1. Unit 2: Consumer Choice, Demand, and Supply
Lecture #4:
Elasticity of Demand and Supply

2. ELASTICITY OF DEMAND (Price Elasticity of Demand)
The degree to which a change in price affects the quantity demanded
ED = % change in quantity demanded
% change in price

3. MIDPOINT FORMULA FOR ELASTICITY OF DEMAND
ED= (Q2 – Q1)
(Q2 + Q1)/2
____________________________
(P2 – P1)
(P2 + P1)/2

4. The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities
Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand, using the midpoint formula, would be calculated as:

5. ELASTIC DEMAND
When a small change in price leads to a relatively large change in the quantity demanded
Ex. A 10 % increase in price leads to a 20% reduction in the quantity demanded
ED > 1

6. Elastic Demand Reasons why demand for a good is elastic:
The product is not necessary
There are substitutes available
The product takes a large portion of the consumer’s income
The market is narrowly defined (like a particular brand name)
The longer the time period to purchase the good
Examples of goods with elastic demand
Fresh peas 2.83
Lamb and mutton 2.65
Restaurant meals 2.27
Residential land 1.60
Beef 1.27

7. Figure 1 The Price Elasticity of Demand
(e) Perfectly Elastic Demand: Elasticity Equals Infinity
Price
1. At any price
above $4, quantity
demanded is zero. $4
Demand
2. At exactly $4,
consumers will
buy any quantity.
3. At a price below $4,
quantity demanded is infinite.
Quantity

8. ED < 1 INELASTIC DEMAND
When a change in price leads to little or no change in the quantity demanded
Ex. A 20% decrease in price leads to a 10% increase in the quantity demanded
ED < 1

9. INELASTIC DEMAND Reasons why demand for a good is inelastic:
The product is necessary with few/no substitutes
Product takes a small portion of the consumer’s income
The market is widely defined (in general, not a brand name, etc.)
There is a short time period to buy the good
Examples of goods with inelastic demand
Electricity .13
Bread .15
Telephone service .26
Gasoline .6
Milk .63

10. Figure 1 The Price Elasticity of Demand
(a) Perfectly Inelastic Demand: Elasticity Equals 0
Price
Demand
100 $5
1. An
increase
in price . . . 4
Quantity
leaves the quantity demanded unchanged.
Copyright©2003 Southwestern/Thomson Learning

11. UNIT ELASTIC DEMAND ED = 1
When the change quantity demanded is proportional to the change in price
Ex. 20% change in price leads to 20% change in quantity demanded
ED = 1

12. Figure 1 The Price Elasticity of Demand
(c) Unit Elastic Demand: Elasticity Equals 1
Price
Demand $5 80
1. A 22%
increase
in price . . . 4
100
Quantity
leads to a 22% decrease in quantity demanded.
Copyright©2003 Southwestern/Thomson Learning

13. The Variety of Demand Curves
Perfectly Inelastic
Quantity demanded does not respond to price changes.
Perfectly Elastic
Quantity demanded changes infinitely with any change in price.
Unit Elastic
Quantity demanded changes by the same percentage as the price.

14. TOTAL REVENUE TEST FOR ELASTICITY OF DEMAND
Total Revenue (TR) = P x Q
Elastic Demand
Price goes up, total revenue goes down
Price goes down, total revenue goes up
Inelastic Demand
Price goes up, total revenue goes up
Price goes down, total revenue goes down
Unit Elastic Demand
Price goes up, total revenue remains unchanged
Price goes down, total revenue remains unchanged

15. Figure 2 Total Revenue Price $4 P × Q = $400 P (revenue) Demand 100
Quantity Q
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16. Figure 3 How Total Revenue Changes When Price Changes: Inelastic Demand
An Increase in price from $1
to $3 …
… leads to an Increase in total revenue from $100 to $240
Demand
Demand $3 80
Revenue = $240 $1
100
Revenue = $100
Quantity
Quantity
Copyright©2003 Southwestern/Thomson Learning

17. Figure 4 How Total Revenue Changes When Price Changes: Elastic Demand
An Increase in price from $4
to $5 …
… leads to an decrease in total revenue from $200 to $100 $5 20
Demand
Demand
Revenue = $100 $4 50
Revenue = $200
Quantity
Quantity
Copyright©2003 Southwestern/Thomson Learning

18. Elasticity of a Linear Demand Curve

19. Elasticity of a Linear Demand Curve
A downward-sloping demand curve will have elastic, unit elastic, and inelastic segments. Elasticity does not equal slope.
At the higher prices and lower quantities, the percent change in quantity will exceed the percent change in price and demand will be elastic
At the lower prices and higher quantities, the percent change in price will exceed the percent change in quantity and demand will be inelastic

20. ELASTICITY OF SUPPLY (Price Elasticity of Supply)
The degree of responsiveness to a change in price by suppliers
Is calculated the same way as elasticity of demand
Time periods are important to elasticity of supply
In the market period, elasticity of supply is very inelastic
In the short-run, supply is more elastic than in the market period and depends on the ability of producers to respond to changes in price
In the long-run, supply is the most elastic because adjustments can be made by producers over time

21. ELASTICITY OF SUPPLY MEASURES
ES > 1  Elastic ED = 1  Unit Elastic ED > 1  Inelastic

22. MIDPOINT FORMULA FOR ELASTICITY OF SUPPLY
ES= (Q2 – Q1)
(Q2 + Q1)/2
____________________________
(P2 – P1)
(P2 + P1)/2

23. Figure 6 The Price Elasticity of Supply
(e) Perfectly Elastic Supply: Elasticity Equals Infinity
Price
1. At any price
above $4, quantity
supplied is infinite. $4
Supply
2. At exactly $4,
producers will
supply any quantity.
3. At a price below $4,
quantity supplied is zero.
Quantity
Copyright©2003 Southwestern/Thomson Learning

24. Figure 6 The Price Elasticity of Supply
(a) Perfectly Inelastic Supply: Elasticity Equals 0
Price
Supply $5
1. An
increase
in price . . . 4
100
Quantity
leaves the quantity supplied unchanged.
Copyright©2003 Southwestern/Thomson Learning

25. CROSS ELASTICITY OF DEMAND
Refers to the effect of a change in a product’s price on the quantity demanded for another product
Exy= % change in quantity of X
% change in price of Y

26. CROSS ELASTICITY OF DEMAND (continued)
Cross Elasticity > 0, Good X and Good Y are Substitute Goods
Cross Elasticity is < 0, X and Y are Complementary Goods
If Cross Elasticity is = 0, X and Y are unrelated, independent products

27. INCOME ELASTICITY OF DEMAND
Refers to the % change in quantity demanded which results from some % change in consumer incomes
Ei = % change in quantity demanded
% change in income

28. INCOME ELASTICITY OF DEMAND (continued)
Income Elasticity > 0 indicates a Normal Good
Income Elasticity < 0 indicates an Inferior Good

29. Elasticity Scenarios
1) Price Coke up 20% QD Pepsi up 40% 2) Price hot dogs up 40% QD relish down 30% 3) Price econ up 30% QD fun unchanged

30. Elasticity Scenarios
4) Income up 20% QD for New York Mets, Pittsburgh Pirates, Houston Astros, Los Angeles Dodgers, tickets up 40% 5) Income up 20% QD for Atlanta Brave, Florida Marlins, Tampa Bay Rays, Minnesota Twins, Colorado Rockies tickets down 60%