1. Ch. 4: Elasticity.
Define, calculate, and explain the factors that influence
the price elasticity of demand
the cross elasticity of demand
the income elasticity of demand
the elasticity of supply

2. Price Elasticity of Demand
If Demand is “steep”, a change in supply brings a small increase in the quantity demanded and a large fall in price.

3. Price Elasticity of Demand
The slope of the demand curve affects how much equilibrium price and quantity change for a given change in supply.
If supply increases,
the decrease in price is greater if demand is steeper
The increase in quantity is smaller if demand is steeper

4. Price Elasticity of Demand
units-free measure of the responsiveness of the quantity demanded of a good to a change in its price, ceteris paribus.
Percentages and percentage changes. Many students need a refresher and some practice at doing what seems too simple to bother with, calculating percentages and percentage changes. Don’t be afraid to start with this pre-elasticity warm up. Just toss out some numbers. Suppose that the campus bookstore increases the price of an economics text from $70 to $80. What is the percentage increase in price? Suppose the campus computer store lowers the price of an iMac from $1500 to $1000. What is the percentage decrease in price?
Next, tell them the prices have moved in the opposite directions: The campus book store cuts the price of an economics text from $80 to $70. What is the percentage decrease in price? And the campus computer store now raises the price of an iMac from $1000 to $1500. What is the percentage increase in price?
You’re now all set to get the students using the average of the original and new price to calculate percentages that are independent of the direction of change.
Many students have a hard time remembering whether quantity or price goes in the numerator of the elasticity formulas. Have the students create their own mnemonic. Suggest McDonald’s Quarter Pounder™ hamburgers. It’s silly, but it works, reminding the student that Q (quantity) appears before P (price) in the ratio of percentage changes.
For practice at calculating the price elasticity of demand, bring out your demand schedule for Coke (or other drink) that you sold in class when you covered demand. Get the students to calculate the price elasticity of demand at various points along that demand curve.

5. Price Elasticity of Demand
%DQ = DQ/Qavg
= 2/10
= .2
%DP = DP/Pavg
= -$1/$20
= -.05
e = .2/.05 =4

6. Price Elasticity of Demand
By using the average price and average quantity, we get the same elasticity value regardless of whether the price rises or falls.
Changing the units of measurement of price or quantity leaves the elasticity value the same (“units free”).
Although the formula yields a negative value for elasticity because price and quantity move in opposite directions, we report the absolute value.

7. Price Elasticity of Demand
Inelastic and Elastic Demand
if e>1: elastic
if e=1: unit elastic
if e<1: inelastic
Shape of
Perfectly inelastic demand curve (e=0)
Perfectly elastic demand curve (e= infinite)

8. Price Elasticity of Demand
At prices above the mid-point of the demand curve, demand is elastic.
At prices below the mid-point of the demand curve, demand is inelastic.

10. Price Elasticity of Demand
Total Revenue and Elasticity
TR=P*QD
When P changes, TR could rise or fall because QD moves in opposite direction.
But a higher price doesn’t always increase total revenue.

11. Price Elasticity of Demand
%D TR = % D P + % D Q
= % D P - % D P(e)
= % D P(1-e)
If demand is elastic (e>1),
P increase  TR decreases
P decrease  TR increases
If demand is inelastic (e<1),
P increase  TR increases
P decrease  TR decreases
If demand is unitary elastic,
P increase or decrease  TR unchanged.

12. Price Elasticity of Demand
As P falls from $25 to $12.50, D is elastic, and TR rises.
At $12.50, D is unit elastic and TR stops increasing.
As P falls from $12.50 to 0, D is inelastic, and TR decreases.

13. Price Elasticity of Demand

14. Price Elasticity of Demand
The elasticity of demand for a good depends on:
The number & closeness of substitutes
The proportion of income spent on the good
The time elapsed since a price change
Fuel for thought: Getting some intuition on what determines whether demand is inelastic or elastic
The demand for gasoline and junk food in general. Students love their cars and junk food, and they know that the demand for both in general is inelastic because there are no good substitutes for personal transportation and a quick snack.
The demand for Joe’s quick-mart gasoline. Ask your students if Joe’s quick-mart (substitute your actual local one) convenience store would lose much business and total revenues if he raised the price of gasoline more than a penny or two compared to the other three gas stations at a street intersection. When the students conclude he’d lose much of his gasoline sales ask them to reconcile this large quantity decrease to a small increase in price (elastic demand) with the fact that they earlier stated that demand for gasoline is very inelastic. They will recognize that gasoline from other corner stations is a very good substitute for Joe’s gasoline.
The demand for Joe’s quick-mart junk food. After students recognize that abundant substitute availability keeps elasticity high, ask the students why Joe’s junk food (and all quick-mart stores’ junk food) is priced so much higher than the near-by grocery store’s junk food. Students will conclude that “convenience” stores are well named. Most people aren’t willing to wait in the grocery store check-out line behind the frazzled mother of three screaming kids, each hanging on the over-loaded basket that will take 15 minutes of coupon validating and price checking to check out. The grocery store is not a good substitute for people on the go looking for a fast snack and a quick gas fill.

15. More Elasticities of Demand
Cross Elasticity of Demand
measures responsiveness of demand for a good to a change in the price of another good.
exy= %D quantity demanded for x
%D change in price of y
exy > 0  substitutes
exy <0  complements

16. More Elasticities of Demand
Income Elasticity of Demand
measures how the quantity demanded of a good responds to a change in income, ceteris paribus. eI = %D in quantity demanded
% D in income
eI >0  normal good
eI >1 luxury good
eI <0 inferior good

17. Price Elasticity of Supply
A change in demand causes
A larger change in equilibrium price if supply is supply is steeper,
A smaller change in equilibrium quantity if supply is steeper.

18. Elasticity of Supply Elasticity of supply
measures the responsiveness of the quantity supplied to a change in the price of a good when all other influences on selling plans remain the same.

19. Elasticity of Supply
The unit elastic demand curve is a good one to use to emphasize that elasticity and slope are not equal. Have the students calculate the elasticity of supply on two linear demand curves that passes through the origin, one with a slope of 0.5 and the other with a slope of 2. They’ll get the message.

20. Elasticity of Supply Factors That Influence the Elasticity of Supply
Resource substitution possibilities
The time frame for supply decisions
Storage costs