1. Chapter 4: Elasticity
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2. Chapter Outline/Learning Objectives
Section
Learning Objectives
After studying this chapter, you will be able to
4.1 Price Elasticity of Demand
explain what price elasticity of demand is and how it is measured.
explain the relationship between total expenditure and price elasticity of demand.
4.2 Price Elasticity of Supply
explain what price elasticity of supply is and how it is measured.
4.3 An Important Example Where Elasticity Matters
see how elasticity of demand and supply determine the effects of an excise tax.
4.4 Other Demand Elasticities
measure the income elasticity of demand and be able to distinguish between normal and inferior goods.
measure cross elasticity of demand and be able to distinguish between substitute and complement goods.
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Chapter 4, Slide

3. 4.1 Price Elasticity of Demand
Demand is said to be elastic when quantity demanded is very responsive to a change in the products own price. Demand is inelastic if quantity demanded is very unresponsive to changes in its price. Elasticity is related to the slope of the demand curve, but it is not exactly the same.
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Chapter 4, Slide

4. Fig. 4-1(i) Elastic Demand
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5. Fig. 4-1(ii) Inelastic Demand
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6. The Measurement of Price Elasticity
Elasticity (Greek letter eta:) is defined as: Demand elasticity is negative, but economists usually emphasize the absolute value. Elasticity usually measures the change in p and Q relative to some "base" values of p and Q.
 =
 QD / QD
 p / p
percentage change in quantity demanded
percentage change in price
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Chapter 4, Slide

7. Demand elasticity between point "0" and point "1" on some demand curve is: where p and Q are the average price and average quantity, respectively. Thus p = (p1+p0)/2 and Q = (Q1+Q0)/2. After a little simplifying, we get:
 =
(Q1 - Q0)/Q
(p1 - p0)/p
 =
(Q1 - Q0)/(Q1 + Q0)
(p1 - p0)/(p1 + p0)
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Chapter 4, Slide

8. A Numerical Example of Price Elasticity
Product
Original Price
New
Price
Average Price
Original Quantity
New Quantity
Average Quantity
Corona Beer (6-pack)
$9.00
$8.00
$8.50
2000
3000
2500
 =
( )/( )/2
(8 - 9)/(8 + 9)/2
(1000)/(2500)
 =
(1)/(8.5)
0.4
 = =
3.40
0.1176
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Chapter 4, Slide

9. Price Elasticity of Demand
LO1
Elasticity Coefficient
a number that measures the responsiveness of quantity demanded to a change in price
If coefficient is:
Demand is:
Greater than 1
Elastic
Less than 1
Inelastic
Equal to 1
Unitary
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10. Price Elasticity of Demand
LO1
Inelastic Demand
quantity demanded that is not very responsive to a change in price
Elastic Demand
quantity demanded that is quite responsive to a change in price
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11. Fig. 4-2 Elasticity Along a Linear Demand Curve
 > 1
Inelastic
 < 1
Perfectly Inelastic
 = 0
Unit Elastic
 = 1
 = 
Perfectly Elastic
Elasticity falls as you move down a linear demand curve.
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Chapter 4, Slide

12. What Determines Elasticity of Demand?
Demand elasticity tends to be high when there are many close substitutes.
The availability of substitutes is determined by:
the length of the time interval considered
whether the good is a necessity or a luxury
how specifically the product is defined
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Chapter 4, Slide

13. Self-Test a) Calculate the elasticity coefficients for each set.
LO1
a) Calculate the elasticity coefficients for each set.
b) In each set the change in price is $1 and the change in quantity is 1 unit. Why aren’t the coefficients the same?
Price
Quantity
Set I $9 1 8 2
Set II 9
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14. Fig. 4-3 Three Demand Curves with Constant Elasticity
D1 is perfectly inelastic
D2 is perfectly elastic at p0
D3 is unit elastic
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15. Fig. 4-4 Short-Run and Long-Run Equilibrium Following an Increase in Supply
The changes depend on the time that consumers have to respond. In the long run, demand is more elastic.
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Chapter 4, Slide

16. Fig. 4-5 Total Expenditure and Quantity Demanded
When demand is elastic, TE increases when price falls. When demand is inelastic, TE decreases when price falls. TE reaches a maximum when demand is unit elastic. Example: What happens when OPEC's output restrictions raise the world price of oil?
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Chapter 4, Slide

17. Elasticity and Total Revenue
LO1
If demand is elastic, an increase in price will decrease revenue
If demand is inelastic, an increase in price will increase revenue
Vancouver to Edmonton
Vancouver to Calgary
Price
Quantity
Total Revenue: C
Total Revenue: D
$650
1000 $
750
900
inelastic
elastic
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18. 4.2 Price Elasticity of Supply
Price elasticity of supply measures the responsiveness of the quantity supplied to a change in the product's own price. It is denoted by s and is defined as:
S =
percentage change in quantity supplied
percentage change in price
 QS / QS
 p / p
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Chapter 4, Slide

19. Determinants of Supply Elasticity
The elasticity of supply depends on how easily firms can increase output in response to an increase in the product’s price.
This depends on:
the technical ease of substitution in production
the nature of production costs
the time span under consideration
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20. Fig. 4-6 Computing Price Elasticity of Supply
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Chapter 4, Slide

21. 4.3 An Important Example Where Elasticity Matters
Fig The Effect of a Cigarette Excise Tax
An excise tax raises the price paid by consumers but reduces the price received by producers.
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Chapter 4, Slide

22. Fig. 4-9 Elasticity and the Incidence of an Excise Tax
The burden of an excise tax is independent of who actually remits the tax to the government—it depends only on the relative elasticities of demand and supply.
Fig Elasticity and the Incidence of an Excise Tax
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Chapter 4, Slide

23. 4.4 Other Demand Elasticities
Income Elasticity of Demand
percentage change in quantity demanded
Y =
percentage change in income
If Y > 0, the good is said to be normal
If Y < 0, the good is said to be inferior
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Chapter 4, Slide

24. Luxuries Versus Necessities
The more necessary an item is in the consumption pattern of consumers, the lower its income elasticity. Income elasticities for any one product also vary with the level of a consumer’s income. The distinction between luxuries and necessities also helps to explain differences in income elasticities between countries.
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Chapter 4, Slide

25. Income Elasticity If coefficient is: Type of Good: Demand is:
LO5
If coefficient is:
Type of Good:
Demand is:
Greater than 1
Normal –
Luxury good
Income elastic
Less than 1 but greater than 0
Normal – Necessity
Income inelastic
Less than 0
Inferior good
Negative income elasticity
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26. Self-Test
LO5
You are given the following data. Assume that the prices of X and Y do not change:
a) Calculate the income elasticity for products X and Y.
b) Are products X and Y normal goods?
Income
Quantity Demanded of X
Quantity Demanded of Y
$10 000
200 50
15 000
350 54
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27. Cross Elasticity of Demand
percentage change in quantity demanded of good X
XY =
percentage change in price of good Y
If XY > 0, then X and Y are substitutes
If XY < 0, then X and Y are complements
EXTENSIONS IN THEORY 4-2
The Terminology of Elasticity
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Chapter 4, Slide

28. Quantity Demanded per Week (lb.)
Cross Elasticity
LO5
Margarine
Butter
Price
Quantity Demanded per Week (lb.)
$1.50
5000
$3.00
1000
2.10
3200
3.00
2000
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29. Cross Elasticity If coefficient is: Goods are: Positive Substitutes
LO5
If coefficient is:
Goods are:
Positive
Substitutes
Negative
Complements
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30. (thousands of person-visits per year)
Review – Chapter 4
Refer to Table. Between the prices of $8 and $10, the elasticity of demand is A) 2. B) 1. C) 2/3. D) 3. E) 1/3.
Price
(per visit
per person)
Quantity Demanded
(thousands of person-visits per year)
$10 2
$ 8 4
$ 6 6
$ 4 8
$ 2 10
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31. Tax Incidence
Consumers will bear a larger burden of an excise tax if A) demand is relatively elastic and supply is relatively inelastic. B) the tax is collected by firms rather than remitted directly to the government by consumers. C) both demand and supply are relatively inelastic. D) both demand and supply are relatively elastic. E) demand is relatively inelastic and supply is relatively elastic.
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32. Elasticity and Slope
Which of the following statements is correct?  A. Demand curve D3 is the most inelastic demand. B. Equilibrium price must be $50. C. If price is $30 and demand is D3 then the quantity demanded is 720 units per day. D. Demand curve D1 is more inelastic than D3. E. Demand curve D1 is perfectly elastic.
© McGraw Hill Publishing Co, 2011