1. DESCRIBING SUPPLY AND DEMAND: ELASTICITIES
Chapter 6
DESCRIBING SUPPLY AND DEMAND: ELASTICITIES

2. Today’s lecture Elasticity The Price Elasticity of Demand
The Price Elasticity of Supply
Calculate elasticity graphically and numerically.

3. The Concept of Elasticity
Elasticity is a measure of the responsiveness of one variable to another.
The greater the elasticity, the greater the responsiveness.
In economics, elasticity is used to describe the responsiveness of quantity supplied or quantity demanded to price.

4. The Price Elasticity of Demand
The price elasticity of demand measures how much the quantity demanded responds to a change in price.
Price elasticity of demand (ED)

5. Example
Suppose that a 10-percent increase in the price of an ice-cream cone causes the amount of ice cream you buy to fall by 20 percent.
The related price elasticity of demand:
-20 percent / 10 percent = 2

6. The Price Elasticity of Supply
The price elasticity of supply measures how much the quantity supplied responds to a change in price.
Price elasticity of supply (ES)

7. Example
Suppose a 10 percent increase in the price of an ice-cream causes a 5 percent increase in the supply of ice-cream.
The related price elasticity of supply:
5 percent/ 10 percent = 0.5

8. Classifying Demand and Supply as Elastic or Inelastic
Demand or supply is elastic if the percentage change in quantity is greater than the percentage change in price.
E>1
Demand or supply is inelastic if the percentage change in quantity is less than the percentage change in price.
E<1

9. Unit Elastic Demand or Supply
Demand or supply is unit elastic if the percentage change in quantity is the same as the percentage change in price.
E=1

10. Elasticities and Supply and Demand Curves
Price
Price
Quantity
Perfectly inelastic demand curve
Perfectly elastic demand curve P
Quantity

11. Elasticity is Not the Same as Slope, But
The steeper the curve at a given point, the less elastic is supply or demand.
Perfectly elastic supply or demand
The curves are flat
The quantity responds enormously to a change in price (E = ∞)
Perfectly inelastic supply or demand
The curves are vertical
The quantity does not response to a change in price (E=0).

12. Example
A diabetic, who will die without insulin, would be willing to pay any price for the life-saving quantity of insulin.
----The diabetic has a perfectly inelastic demand of insulin.

13. Example
In agriculture individual producers generally have no control over the price because she or he will not be able to sell any of the crop if she or he raise the price slightly above the market price.
---- The demand of crop is perfectly elastic.

14. Question The elasticity of demand is same along the demand curve?
----To find out the answer, we just calculate them by ourselves.

15. Calculating Elasticity of Demand Between Two Points
Elasticity of demand between A and B:
$26 B 24 22
midpoint C
Price 20 A 18 16
Demand 14 10 12 14
Quantity of software (in hundred thousands)

16. Question
A major cereal producer decides to lower price from $3.60 to $3 per 15-ounce box.
Q: If quantity demanded increases by 18 percent, what is the price elasticity of demand?

17. Calculating Elasticity at a Point
Price
Quantity
$10 9 8 7 6 5 4 3 2 1 C B A 24 40 28 20
To calculate elasticity at a point determine a range around that point and calculate the arc elasticity.

18. Calculating Elasticity along the Demand Curve
The elasticity at point C:
[(16-24)/20]/[(6-4)/5]=0.4/0.4=1
Price
Quantity
$10 9 8 7 6 5 4 3 2 1 C B A 24 40 28 20 G F
The elasticity at point F:
[(16-0)/8]/[(6-10)/8]=4 E D
The elasticity at point A:
[(28-20)/24]/[(3-5)/4]=0.65 8 12 16

19. Elasticity Along a Demand Curve
Ed = ∞
Elasticity declines along demand curve as we move toward the quantity axis
$10 9 8
Ed > 1 7 6
Ed = 1
Price 5 4 3
Ed < 1 2 1
Ed = 0 1 2 3 4 5 6 7 8 9 10
Quantity

20. Question
If a good have several substitutes, the demand of this good is elastic or inelastic?
Substitutes are often pairs of goods that are used in place of each other and an increase in the price of one leads to an increase in the demand for the other.
If a good is necessary, such as salt, the demand of this good is elastic or inelastic?

21. Elasticity and Demand
As a general rule, the more substitutes a good has, the more elastic is its supply and demand.
The larger the time interval considered, the more elastic is the demand curve.
The less a good is a necessity, the more elastic is its demand curve.
Demand becomes more elastic as the definition of the good becomes more specific.
Demand for goods that represent a large portion of one’s budget are more elastic.

22. Elasticity and Supply
The longer the time period considered, the more elastic the supply.
There are three time periods relevant to supply:
The instantaneous period – supply is fixed, perfectly inelastic.
The short run – supply is somewhat elastic.
The long run – supply is very elastic.

23. Elasticity and Total Revenue
Unit Elastic Demand
E = 1 6
Price
Quantity
$10 8 4 2 1 3 5 7 9
TRE= $4x6=$24
TRF= $6x4=$24
TR constant F
Gained revenue:FO46(C) C E O
Lost revenueEO46 (B) A B

24. Elasticity and Total Revenue
Elastic Demand
E > 1
$10 K 9 J C
TR falls if price increases.
TR rises if price decreases. 8 B
TRJ = $8 x 2 = $16
TRK = $9 x 1 = $9 6 A
Price 4 2 1 2 3 4 5 6 7 8 9
Quantity

25. Elasticity and Total Revenue
Inelastic Demand
E < 1
$10
TR rises if price increases 8
TRG = $1 x 9 = $9
TRH = $2 x 8 = $16 6
Price 4 H 2 C G A B 1 2 3 4 5 6 7 8 9
Quantity

26. Total Revenue Along a Demand Curve
Price
Quantity A
Elastic ED > 1
Total Revenue Along a Demand Curve
ED = 1 C Q0
Inelastic ED < 1 B
Total revenue
Quantity

27. Question
If you find that in California where vanity plates cost $28.75, the elasticity of demand is In Massachusetts where vanity plates cost $50, the elasticity of demand is 3.52.
Q: What recommendation would you have for each state to maximize revenue?

28. Question
A newspaper recently lowered its price from 50 cents to 30 cents. As it did, the number of newspapers sold increased from 240,000 to 280,000.
What was the newspaper’s elasticity of demand?
Given that elasticity, did it make sense for the newspaper to lower its price?

29. Question
Comparing a rich person and a poor guy, for a given good, which person has a more elastic demand of the good?
If you can charge different price for different person, you will charge a higher price or lower price to the person who has a more elastic demand of the good?

30. Elasticity of Individual and Market Demand
Price discrimination occurs when a firm separates the people with less elastic demand from those with more elastic demand.
Firms charge more to the individuals with inelastic demand and less to individuals with elastic demand.
Examples of price discrimination:
Airlines’ Saturday stay-over specials
Sales of new cars
Almost-continual sales

31. Income Elasticity of Demand
Income elasticity of demand measures the responsiveness of demand to changes in income.

32. Income Elasticity of Demand
Normal goods are those whose consumption increases with an increase in income.
Normal goods can be luxuries or necessities:
Luxuries are goods that have an income elasticity greater than one.
A necessity has an income elasticity less than 1.
Inferior goods are those whose consumption decreases when income increases.
Inferior goods have income elasticities less than zero.

33. Cross-Price Elasticity of Demand
Cross-price elasticity of demand measures the responsiveness of demand to changes in prices of other goods.

34. Complements and Substitutes
Substitutes are goods that can be used in place of another.
Substitutes have positive cross-price elasticities.
Complements are goods that are used in conjunction with one another.
Complements have negative cross-price elasticities.