity
Elastic Demand: > |1| (% ΔQd > %ΔP)
FLATTER!
Lots of substitutes available - > more price responsive
Good/close substitutes
More time to adjust to the price change (find substitutes)
Elasticity in the long-run > elasticity in the short-run
Inelastic Demand: < |1| (% ΔQd > %ΔP)
No close/good substitutes
STEEPER!!

11. What Affects the Magnitude of the (Own-Pirce) Demand Elasticity
Availability and closeness of substitutes
“better/closer” substitute makes switching easier
Results in either
Greater movement along the demand curve (own)
Greater shift of the demand curve (cross)
Time
More time to adjust, more options you can find
Long-run elasticity > short-run
Proportion of Income spent on the good
Larger proportion -> more sensitive to changes in Income

12. 2 Total revenue Price 1. an $4 P ˣ Q=$400 (revenue) Demand P 100
Quantity Q
The total amount paid by buyers, and received as revenue by sellers, equals the area of the box under the demand curve, P × Q. Here, at a price of $4, the quantity demanded is 100, and total revenue is $400.

13. Elasticity of a linear demand curve (graph)4
Elasticity of a linear demand curve (graph)
Price
Elasticity
is larger
than 1
1. an
Demand $7 14 6 2 5 4 4
Elasticity
is smaller
than 1 6 3 8 2 10 1 12
Quantity
The slope of a linear demand curve is constant, but its elasticity is not. The demand schedule in the table was used to calculate the price elasticity of demand by the midpoint method. At points with a low price and high quantity, the demand curve is inelastic. At points with a high price and low quantity, the demand curve is elastic.

14. Elasticity and Total Revenue
Unit elastic

15. The Elasticity of Demand
Total revenue and price elasticity of demand
Inelastic demand
Increase in price
Increase in total revenue
Elastic demand
Decrease in total revenue

16. Other Types of Elasticities
Generally 3 categories we are concerned about
Price elasticity
Own-price:
How quantity demanded changes with the (own) price
Cross-price
How quantity demanded changes with another (cross) good’s price changes
Income
How quantity demanded changes with a change in your income
Supply elasticity
How quantity supplied changes with a change in (own/market) price

17. The Elasticity of Demand
Cross-price elasticity of demand
Measure of how much the Demand Curve shifts when the price of a related good (subst or complement) changes
[∆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)

18. Elasticity Measures 3 Major Types for Demand Elasticities Own-price
Measures the change in quantity demanded with a change in the (own) good’s price
Always negative (F.L.O.D)
Always expressed in absolute value (as it’s always negative)
Cross-price
Measures the change in quantity demanded with a change in the price of a related good (e.g. complement or substitute)
Complement (-) Substitute (+)
Income
Measures the change in quantity demanded with a change in income
Normal/superiors goods (+) Inferior goods (-)

19. What Does the Magnitude of the Elasticity Tell Us?
Own-price
Larger absolute value (|e| > 1)
Large changes in Qd with small changes in price
Close substitutes exist (pepsi/coke)
Or much consumption is discretionary (micro-brews)
Cross-price
Large value (e >1)
Close (or good) substitute for good exists
Complements
Large absolute value (|e| > 1)
Consumption in fixed proportions
Income
>1 superior (luxury?) good
>0 normal
< 0 inferior (Animal beer)