1. Elasticity and its Applications
Copyright 2012 Worth Publishers

3. A hard question:
Does slave redemption create more slavery? How will slave traders respond to an increase in demand for slaves?
Harvard Sophomore Jay Williams redeems slaves in the Sudan

4. The Elasticity of Demand The Elasticity of Supply
Using Elasticities for Quick Predictions (Optional)
Appendix 1: Using Excel to Calculate Elasticities (see book)
Appendix 2: Other Types of Elasticities
For applications, click here
To Try it! questions
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5. But how much does quantity demanded change when price changes?
Elasticity of Demand
We know there is an inverse relationship between price and quantity demanded.
But how much does quantity demanded change when price changes?
Instructor Notes:

6. Elasticity of Demand
A demand curve is elastic when an increase in price reduces the quantity demanded a lot (and vice versa). When the same increase in price reduces quantity demanded just a little, then the demand curve is inelastic.

7. Elasticity of Demand Price Inelastic Demand
… Causes a Small Decrease in Quantity Demanded if Demand is Inelastic
$50
The Same Price Increase 75
Elastic Demand
… Causes a Big Decrease in Quantity Demanded if Demand is Elastic 20
$40 80
Instructor Notes: Figure 4.1: The Same Price Increase Causes a Big Decrease in Quantity Demanded if Demand is Elastic, and a Small Decrease in Quantity Demanded if the Demand Curve is Inelastic
Students should note that elastic demand curves are relatively flat while inelastic demand curves are relatively steep. However, it is important that students do not confuse elasticity and slope. They are not the same! Footnote 3 in the text has a nice mathematical presentation of this point.
Quantity
The More Responsive Quantity Demanded is to a Change in Price, the More Elastic is the Demand Curve

8. Elasticity Rule Elasticity slope BUT:
If two linear demand (or supply) curves run through a common point, then at any given quantity the curve that is FLATTER is MORE ELASTIC

9. Determinants of the Elasticity of Demand: a preview
Availability of Substitutes ***
Time Horizon
Category of product (specific or broad)
Necessities vs. Luxuries
Purchase Size
*** this is the fundamental determinant

10. Determinants of the Elasticity of Demand
The availability of substitutes is very important.
fewer substitutes makes it harder for consumers to adjust Q when P changes… so demand is inelastic.
many substitutes? Switching brands when prices change is EASY, so demand is elastic.
Instructor Notes: The remaining determinants ultimately relate to this point, so it may be helpful to point this out.

11. When the patent expires on a brand-name drug and 5 generic drugs come on the market, what happens to elasticity of demand?
It rises
It falls
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12. Determinants of Elasticity of Demand
The time horizon matters.
Less time to adjust means lower elasticity
Over time consumers can adjust their behavior by finding substitutes (making demand more elastic).
Instructor Notes:

13. Determinants of Elasticity of Demand
The classification of the good matters.
The less specific the classification, the fewer substitutes there are (making demand inelastic).
And vice versa…
E.g. the elasticity of demand is higher for “lettuce” than for “food.”
Instructor Notes:
vs.

14. Determinants of Elasticity of Demand
The nature of the good to the consumer can also affect the elasticity of demand.
For necessities, we do not change Q much when P changes
For luxuries, we are more sensitive to P changes
Instructor Notes:
vs.

15. Determinants of Elasticity of Demand
The size of the purchase (relative to our budget) matters.
We are less sensitive to price changes when the good feels cheap
We are more sensitive to price changes when the good feels expensive
Instructor Notes:

16. Mathematics of Demand Elasticity
Elasticity of demand = the percentage change in quantity demanded divided by the percentage change in price.
Ed = the percentage change in quantity demanded
percentage change in price
Or,
Where D is the mathematical symbol for “change in”
Instructor Notes: Students may need to be reminded how to correctly calculate the Percentage Change in Quantity Demand and Price.
Percentage Change in Quantity Demanded: (Qnew – Qold)/Qold
Percentage Change in Price: (Pnew – Pold)/Pold

17. Determinants of Elasticity of Demand
Summary of Determinants of Elasticity of Demand
Less Elastic
More Elastic
Fewer Substitutes
More Substitutes
Short Run (less time)
Long Run (more time)
Necessities
Luxuries
Small Part of Budget
Large Part of Budget
Instructor Notes: Table 4.1: Some Factors Determining the Elasticity of Demand

18. Mathematics of Demand Elasticity
Example:
If the price of oil increases by 10% and over a period of several years, the quantity demanded falls by 5%, then the long run elasticity of demand for oil is:
Instructor Notes:

19. cigarette tax increase.
A Kentucky governor
proposed a 70 cent/pack
cigarette tax increase.
Estimated effects:
Average cost of a pack would go from $3.67 to $4.55.
Youth smoking would be cut by an estimated 16.6 percent.
Adult smoking would decrease by an estimated 4 percent.
Instructor Notes: Classroom questions:
Is the demand for cigarettes elastic or inelastic? Inelastic
Why? Smokers probably view cigarettes as necessities.
Why is the elasticity of demand different for youth and adult smokers? Share of budget larger for youth than adult smokers. Could also argue that cigarettes are more of a necessity for adult smokers who have probably been smoking longer and are more addicted.

20. Using the Midpoint Formula for Elasticity
To erase the natural bias associated with choice of base point, we calculate the elasticity of demand using the Midpoint Formula given by:
Instructor Notes:

21. Mathematics of Demand Elasticity
Elasticity of demand is always negative, so we typically drop the negative sign and use absolute value instead.
If the |Ed| < 1, the demand curve is inelastic.
If the |Ed| > 1, the demand curve is elastic.
If the |Ed| = 1, the demand curve is unit elastic.
Instructor Notes: Students should note some extreme cases that are not explicitly defined in the text but are often used for simplification:
Perfectly Elastic Demand
Elasticity of demand is infinite
A very small change in price will lead to an infinitely large change in quantity demanded
Horizontal demand curve
Perfectly Inelastic Demand
Elasticity of demand is zero
A change in price will cause no change in quantity demanded.
Vertical demand curve

22. Mathematics of Demand Elasticity
Example: At the initial price of $10, the quantity demanded is When the price rises to $20, the quantity demanded is 90.
Instructor Notes:

23. What is the elasticity of demand for Google searches?
The summary: Google ran an experiment and observed the following:
Using “time waiting” as the price, calculate Elasticity of Demand for Google searches.
Answer:
-20% / ((0.5/0.65)x100) = -0.26
The page with 10 results took .4 seconds to generate. The page with 30 results took .9 seconds.
Half a second delay caused a 20% drop in traffic. Half a second delay killed user satisfaction.
The full text of the post:
In an experiment earlier this year, Google discovered how much people care about how long it takes to perform a search. The company varied the number of search results generated per page from 10 to 30.
The page with 10 results took .4 seconds to generate. The page with 30 results took .9 seconds.
Half a second delay caused a 20% drop in traffic. Half a second delay killed user satisfaction.
What’s interesting about this study is that it gives students an opportunity to calculate the price elasticity of demand for Google searches, using “time waiting” as the price of the search: -20% / ((0.5/0.65)*100) = Astute students would note that the actual elasticity is higher than what we calculated since all things are not equal. Getting 30 results per page is more valuable than getting 10.

24. Elasticity of Demand and Total Revenue
A firm’s revenues are equal to price per unit times quantity sold.
Revenue = Price x Quantity
The elasticity of demand directly influences revenues when the price of the good changes.
Instructor Notes:

25. Elasticity of Demand and Total Revenue
Revenues Rise as Price Rises if Demand is Inelastic Q P D
$10
100
R=$10x100
=$1,000
$20 90
R=$20x90
=$1,800
R=$10x100
=$1,000
Instructor Notes: Figure 4.2: Elasticity and Revenue Panel A Inelastic Demand
Revenues rise because the decrease in quantity demanded is less than the increase in price.

26. Elasticity of Demand and Total Revenue
Revenues Fall as Price Rises with Elastic Demand Curves Q P D
$10
250
R=$10x250
=$2,500
$20 50
R=$20x50
=$1,000
R=$10x250
=$2,500
Instructor Notes: Figure 4.2: Elasticity and Revenue Panel B Elastic Demand
Revenues fall because the decrease in quantity demanded is less than the increase in price.

27. Elasticity of Demand and Total Revenue
Summary of Relationship between Elasticity of Demand and Revenues
Absolute Value of Elasticity
Name
Price and Revenue
Inelastic
P and R Move Together
Elastic
P and R Move Opposite
Unit Elastic
P Moves but R Stays the Same
Instructor Notes:

28. Applications of Elasticity of Demand
How the American Farmer has Worked Himself Out of a Job:
Increased agricultural productivity has the supply of food BUT the supply of farmers….
And their revenues because the demand for most agricultural products is inelastic.

29. Applications of Elasticity of Demand
Why the War on Drugs is Hard to Win:
Because demand for most illegal drugs is inelastic, drug dealers earn greater revenue and gain more power as the drug war becomes more effective.
Instructor Notes:

30. The elasticity of demand for eggs has been estimated to be 0. 1
The elasticity of demand for eggs has been estimated to be If egg producers raised their prices by 10 percent, what will happen to their total revenue?
It will increase
It will decrease
It won’t change
Instructor Notes:
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31. They think it’s elastic They think it’s inelastic
If a fashionable clothing store raised its prices by 25 percent, what does that tell you about the store’s estimate of the elasticity of demand for its products?
They think it’s elastic
They think it’s inelastic
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32. But how strong is that relationship?
Elasticity of Supply
The law of supply indicates a direct relationship between price and quantity supplied.
But how strong is that relationship?
Instructor Notes:

33. Elasticity of Supply
A supply curve is elastic if a rise in price increases the quantity supplied a lot (and vice versa). it’s inelastic if sellers change quantity just a little.

34. Elasticity of Supply
Quantity
Price per Unit
Elasticity of Supply Captures the Sensitivity of Quantity Supplied to Changes in Price
Inelastic Supply
Elastic Supply
…Causes a Small Increase in Quantity Supplied if Supply is Inelastic
$50
The Same Price Increase 85
…Causes a Big Increase in Quantity Supplied if Supply is Elastic
170
$40
Instructor Notes: Figure 4.5 The Same Price Increase Causes a Small Increase in Quantity Supplied If the Supply Curve is Inelastic and a Big Increase in Quantity Supplied Is Inelastic and a Big Increase In Quantity Supplied If the Supply Curve Is Inelastic 80

35. Determinants of Elasticity of Supply
Change in Per-Unit Costs with Increased Production
Time Horizon
Share of Market for Inputs
Geographic Scope
Instructor Notes:

36. Determinants of Elasticity of Supply
How quickly do per-unit costs increase when more is produced?
If increased production is very expensive, then the supply curve will be inelastic.
If production can increase with little extra cost, then the supply curve will be elastic.
Instructor Notes:
Ivory: increasing collection costs, inelastic supply

37. Determinants of Elasticity of Supply
The time horizon matters.
Immediately following a price increase, producers can expand output only using their current capacity (making supply inelastic).
Over time, however, producers can expand their capacity (making supply elastic).
Instructor Notes:

38. Determinants of Elasticity of Supply
The share of the market for the inputs used in production matters.
Supply is elastic when the industry can be expanded without causing a big increase in the demand (and price) for the industry’s inputs.
Supply is inelastic when industry expansion causes a significant increase in the demand/price for inputs.
Instructor Notes:

39. Determinants of Elasticity of Supply
The geographic scope of the market matters.
The wider the scope of the market of a good, the less elastic its supply.
The narrower the scope of the market of a good, the more elastic its supply.
Instructor Notes:

40. Determinants of Elasticity of Supply
Summary of Determinants of Elasticity of Supply
Less Elastic
More Elastic
Difficult to Increase Production at Constant Unit Cost
Easy to Increase Production at Constant Unit Cost
Raw Materials
Manufactured Goods
Short Run
Long Run
Large Share of Market for Inputs
Small Share of Market for Inputs
Global Supply
Local Supply
Instructor Notes:

41. Mathematics of Supply Elasticity
Elasticity of supply = the percentage change in quantity supplied divided by the percentage change in price
(use the midpoint formula here too!)
Es = the percentage change in quantity supplied
percentage change in price
Or,
Instructor Notes: Students may need to be reminded how to correctly calculate the Percentage Change in Quantity Demand and Price.
Percentage Change in Quantity Demanded: (Qnew – Qold)/Qold
Percentage Change in Price: (Pnew – Pold)/Pold

42. Using the Midpoint Formula for Elasticity
Again we use the Midpoint Formula given by:
Instructor Notes:

43. Mathematics of Supply Elasticity
Example: If the price of cocoa rises by 10% and the quantity supplied increases by 3%, then the elasticity of supply for cocoa is:
Instructor Notes:

44. Mathematics of Supply Elasticity
If the Es < 1, the supply curve is inelastic. If the Es > 1, the supply curve is elastic. If the Es = 1, the supply curve is unit elastic.
Instructor Notes: Students should note some extreme cases that are not explicitly defined in the text but are often used for simplification:
Perfectly Elastic Demand
Elasticity of demand is infinite
A very small change in price will lead to an infinitely large change in quantity demanded
Horizontal demand curve
Perfectly Inelastic Demand
Elasticity of demand is zero
A change in price will cause no change in quantity demanded.
Vertical demand curve

45. Mathematics of Supply Elasticity
Example: At the initial price of $10, the quantity supplied is When the price rises to $20, the quantity supplied is 110.
Instructor Notes:

46. Slave Redemption and Elasticity
Slave Redemption Works Best When the Supply Curve for Slaves is Perfectly Inelastic
If the Supply Curve for Slaves is Elastic, Slave Redemption is less helpful

47. In this moving yet pragmatic talk, Kevin Bales explains the business of modern slavery, a multibillion-dollar economy that underpins some of the worst industries on earth. He shares stats and personal stories from his on-the-ground research -- and names the price of freeing every slave on earth right now. (18:01 minutes)
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48. Gun Buybacks and Elasticity
The supply of guns to a local region is very elastic, so local buybacks don’t affect the number of guns on the street (nor affect their price.)

49. A computer manufacturer makes an experimental computer chip that critics praise, leading to a huge increase in the demand for the chip. How elastic is supply in the short run? What about the long run? Graph both.
Instructor Notes:
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50. Will the same increase in the demand for housing increase prices more in Manhattan or in Des Moines, Iowa? Graph both.
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51. If the price of a sushi roll drops from $8 to $4, and sales rise from 20 to 40 units, what is the (absolute value) of the price elasticity of demand?
0.5
0.66 1 2
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52. If price falls from $60 to $40, total revenue changes by _______, so demand is _______.
$240; inelastic
$480; elastic
$360; inelastic
$120; elastic
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53. Which supply curve is the most elastic?
Price
Quantity S1 S2 S3 S4
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54. Elasticity and Quick Predictions
Two simple formulas allow for quick predictions of price changes (using elasticities):
Instructor Notes:

55. Cross-Price Elasticity of Demand
The Cross-Price Elasticity of Demand measures how sensitive the quantity demanded of good A is to the price of good B. Cross-Price Elasticity of Demand =
Instructor Notes: Students may need to be reminded how to correctly calculate the Percentage Change in Quantity Demanded and Price.
Percentage Change in Quantity Demanded: (Qnew – Qold)/Qold
Percentage Change in Price: (Pnew – Pold)/Pold

56. Cross-Price Elasticity of Demand
For substitutes, Cross-Price Elasticity of Demand is positive.
An increase in the price of one brand of milk will increase the demand for other brands.
For complements, Cross-Price Elasticity of Demand is negative.
An increase in the price of milk causes a decrease in demand for Oreos.
Instructor Notes:

57. Income Elasticity of Demand
The Income Elasticity of Demand measures how sensitive the quantity demanded of a good is to changes in income. Income Elasticity of Demand =
Instructor Notes: Students may need to be reminded how to correctly calculate the Percentage Change in Quantity Demanded and Income.
Percentage Change in Quantity Demanded: (Q – Q)/Q
Percentage Change in Income: (I – I)/I

58. Income Elasticity of Demand
The income elasticity of demand can be used to distinguish normal from inferior goods.
For normal goods, Income Elasticity is positive.
For luxury goods, Income Elasticity is greater than one.
For inferior goods, Income Elasticity is negative.
Instructor Notes:

59. Tonya consumes 10 boxes of Ramen Noodles a year when her yearly income is $40,000. After her income falls to $30,000 a year, she consumes 40 boxes of Ramen Noodles a year. Calculate her income elasticity of demand for Ramen Noodles.
4.2
–4.2
–2.25
2.25
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60. The price of Good B increases by 4%, causing the quantity demanded of Good A to decrease by 6%. The cross-price elasticity of demand is _____, and the goods are ______.
1.5; substitutes
–1.5; complements
0.67; complements
–2.4; substitutes
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