1. Chapter 6 Elasticity of Demand & Supply McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Price Elasticity of Demand
Def: The degree of responsiveness or sensitivity of consumers to a change in price is measured by the concept of price elasticity of demand.
Ed = % change in quantity / % change in price.
Note: The % changes are compared, not the absolute changes.
a. Absolute changes depend on choice of units. For example, a change in the price of$10,000 car by $1 and is very different than a change in the price a of $1 can of Pepsi by $1. The auto’s price is rising by a fraction of a percent while the Pepsi price is rising 100 percent.
b. Percentages also make it possible to compare elasticities of demand for different products.
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3. Price Elasticity of Demand
Price-elasticity coefficient and formula
Percentage Change in Quantity
Demanded of Product X
Ed =
Percentage Change in Price
of Product X
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4. Price Elasticity of Demand
Calculation problem
Starting point matters
Midpoint formula
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5. Possible Outcome Ed < 1 we say demand is inelastic (Necessity good)
Ed > 1 we say demand is elastic (Luxury good)
Ed = 1 this is called unit elasticity (Undetermined)

6. Interpretations of Elasticity
Elastic Demand
Ed =
.04
.02
= 2
Inelastic Demand
Ed =
.01
.02
= .5
Unit Elasticity
Ed =
.02
= 1
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7. Price Elasticity of Demand
Why use percentages?
Unit free measure
Compare responsiveness across products
Elimination of the (-) sign
Extreme cases
Perfectly inelastic demand
Perfectly elastic demand
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8. Extreme situations Perfectly Inelastic Demand -- Ed = 0
Perfectly Elastic Demand - Ed = huge

9. The Total Revenue & Total Revenue = TR = PxQ All depends on:
1- Substitutes 2- proportion to income 3- luxury or a necessity 4- time
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10. Price Elasticity of Supply
Responsiveness to price changes by producers
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11. Price Elasticity of Supply & time period
Example:
Antiques and Concerts (perfect inelastic).
Gold (some how inelastic)
Oil (elastic unless OPEC controls)
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12. Cross Elasticity of Demand
Responsiveness of sales to change in price of another good
1. If cross elasticity is positive, then X and Y are substitutes.
2. If cross elasticity is negative, then X and Y are complements.
3. Note: if cross elasticity is zero, then X and Y are unrelated, independent products.
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13. Income Elasticity of Demand
Responsiveness of sales to change in income
X is a Normal goods – positive sign
X is an Inferior goods– negative sign
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14. Elasticity and Pricing Power
Competitive markets
No pricing power
Firms with market power
Charge different prices
Differences in group elasticities
Business vs. leisure travelers
Discounting for children
College tuition
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