1. Prepared by :Dr.Hassan Sweillam
ELASTICITY
Prepared by :Dr.Hassan Sweillam
Elasticity

2. ELASTICITY
Elasticity is the concept economists use to describe the steepness or flatness of curves or functions.
In general, elasticity measures the responsiveness of one variable to changes in another variable.
It’s always a ratio of percentage changes.
That means it is a pure number -- there are no units of measurement on elasticity.
Elasticity

3. PRICE ELASTICITY OF DEMAND
Measures the responsiveness of quantity demanded to changes in a good’s own price.
The price elasticity of demand is the percent change in quantity demanded divided by the percent change in price that caused the change in quantity demanded.
Price elasticity of demand is computed along a demand curve.
Elasticity

4. COMPUTE OF ELASTICITIES
THERE ARE LOTS OF WAYS TO COMPUTE ELASTICITIES. SO BEWARE! THE DEVIL IS IN THE DETAILS.
MOST OF THE AMBIGUITY IS DUE TO THE MANY WAYS YOU CAN COMPUTE A PERCENTAGE CHANGE. BE ALERT HERE. IT’S NOT DIFFICULT, BUT CARE IS NEEDED.
Elasticity

5. What’s the percent increase in price here because of the shift in supply?D QE Q
CIGARETTE MARKET
Elasticity

6. COMPUTE OF ELASTICITIES
IS IT:
A) [.5/2.00] times 100?
B) [.5/2.50] times 100?
C) [.5/2.25] times 100?
Elasticity

7. COMPUTE OF ELASTICITIES
From time to time economists have used ALL of these measures of percentage change .
Notice that the numerical values of the percentage change in price is different for each case:
A) [.5/2.00] times 100 = 25 percent
B) [.5/2.50] times 100 = 20 percent
C) [.5/2.25] times 100 = percent
Elasticity

8. The Midpoint Formula
Economists usually use the “midpoint” formula (option C), above) to compute elasticity.
Elasticity =
% change in p = times 100.
% change in p =
For the prices $2 and $2.50, the % change in p is approx percent.
Elasticity

9. What’s the percent change in Q due to the shift in supply?
price S
pE’ = $2.50
pE = $2.00 D
QE’ = 7
QE = 10
Q (millions)
CIGARETTE MARKET
Elasticity

10. Use the midpoint formula again.
Elasticity =
% change in Q =
For the quantities of 10 and 7, the % change in Q is approx percent. (3/8.5 times 100)
Elasticity

11. NOW COMPUTE ELASTICITY
% change in p = percent
% change in Q = percent
E = / = -1.6 (approx.)
Elasticity

12. But you can do the other options as well:
If you use the low price 2 , and its corresponding quantity 10 , as the base values,
%change in Q / % change in P = 3/10 / 0.5/2
then elasticity = 1.2
If you use the high price, and its corresponding quantity, as the base values,
%change in Q / % change in P = 3/7 / 0.5/2.5
then elasticity = 2.1 (approx.)
And the midpoint formula gave
%change in Q / % change in P = 3/8.5 / 0.5/2.25
then elasticity = 1.6 (approx.)
SAME PROBLEM...DIFFERENT ANSWERS!!!
Elasticity

13. MORE ELASTICITY COMPUTATIONS
QUANTITY
PRICE P 10 14
Compute elasticity between
prices of $9 and $8. 1 9 12 2 8 10 3 7 8 4 6 6 5 5 4 6 4 2 7 3 Q 8 2 2 4 6 8 10 12 14 9 1 10
Elasticity

14. USE THE MIDPOINT FORMULA
The % change in Q =
The % change in P =
Therefore elasticity =
The % change in Q = = 1 / 1.5 times 100
The % change in P = = 1 / 8.5 times 100
Therefore elasticity = / = (approx.)
Elasticity

15. Now we try different prices
QUANTITY
PRICE 10 P 1 9 14
Compute elasticity between
prices of $3 and $2. 2 8 12 3 7 10 4 6 8 5 5 6 6 4 4 2 7 3 Q 8 2 2 4 6 8 10 12 14 9 1 10
Elasticity

16. Therefore elasticity = -13.33 / 40 = -.33 (approx.)
The % change in Q =
The % change in P =
Therefore elasticity =
The % change in Q = = 1 / 7.5 times 100
The % change in P = 40 = 1 / 2.5 times 100
Therefore elasticity = / 40 = (approx.)
Elasticity

17. ELASTICITY IS NOT SLOPE!
QUANTITY
PRICE P
Note that elasticity is different
at the two points even though
the slope is the same.
(Slope = -1) 10 14 1 9 12
E = -5.67 2 8 10 3 7 8 4 6 6
E = -.33 5 5 4 6 4 2 7 3 Q 8 2 2 4 6 8 10 12 14 9 1 10
Elasticity

18. TERMS TO LEARN
Demand is ELASTIC when the numerical value of elasticity is greater than 1.
Demand is INELASTIC when the numerical value of elasticity is less than 1.
Demand is UNIT ELASTIC when the numerical value of elasticity equals 1.
NOTE: Numerical value here means “absolute value.”
Elasticity

19. LIKE THIS! QUANTITY PRICE 10 1 9 2 8 3 7 4 6 5 5 6 4 7 3 8 2 9 1 1014 10 12
Demand is elastic here. 1 9 10 2 8 8 3 7
Demand is inelastic here. 6 4 6 4 5 5 2 6 4 Q 7 3 2 4 6 8 10 12 14 8 2 9 1 10
Elasticity

20. There is an important relationship between what happens to consumers’ spending on a good and elasticity when there is a change in price.
Spending on a good = P Q.
Because demand curves are negatively sloped, a reduction in P causes Q to rise and the net effect on PQ is uncertain, and depends on the elasticity of demand.
Elasticity

21. QUANTITY PRICE 10 Demand is elastic here. 1 9 2 8 3 7 4 6 5 5 6 4 7 3
At P = $9, spending is $9 (= 1 times $9).
At P = $8, spending is $16 ( = 2 times $8).
When price fell from $9 to $8, spending rose. Q must have increased by a larger percent than P decreased. So...
QUANTITY
PRICE 10 P
Demand is elastic here. 1 9 14 2 8 12 3 7 10 4 6 8 5 5 6 6 4 4 7 3 2 8 2 Q 9 1 2 4 6 8 10 12 14 10
Elasticity

22. Demand is inelastic here. 4 6 5 5 6 4 7 3 8 2 9 1 10
At P = $3, spending is $21 (= 7 times $3).
At P = $2, spending is $16 ( = 8 times $2).
When price fell from $3 to $2, spending fell. Q must have
increased by a smaller percent than P decreased. So...
QUANTITY
PRICE P 10 14 1 9 12 2 8 10 3 7 8
Demand is inelastic here. 4 6 6 5 5 4 6 4 2 7 3 8 2 Q 2 4 6 8 10 12 14 9 1 10
Elasticity

23. If, when price falls, total spending increases, demand is elastic.
There is an easy way to tell whether demand is elastic or inelastic between any two prices.
If, when price falls, total spending increases, demand is elastic.
If, when price falls, total spending decreases, demand is inelastic.
Elasticity

24. But total spending is easy to see using a demand curve graph:
QUANTITY
PRICE 14 10 12
The shaded area is P times Q,
or total spending when P = $9. 1 9 10 2 8 8 3 7 4 6 6 5 5 4 6 4 2 7 3 Q 2 4 6 8 10 12 14 8 2 9 1 10
Elasticity

25. The shaded area is P times Q or total spending when P = $8. QUANTITY 14
The shaded area is P times Q
or total spending when P = $8.
QUANTITY
PRICE 12 10 10 1 9 8 2 8 6 3 7 4 4 6 2 5 5 Q 6 4 2 4 6 8 10 12 14 7 3 8 2 9 1 10
Elasticity

26. Total spending is higher at the price
= loss in TR
due to fall in P
= gain in TR due to
rise in Q P 14
Total spending is higher at the price
of $8 than it was at the price of $9.
QUANTITY
PRICE 12 10 10 1 9 8 2 8 6 3 7 4 6 4 5 5 2 6 4 Q 2 4 6 8 10 12 14 7 3 8 2 9 1 10
Elasticity

27. The shaded area is total spending (total revenue of 14
QUANTITY
PRICE
The shaded area is total
spending (total revenue of
sellers) when P = $3. 10 12 1 9 10 2 8 8 3 7 6 4 6 4 5 5 2 6 4 7 3 2 4 6 8 10 12 14 Q 8 2 9 1 10
Elasticity

28. Total revenue of sellers (total spending by buyers) falls when
QUANTITY
PRICE 14 10
Total revenue of sellers (total
spending by buyers) falls when
price falls from $3 to $2. 12 1 9 10 2 8 8 3 7 6 4 6 4 5 5 6 4 2 7 3 Q 8 2 2 4 6 8 10 12 14 9 1 10
Elasticity

29. Here’s a convenient way to think of the relative elasticity of demand curves.p
relatively more elastic
at p* p*
relatively more inelastic
at p* Q Q*
Elasticity

30. Examples of elasticity
Doctors through the AMA restrict the supply of physicians. How does this affect the incomes of doctors as a group?
A labor union negotiates a higher wage. How does this affect the incomes of affected workers as a group?
MSU decides to raise the price of football tickets. How is income from the sale of tickets affected?
Airlines propose to raise fares by 10%. Will the boost increase revenues?
Elasticity

31. MORE ...
MSU is considering raising tuition by 7%. Will the increase in tuition raise revenues of MSU?
CATA recently raised bus fares in the Lansing area. Will this increase CATA’s total receipts?
Elasticity

32. The answers to all of these questions depend on the elasticity of demand for the good in question. Be sure you understand how and why!
Elasticity

33. DETERMINANTS OF DEMAND ELASTICITY
The more substitutes there are available for a good, the more elastic the demand for it will tend to be. [Related to the idea of necessities and luxuries. Necessities tend to have few substitutes.]
The longer the time period involved, the more elastic the demand will tend to be.
The higher the fraction of income spent on the good, the more elastic the demand will tend to be.
Elasticity

34. OTHER ELASTICITY MEASURES
In principle, you can compute the elasticity between any two variables.
Income elasticity of demand
Cross price elasticity of demand
Elasticity of supply
Elasticity

35. Each of these concepts has the expected definition
Each of these concepts has the expected definition. For example, income elasticity of demand is the percent change in quantity demand divided by a percent change income:
EINCOME =
Income elasticity of demand will be positive for normal goods, negative for inferior ones.
Elasticity

36. Review questions True or False Questions
1- Elasticity is the concept economists use to describe the steepness or flatness of curves or functions.
Answer: True
2- In general, elasticity not always a ratio of percentage changes.
Answer: False

37. True or False Questions
Review questions
True or False Questions
3- The price elasticity of demand is the percent change in quantity supplied divided by the percent change in price that caused the change in quantity demanded.
Answer: False
4- Price elasticity of demand is computed along a demand curve.
Answer: True

38. Review questions Multiple Choice Questions
1- __________is the concept economists use to describe the steepness or flatness of curves or functions.
A- Demand
B- Elasticity
C- Supply elasticity
D- Curve
Answer: B

39. Review questions A- Neutral B- Average C- Midpoint D- None of these
2- Economists usually use the ____________ formula to compute elasticity.
A- Neutral
B- Average
C- Midpoint
D- None of these
Answer: C

40. Review questions
3- Demand is ____________ when the numerical value of elasticity is less than 1.
A- Elastic
B- Inelastic
C- Small
D- None of these
Answer: B

41. Brief explain Questions
Review questions
1- Briefly explain the concept of elasticity ?
2- Briefly explain the price elasticity of demand?
3-Briefly explain the Midpoint formula of computing elasticity illustrated with graphics?
Brief explain Questions