1. Objectives Express and calculate price elasticity of demand
Understand the relationship between the price elasticity of demand and total revenues
Discuss the factors that determine the price elasticity of demand

2. Objectives
Describe the cross price elasticity of demand and how it may be used to indicate whether two goods are substitutes or complements
Explain the income elasticity of demand
Classify supply elasticities and explain how the length of time for adjustment affects the price elasticity of supply 2

3. Price Elasticity Price Elasticity of Demand (Ep)
The responsiveness of quantity demanded of a commodity to changes in its price

4. Price Elasticity Price Elasticity of Demand (Ep)
percentage change in quantity demanded
percentage change in price
Ep =
%ΔQd
%ΔP

5. Calculating Elasticity
% change in Qd =
change in Qd
original Qd
% change in price =
change in price
original price

6. Calculating Elasticity
Adjusting for the percent change bias
change in Q
sum of quantities/2
Ep =
change in P or
change in Q
(Q1 + Q2)/2
Ep =
change in P
(P1 + P2)/2
Δ Q
Avg. Q
Ep =
Δ P
Avg. P or

7. Price Elasticity Relative quantities only Always negative
Elasticity is measuring the change in quantity relative to the change in price
Always negative
An increase in price decreases the quantity demanded, ceteris paribus

8. Relationship Between Price Elasticity of Demand and Total Revenues
Price Elasticity Effect of Price Change
of Demand on Total Revenues (TR)
Price Price
Decrease Increase
Inelastic (Ep < 1) TR TR
Unit-elastic (Ep = 1) No change in TR No change in TR
Elastic (Ep > 1) TR TR

9. Price Elasticity Example Price of oil increases 10 percent
Quantity demanded decreases 1 percent
Ep =
-1%
+10%
= -.1

10. Price Elasticity Question Answer
How would you interpret an elasticity of -0.1?
Answer
A one percent increase in the price of oil will lead to a one percent decrease in quantity demanded

11. Calculating Elasticity
Example
If the price increases from 1 to 2: 1
3/2
%ΔP =
= .67

12. Calculating Elasticity
Example
If the price decreases from 2 to 1: 1
3/2
%ΔP =
= .67

13. International Example: Price Elasticity of Demand for World’s Fair Tickets
Price of admission to World’s Fair in Hannover, Germany was lowered from $12 to $5.
Daily attendance rose from 60,000 to 100,000.

14. International Example: Price Elasticity of Demand for World’s Fair Tickets
Δ Q
(Q1 + Q2)/2
Ep =
Δ P
(P1 + P2)/2
Ep =
100, ,000
(100, ,000)/2
12 - 5
(12 + 5)/2

15. International Example: Price Elasticity of Demand for World’s Fair Tickets
40,000
80,000
Ep =
7.0
8.5
= .61
Interpretation
A 1 percent decrease in price would increase quantity demanded by .61 percent.

16. Price Elasticity Ranges
Elastic Demand
Percentage change in quantity demanded is larger than the percentage change in price
Ep > 1

17. Price Elasticity Ranges
Unit Elasticity of Demand
Percentage change in quantity demanded is equal to the percentage change in price
Ep = 1

18. Price Elasticity Ranges
Inelastic Demand
Percentage change in quantity demanded is smaller than the percentage change in price
Ep < 1

19. Price Elasticity Ranges
Extreme elasticities
Perfectly Inelastic Demand
A demand curve that is a vertical line
It has only one quantity demanded for each price
No matter what the price, quantity demanded does not change

20. Extreme Price Elasticities
Quantity Demanded per Year (millions of units)

21. Extreme Price ElasticitiesD
Perfect inelasticity, or zero elasticity
Price 8
Quantity Demanded per Year (millions of units)

22. Extreme Price ElasticitiesD P1
Price
Perfect inelasticity, or zero elasticity P0 8
Quantity Demanded per Year (millions of units)

23. Price Elasticity Ranges
Extreme elasticities
Perfectly Elastic Demand
A demand curve that is a horizontal line
It has only one price for every quantity
The slightest increase in price leads to zero quantity demanded

24. Extreme Price Elasticities
Price (cents)
Quantity Demanded per Year (millions of units)

25. Extreme Price Elasticities30 D
Price (cents)
Perfect elasticity, or infinite elasticity
Quantity Demanded per Year (millions of units)

26. Extreme Price Elasticities
P1 never touches the demand curve P1 30 D
Price (cents)
Perfect elasticity, or infinite elasticity
Quantity Demanded per Year (millions of units)

27. Quantity per period (billions of minutes)
The Relationship Between Price Elasticity of Demand and Total Revenues for Cell Phone Service
1.10
1.00
.90
.80
.70
Price per Minute ($)
.60
.50
.40
.30
.20
.10 10 20 30 40 50 60 70 80 90
100
110
Quantity per period (billions of minutes)

28. Quantity per period (billions of minutes)
The Relationship Between Price Elasticity of Demand and Total Revenues for Cell Phone Service
1.10
Elastic (Ep >1)
1.00
Unit-Elastic (Ep =1)
.90
Inelastic (Ep <1)
.80
.70
Price per Minute ($)
.60
.50
Demand, or average revenue curve
.40
.30
.20
.10 D 10 20 30 40 50 60 70 80 90
100
110
Quantity per period (billions of minutes)

29. The Relationship Between Price Elasticity of Demand and Total Revenues for Cell Phone Service
3.0
2.5
2.0
Total Revenue ($ billions)
1.5
1.0
0.5 10 20 30 40 50 60 70 80 90
100
110
Quantity per period (billions of minutes)

30. The Relationship Between Price Elasticity of Demand and Total Revenues for Cell Phone Service
3.0
Elastic
2.5
Unit-Elastic
Inelastic
2.0
Total Revenue ($ billions)
1.5
Total revenue curve
1.0 D
0.5 10 20 30 40 50 60 70 80 90
100
110
Quantity per period (billions of minutes)

31. Elasticity and Total Revenues
Elastic Demand
A negative relationship exists between small changes in price and changes in total revenue

32. Elasticity and Total Revenues
Unit-Elastic Demand
Changes in price do not change total revenue

33. Elasticity and Total Revenues
Inelastic Demand
A positive relationship exists between changes in price and total revenues

34. Relationship Between Price Elasticity of Demand and Total Revenues
Price Elasticity Effect of Price Change
of Demand on Total Revenues (TR)
Price Price
Decrease Increase
Inelastic (Ep < 1) TR TR
Unit-elastic (Ep = 1) No change in TR No change in TR
Elastic (Ep > 1) TR TR

35. Determinants of Price Elasticity of Demand
Existence of substitutes
The closer the substitutes and the more substitutes there are, the more elastic is demand.
Share of the budget
The greater the share of the consumer’s total budget spent on a good, the greater is the price elasticity.

36. Determinants of Price Elasticity of Demand
The length of time allowed for adjustment
The longer any price change persists, the greater is the price elasticity of demand.
Price elasticity is greater in the long-run than in the short-run.

37. Demand Elasticity for Selected Goods
Estimated Elasticity
Category Short Run Long Run
Air travel (vacation) Air travel (business)
Beef ——
Cheese ——
Electricity
Fresh tomatoes ——
Gasoline
Hospital services
Intercity bus service
Physician services
Private education
Restaurant meals ——
Tires

38. Determinants of Price Elasticity of Demand
How to define the short run and the long run
The short run is a time period too short for consumers to fully adjust to a price change.
The long run is a time period long enough for consumers to fully adjust to a change in price other things constant.

39. Policy Example: Making the Price of a “High” Higher
Teenage cocaine abusers are three times as sensitive to price changes compared to adults.
Legal crackdowns on cocaine dealers to decrease supply and raise prices may be an appropriate strategy in the war on drugs.

40. Short-Run and Long-Run Price Elasticity of Demand
In the short run, quantity
demanded falls slightly.
However, with more time
for adjustment the
demand curve becomes
more elastic and quantity
demanded falls by a
greater amount. P1 E
Price per Unit Pe D2 D1 Q2 Q1 Qe
Quantity Demanded per Period

41. Short-Run and Long-Run Price Elasticity of Demand
In the short run, quantity
demanded falls slightly.
However, with more time
for adjustment the
demand curve becomes
more elastic and quantity
demanded falls by a
greater amount. P1 E
Price per Unit Pe D3 D2 D1 Q3 Q2 Q1 Qe
Quantity Demanded per Period

42. Cross Price Elasticity of Demand
Cross Price Elasticity of Demand (Exy)
The percentage change in the demand for one good (holding its price constant) divided by the percentage change in the price of a related good
The responsiveness of change in demand of one good to the change in prices of related goods

43. Cross Price Elasticity of Demand
Formula for computing cross elasticity of demand
%Δ in demand for good X
%Δ in price of good Y
Exy =

44. Cross Price Elasticity of Demand
Substitutes
Exy would be positive
An increase in the price of X would increase the quantity of Y demanded at each price.
Complements
Exy would be negative
An increase in the price of X would decrease the quantity of Y demanded at each price.

45. Issues and Applications: Taxation and Cigarette Smoking
Would higher taxes on beer discourage cigarette smoking?
Because the demand for cigarettes is relatively price inelastic, higher cigarette taxes do not appear to discourage smoking

46. Issues and Applications: Taxation and Cigarette Smoking
If alcoholic beverages and cigarettes are complements, then taxes on alcohol could reduce the amount of smoking
Estimates indicate that the cross-price elasticity of demand between beer and cigarettes is -.2
Therefore, a 10 percent increase in beer prices would reduce the number of cigarettes consumed by 2 percent.

47. Income Elasticity of Demand
Income Elasticity of Demand (Ei)
The percentage change in demand for any good, holding its price constant, divided by the percentage change in income
The responsiveness of demand to changes in income, holding the good’s relative price constant

48. Income Elasticity of Demand
percentage change in demand
percentage change in income
Ei =

49. Income Elasticity of Demand
Normal
Exy would be positive
Inferior
Exy would be negative

50. Income Elasticity of Demand
refers to a horizontal shift in the demand curve in response to changes in income
Price elasticity of demand
refers to a movement along the curve in response to price changes

51. How Income Affects Quantity of DVDs Demanded
Number of CDs
Period Demanded per Month Income per Month
1 6 $4,000
2 8 6,000

52. How Income Affects Quantity of DVDs Demanded
Income increases from $400 to $600 per month
(8 - 6)/6
( )/4000
Ei = =
1/3
1/2 2 3
= .667

53. How Income Affects Quantity of DVDs Demanded
Income decreases from $6000 to $4000 per month
(6 - 8)/8
( )/6000
Ei = =
-1/4
-1/3 3 4
= .75

54. Income Elasticity of Demand
Eliminating the bias of the base
ΔQuantity
sum of quantities/2
Ei =
ΔIncome
sum of income/2

55. Income Elasticity of Demand
Demand and elasticities
Accurate estimates of Ep and Ei can yield accurate forecasts of the demand for goods and services.

56. Elasticity of Supply Price Elasticity of Supply (Es)
The responsiveness of the quantity supplied of a commodity to a change in its price
The percentage change in quantity supplied divided by the percentage change in price

57. Elasticity of Supply Formula for computing price elasticity of supply
percentage change in quantity supplied
percentage change in price
ES =

58. Elasticity of Supply Classifying supply elasticities
Perfectly Elastic Supply
Quantity supplied falls to zero when there is any decrease in price.
The supply curve is horizontal at a given price.

59. Elasticity of Supply Classifying supply elasticities
Perfectly Inelastic Supply
Quantity supplied is constant no matter what happens to price.
The supply curve is vertical at a given price.

60. The Extremes in Supply CurvesQ1 S’
Perfect inelasticity
Price per Unit
Quantity Supplied per Period

61. The Extremes in Supply Curves
Perfect inelasticity P1 S
Price per Unit
Perfect elasticity Q1
Quantity Supplied per Period

62. Elasticity of Supply
Price elasticity of supply and length of time for adjustment
The longer the time allowed for adjustment, the more elastic is supply.
Firms can find ways to increase (or decrease) output.
Resources can flow into (or out of) an industry through expansion (or contraction) of existing firms.

63. The Extremes in Supply Curves
Price per Unit
Quantity Supplied per Period

64. The Extremes in Supply Curves
In the short run, the supply curve, S1, is vertical with price Pe and quantity supplied of Qe. Pe E
Price per Unit Qe
Quantity Supplied per Period

65. Short-Run and Long-Run Price Elasticity of Supply
If price increases to P1 quantity stays unchanged P1 Pe
Price per Unit E Qe
Quantity Supplied per Period

66. Short-Run and Long-Run Price Elasticity of SupplyQ1
As time passes the supply curve rotates from S1 to S2 and quantity supplied rises first to Q1. Pe
Price per Unit E Qe
Quantity Supplied per Period

67. Short-Run and Long-Run Price Elasticity of SupplyPe
Price per Unit E
As time passes the supply curve rotates to S2 then to S3 and quantity supplied rises first to Q1 and then to Q2. Qe Q1 Q2
Quantity Supplied per Period

68. Summary Expressing and calculating the price elasticity of demand
Percentage change in quantity demanded divided by the percentage change in price

69. Summary
The relationship between the price elasticity of demand and total revenues
When demand is elastic, price and total revenue are inversely related
When demand is inelastic, price and total revenue are positively related
When demand is unit elastic, total revenue does not change when price changes

70. Summary Factors that determine price elasticity of demand
Availability of substitutes
Percentage of a person’s budget spent on the good
The length of time allowed for adjustment to a price change

71. Summary
The cross price elasticity of demand and using it to determine whether two goods are substitutes or complements
Percentage change in the demand for one good divided by the percentage change in the price of another
If cross elasticity is positive, the goods are substitutes
If cross elasticity is negative, the goods are complements

72. Summary Income elasticity of demand
Percentage change in the demand for a good divided by the percentage in income
Defines Normal vs Inferior goods

73. Summary
Classifying supply elasticities and how the length of time for adjustment affects price elasticity of supply
Elastic supply: price elasticity of supply is > 1
Inelastic supply: price elasticity of supply is < 1
Unit-elastic supply: price elasticity of supply is = 1
The longer the time period for adjustment, the more elastic is supply