1. © 2015 by McGraw-Hill Ryerson Ltd.

2. © 2015 by McGraw-Hill Ryerson Ltd.
Chapter 3 Elasticity
© 2015 by McGraw-Hill Ryerson Ltd.

3. © 2015 by McGraw-Hill Ryerson Ltd.
Learning Objectives
After this chapter, you will be able to:
describe price elasticity of demand, its relation to other demand elasticities, and its impact on sellers’ revenues
define price elasticity of supply and the links between production periods and supply
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4. Elastic and Inelastic Demand
Price elasticity of demand shows how responsive consumers are to price changes.
Elastic demand means the % change in QD is more than in price
Inelastic demand means the % change in QD is less than in price.
Unit-elastic demand means the % change in QD equals the % change in price.
asticityLesson/ElasticityLesson.html
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5. Elastic and Inelastic Demand FIGURE 3.1
Elastic Demand Curve
for Ice Cream Cones
Inelastic Demand Curve
for Ice cream Cones
2.40
2.40
20%
20%
2.00
2.00 D1
1.60
1.60 D2
50%
Price ($ per cone)
1.20
Price ($ per cone)
1.20
10%
0.80
0.80
0.40
0.40
500
1000
500
1000
Quantity Demanded
(cones per winter month)
Quantity Demanded
(cones per summer month)
For the elastic demand curve (D1), a 20% increase in price leads to a greater 50% decrease in quantity demanded. For the inelastic demand curve (D2) the same 20% increase in price now leads to a smaller 10% decrease in quantity demanded. Percent calculation— difference / original amount

6. Perfectly Elastic and Perfectly Inelastic Demand (a)
Perfectly elastic demand means a constant price and a horizontal demand curve.
Perfectly inelastic demand means a constant quantity demanded and a vertical demand curve.
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7. Perfectly Elastic and Perfectly Inelastic Demand FIGURE 3.2
Demand Curve
for Soybeans
Perfectly Inelastic
Demand Curve
for Insulin D4
1.60 D3
Price ($ per tonnes)
Price ($ per tonnes)
1000
Quantity Demanded
(tonnes)
Quantity Demanded
(litres)
A single soybean farmer might face a perfectly elastic demand curve with a constant price. A producer of insulin might face a vertical or perfectly inelastic demand curve with the quantity demanded constant.

8. Impact on Total Revenue
A price change causes total revenue to change in the opposite direction when demand is elastic.
A price change causes total revenue to change in the same direction when demand is inelastic.
A price change does not affect total revenue when demand is unit-elastic.
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9. Revenue Changes with Elastic Demand Figure 3.3 Page 63
Revenues with Elastic Demand
FIGURE 3.3
Demand Curve for hot dogs 5 4 A 3
Price ($ per hotdog) D 2 B C 1
500
1000
1500
Quantity Demanded (hotdogs per day)
With elastic demand, a 40% decrease in the price from $5 to $3 causes a larger 200% increase in daily sales. Total revenue for the business increases from the area AB to the area BC. The changes in price and total revenue are in opposite directions.

10. Revenue Changes with Inelastic Demand Figure 3.4 Page 64
Revenues with Inelastic Demand FIGURE 3.4
Demand Curve for Amusement Park Rides 5 4 3
Price ($ per ride) E 2 D 1 F G
2000
4000
6000
8000
10 000
Quantity Demanded (riders each day)
Because demand is inelastic, a 50% rise in the price of the ride causes a smaller 20% drop in daily ridership. As a result, total revenue for the ride’s operator grows from area FG to area EF. The changes in price and total revenue are in the same direction.

11. Total Revenue and Elasticity FIGURE 3.5
Demand Elasticity and Changes in Total Revenue
Elastic Demand
Inelastic Demand
Unit-Elastic Demand
Price
Change up
down
Change in
Total Revenue
down up
unchanged
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12. Determinants of Demand Elasticity
There are four determinants of price elasticity of demand:
portion of consumer incomes (products with smaller portions are more inelastic)
access to substitutes (products with more substitutes are more elastic)
necessities versus luxuries (more inelastic for necessities and more elastic for luxuries)
time (more elastic with the passage of time)
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13. Calculating Demand Elasticity
A numerical value for price elasticity of demand (ed) is found by taking the ratio of the changes in quantity demanded and in price, each divided by its average value.
In mathematical terms:
ed = ΔQd ÷ average Qd
Δprice ÷ average price
/ElasticityLesson.html (different formula)
Virtual Economics

14. Elasticity and a Linear Demand Curve
A linear demand curve has a different price elasticity (ed) at every point.
At high prices, the change in QD is large relative to average QD, while the change in P is smaller at low prices relative to average P, giving a large ed
At low values of price, the change in QD is small relative to average QD, while the change in P is large relative to average P, giving a small ed. 
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15. Elasticity and a Linear Demand Curve FIGURE 3.6
Market Demand Curve for Sodas
Market Demand Schedules
for Sodas 5
ed > 1
Price
($ per soda)
Quantity
Demanded
(millions of sodas)
Price
Elasticity
of Demand
(ed) 4 3
ed = 1
Price ($ per soda) 5 4 3 2 1 1 2 3 4 5 2
9.00
2.33
1.00
0.43
0.11
ed < 1 1 D 1 2 3 4 5
The slope of this linear demand curve is always -1 millionth. But at any price range above $3 this linear demand curve is elastic, between prices $3 and $2 the curve is unit-elastic and at any price range below $2 the curve is inelastic.
Quantity Demanded
(millions of sodas)

16. Income Elasticity In mathematical terms: ei = ΔQd ÷ average Qd
Income elasticity (ei) is the responsiveness of a product’s quantity demanded to changes in consumer income.
In mathematical terms:
ei = ΔQd ÷ average Qd
ΔI ÷ average I
Income elasticity’s sign (- or +) is important
For inferior products the sign is – because changes in consumer incomes and quantity demanded are in opposite directions
Income elasticity is + for a normal product because changes in consumer income and the product’s quantity demanded are in the same direction

17. Cross-Price Elasticity
Cross-price elasticity (exy) is the responsiveness of the quantity demanded of one product (x) to a change in price of another (y).
In mathematical terms:
exy = ΔQdx ÷ average Qdx
ΔPy ÷ average Py
Cross-price elasticity’s sign differs depending on whether products x and y are substitutes or complementary
When one product is a substitute for another the cross- price elasticity is + because changes in both x’s quantity demanded and y’s price are in the same direction
The cross-price elasticity for complementary products is – because an increase in the quantity demanded of one product might be caused by a fall in the price of its complementary product
Page Practice Problems #1 and #2

18. © 2015 by McGraw-Hill Ryerson Ltd.
Assignments
Page 75 #2, 3, 4, 5, 6, 7, 8
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19. Price Elasticity of Supply
Price elasticity of supply measures the responsiveness of quantity supplied to price changes.
Elastic supply means the % change in Qs is more than the % change in price.
Inelastic supply means the % change in Qs is less than the % change in price.
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20. Elastic and Inelastic Supply FIGURE 3.7
Elastic Supply Curve
for Tomatoes
Inelastic Supply Curve
For Tomatoes 4 4 S2 S1 3 3
50%
50%
Price ($ per kilogram)
Price ($ per kilogram) 2 2
100%
20% 1 1
120000
Quantity Supplied
(kilograms per year)
Quantity Supplied
(kilograms per year)
The elastic supply curve (S1) shows a 50% increase in price leading to a greater 100% increase in quantity supplied. An inelastic demand curve shows the same 50% increase in price now leads to a smaller 20% increase in quantity supplied.

21. Perfectly Elastic and Perfectly Inelastic Supply
Perfectly elastic supply means a constant price and a horizontal supply curve.
Perfectly inelastic supply means a constant quantity supplied and a vertical supply curve.
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22. Time and Supply Elasticity
Price elasticity of supply changes over three production periods:
Supply is perfectly inelastic in the immediate run--the production period during which none of the resources required to make a product can be varied
Supply is either elastic or inelastic in the short run--the production period during which at least one of the resources required to make a product cannot be varied
Supply is perfectly elastic for a constant-cost industry and very elastic for an increasing-cost industry in the long run--the production period during which all resources required to make a product can be varied, and businesses may either enter or leave the industry

23. In the Immediate and Short Run FIGURE 3.8
Immediate-Run
Supply Elasticity
for Strawberries
Short-Run
Supply Elasticity
For Strawberries S2
2.50 S1
2.00
Price ($ per kilogram)
Price ($ per kilograms) 9 11
Quantity Supplied
(kilograms per month)
Quantity Supplied
(millions of kilograms per year)
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24. Constant Cost Industry
If strawberries are produced in a constant- cost industry (an industry that is not a major user of any single resource):
A higher price of strawberries raises production but not resource prices.
As new businesses enter the industry in the long run due to a higher price of strawberries, this price is gradually pushed back down to its original level.
Therefore the long-run supply curve for a constant-cost industry is perfectly elastic. 
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25. Increasing Cost Industry
If strawberries are produced in an increasing- cost industry (an industry that is a major user of at least one resource):
A higher price of strawberries raises production and also resource prices.
As new businesses enter the industry in the long run due to a higher price of strawberries, this price is gradually pushed back down to its lowest possible level, but this level is higher than it was originally.
Therefore the long-run supply curve for an increasing-cost industry is very elastic.
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26. Increasing and Constant Cost Industries
e.g. Increasing cost industry - Farming can be an example of this because so many different factors can impact upon production costs during expansion e.g. specialized materials and equipment will differ between the types of produce such as seed, fertilizer, irrigation, yield per acre, sowing and harvesting equipment etc. Constant cost industry - If you produce black leather shoes and you expand to produce brown leather shoes then it is reasonable that your average production costs will remain the same.
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27. Time and the Price Elasticity of Supply (b) Figure 3
Time and the Price Elasticity of Supply (b) Figure 3.8, Page 63 (continued in part (e))
Immediate-Run
Supply Elasticity
for Strawberries
Short-Run
Supply Elasticity
For Strawberries S2
2.50 S1
2.00
Price ($ per kilogram)
Price ($ per kilograms) 9 11
Quantity Supplied
(kilograms per month)
Quantity Supplied
(millions of kilograms per year)
The immediate-run supply curve S1 is perfectly inelastic since a price change does not affect quantity supplied. The short-run supply curve S2 is either elastic or inelastic with quantity supplied varying in the same direction as price. The long-run supply curve S3 shows the case of a constant-cost industry where supply is perfectly elastic since price is constant for every possible quantity supplied. The long-run supply curve S4 shows the case of an increasing-cost industry where price rises as quantity supplied expands.

28. © 2015 by McGraw-Hill Ryerson Ltd.
Time and the Price Elasticity of Supply (e) Figure 3.8, Page 71 (continued from part (b))
In the Long Run
FIGURE 3.8
Long-Run Supply Elasticity S4
Constant-
cost Industry
2.00 S3
Increasing-
cost Industry
Price ($ per kilograms)
Quantity Supplied
(millions of kilograms per decade)
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29. Calculating Price Elasticity of Supply
A numerical value for price elasticity of supply (es) is found by taking the ratio of the changes in quantity supplied and in price, each divided by its average value.
In mathematical terms:
es = ΔQs ÷ average Qs
Δprice ÷ average price
© 2015 by McGraw-Hill Ryerson Ltd.

30. © 2015 by McGraw-Hill Ryerson Ltd.
Assignments
Page 74 Practice Problem 3.2
Page 77 #9, 10, 11, 12
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31. Excise Taxes
An excise tax is an indirect tax charged on a particular product
Excise taxes are considered an indirect form of taxation because the government does not directly apply the tax
An intermediary, either the producer or merchant, is charged and then must pay the tax to the government
These taxes can be categorized in two ways:
Ad Valorem: A fixed percentage is charged on a particular good.
Specific: A fixed dollar amount dependent upon the quantity purchased is charged.
(Mr. Clifford)

32. The Impact of an Excise Tax FIGURE 7.8
5.00 S1 b
4.00 a $1 S0
3.50 A
Price ($ per kg)
3.00 C B c
2.50 D d
2.00
1.00 1 3 5 7 9 11
Quantity (millions of kg per year)
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33. Explanation of Figure 7.8
A $1 excise tax/kg causes the supply curve seen by strawberry consumers to shift to S1
At the initial equilibrium, consumers pay a price of $4 (point b) and producers receive a price of $3 (point c)
At the new equilibrium, consumers pay a price of $3.50
Producers receive a price of $2.50
The total tax payment is equally divided—Area A paid by consumers and Area B by producers

34. The Effect of Elasticity
For a given supply curve, the more elastic the demand curve the greater the proportion of an excise tax paid by producers.
For a given demand curve, the more elastic the supply curve the greater the proportion of an excise tax paid by consumers.

35. Excise Taxes and Demand Elasticity FIGURE 7.9 Page 184
Elastic Demand S1
Inelastic Demand S1
Consumers pay .25 of a $1 excise tax
Producers pay .75 of a $1 excise tax S0 D c b $1 b $1
4.00
4.00 S0 D c a d A B
3.75 A B d a
3.25
3.00
3.00
Price ($ per kg)
Price ($ per kg)
2.75
2.25 6 9 8 9
Quantity (millions of kg per year)
Quantity (millions of kg per year)
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36. © 2015 by McGraw-Hill Ryerson Ltd.
Explanation of Figure 7.9
Elastic Demand
A $1 excise tax causes supply as seen by consumer to shift to S1
Initially consumers see a price of $4 (point b)
At the new equilibrium consumers pay a price of $3.25 (point a) while producers receive a price of $2.25
Because D is elastic, producers pay more of the tax (area B) than do consumers (area A)
Inelastic Demand
Consumers pay more of the tax (area A) than producers do (area B)
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37. Excise Taxes and Supply Elasticity FIGURE 7.10 Page 185
Elastic Supply
Inelastic Supply S1 a S0 D S0 D S1 a b $1
4.00
4.00
3.75 d A B
3.25
3.00 c
3.00
Price ($ per kg)
2.75
Price ($ per kg)
2.25 6 9 8 9
Quantity (millions of kg per year)
Quantity (millions of kg per year)
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38. © 2015 by McGraw-Hill Ryerson Ltd.
Explanation of Figure 7.10
Elastic Supply
Consumers initially pay a price of $4 (point b) after an excise tax shifts supply as seen by consumers to S1
At the new equilibrium the price for consumers is $3.75 and for producers $2.75
Because S is elastic, consumers pay more of the tax (area A) than do producers (area B)
Inelastic Supply
Producers pay more of the tax (area B) than consumers do (area A)
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39. Price Controls http://www.youtube.com/watch?v=Ffcd6Wdkn5w&safe=acti ve
A price floor is a minimum price set above the equilibrium price.
It results in a surplus in the market.
A price ceiling is a maximum price set below the equilibrium price.
It results in a shortage in the market.
Price Ceilings and FloorsandExciseTax.docx

40. Agricultural Price Supports
Price supports for agricultural goods are an example of a price floor
They help overcome unstable agricultural prices
Farmers win from these supports
Consumers and taxpayers lose from these supports

41. Reasons for Price Supports Figure 3.12, page 69
Market Demand and Supply
Curves for Wheat
Market Demand and Supply
Schedules for Wheat 20
120
100 80 60 40
140 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Quantity (millions of tonnes per year) S1 S0 D a b
(millions of tonnes)
Price
($ per tonne)
Quantity
Supplied
Demanded
(D)
(S0)
(S1)
$140
120
100 80 60 10 11 12 13 14 9 8
Price ($ per tonne)

42. Effects of Price Supports Figure 3.14, page 71
Market Demand and Supply Curves
for Milk
Market Demand and Supply
Schedules for Milk
surplus S
1.30
Price
($ per litre)
Quantity
Demanded
(D)
Quantity
Supplied
(S)
1.10
(millions of litres)
Price ($ per litre)
.90
$1.30 59 62
A price floor
creates
a surplus. D
.70
1.10 60 60
0.90 61 58 58 59 60 61 62
Quantity
(millions of litres per year)

43. Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Rent Controls
Rent controls are an example of a price ceiling
They keep down prices of controlled rental accommodation
Some (especially middle-class) tenants win from these controls
Other (especially poorer) tenants lose from these controls
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.

44. Effects of Rent Controls Figure 3.15, page 71
Market Demand and Supply
Curves for Units
Market Demand and Supply
Schedules for Units S
Price
($ rent per month)
Quantity
Demanded
(D)
Quantity
Supplied
(S)
700
A price ceiling
creates
a shortage.
500
(units rented per month)
Price ($ per unit)
300
$700
1700
2500
shortage
500
2000
2000 D
300
2300
1500
1500
2000
2300
2500
Quantity
(units rented per month)
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45. Price Ceilings/Price Floors
Supports/Benefits
Opposes
Price Ceilings—to be effective are set below equilibrium
Consumer
Producers
Price Floors—to be effective are set above equilibrium
Consumers

46. Prophet of Capitalism’s Doom
According to Karl Marx’s theory of exploitation:
a product’s price is based on the amount of labour that goes into producing it
capitalists cut costs by minimizing workers’ wages and by maximizing the length of the workday
capitalists keep any surplus value, which is the excess of their revenues over their costs

47. Marx’s Theory of Exploitation Figure A, Page 78
Creation of Surplus Value
(when producing 2 shirts or 1 suit)
Creation of Surplus Value 80
Daily Wage
Value produced ($ per day) 20 40 60
$50 Wage
$50
$10
$20
$80 2 5
$30 Wage
$30
$10
$40
$80 4 3
W = 50
M = 10
SV = 10
SV = 40
W = 10
W = 30
Daily Wage
Materials and
machine wear
and tear (M)
Surplus Value (SV)
Total Value
Exploitation Rate
(SV/W)
$50
$30

48. The Economic Role of Government
Besides intervening in private markets, Canadian governments have an independent role.
Government programs include payments to adults with children, retirement funds for the elderly, unemployment insurance, welfare, higher education subsidies, free health care and schooling, and subsidized public housing.

49. Federal Spending The main federal spending programs are:
transfer payments to seniors (the Seniors Benefit)
tax credits to low-income parents (the Child Tax Credit)
transfer payments to the unemployed (Employment Insurance)
pensions (the Quebec and Canada Pension Plans)

50. Provincial and Territorial Spending
The responsibilities of provincial and territorial governments include:
health care
subsidies for post-secondary education
welfare services
The federal government pays a portion of these costs through the Canada Health and Social Transfer (CHST).

51. Government Expenditures Figure A, Page 81
Federal (2005)
($ billions)
Provincial (2005)
($ billions)
Local (2005)
($ billions)
Goods and services
Transfers to
Persons
Businesses
Nonresidents
Provinces and local
Debt charges
55.3
67.5
5.4
4.3
56.1
31.4
219.9
Goods and services
Transfers to
Persons
Businesses
Governments
Debt charges
163.5
31.9
10.3
39.4
27.3
272.5
Goods and services
Transfers to
Persons
Businesses
Provinces
Debt Charges
85.8
3.9
1.4
0.1
3.3
94.5

52. Taxation (a) Canadian governments use five main types of taxation:
Personal income taxes are levied by both federal and provincial governments, and are based on four marginal federal tax rates (16%, 22%, 26%, and 29%).
Sales taxes are levied by both federal and provincial governments, and are charged as a percentage of price on a wide range of products.

53. Taxation (b)
Excise taxes are levied by both federal and provincial governments, and are usually charged as a dollar amount per unit of quantity on particular products.
Property taxes are charged by local governments on buildings and land.
Corporate income taxes are paid by corporations to both federal and provincial governments as a percentage of annual profits.

54. Tax Revenues for All Levels of Government (2005) Figure B, Page 81
Percent of
Gross Domestic Product
11.6
7.6
3.4
3.3
3.8
29.8
Percent of
Total Taxes
39.0
25.5
11.4
11.2
12.7
100.0
Personal income taxes
Sales and excise taxes
Property taxes
Corporate income taxes
Miscellaneous taxes
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55. Government Taxes and the Canadian Economy Figure C, Page 82
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.

56. Debates over Government’s Role (a)
Taxes have increased significantly as a proportion of the total Canadian economy over the past few decades.
Critics argue that taxes and some spending programs reduce productive activity.
Critics also contend that many government programs are inequitable, and hampered by administrative problems.

57. Debates Over Government’s Role (b)
Supporters of government admit that public spending and taxation are not as effective as they could be. But they argue that these problems need to be seen in perspective, given that private markets are also subject to a variety of flaws.

58. Prophet of Capitalism’s Doom
According to Karl Marx’s theory of exploitation:
a product’s price is based on the amount of labour that goes into producing it
capitalists cut costs by minimizing workers’ wages and by maximizing the length of the workday
capitalists keep any surplus value, which is the excess of their revenues over their costs
© 2015 by McGraw-Hill Ryerson Ltd.

59. Marx’s Theory of Exploitation FIGURE A
Creation of Surplus Value
(when producing 2 shirts or 1 suit)
Creation of Surplus Value 80
Daily Wage
Value produced ($ per day) 20 40 60
$50 Wage
$50
$10
$20
$80 2 5
$30 Wage
$30
$10
$40
$80 4 3
W = 50
M = 10
SV = 10
SV = 40
W = 10
W = 30
Daily Wage
Materials and
machine wear
and tear (M)
Surplus Value (SV)
Total Value
Exploitation Rate
(SV/W)
$50
$30
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