chapter 4: elasticity. 4.1 price elasticity elasticity is a measure of the responsiveness of one...

Chapter 4:Elasticity

4.1 Price Elasticity

• Elasticity is a measure of the responsiveness of one variable to another.

• The greater the elasticity, the greater the responsiveness.

• Eg. Chocolate bar is $0.50 how many will you buy? 5? If price changes to $1.00, how many will you now demand? 1?– Elasticity measures how your demand will

change if the price changes

Price Elasticity

• The price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price.

Price Elasticity

• Eg. Chocolate bar

• Price increase from $0.50 to $0.75

• % changed = $0.75 - $0.50

($0.50 + $0.75)/2

= $0.25 / ($1.25/2)

= $0.25 / $0.625

= 0.4%

Price Elasticity


• Demand decrease from 5 to 1

• % changed = 1 – 5 / (1+5)/2

= -4 / 6

= -0.67%

Price Elasticity


EDChoc = -0.67% / 0.4%

= -1.67%

So, a 0.4% increase in price leads to a 1.6% decrease in quantity demanded

Sign of Price Elasticity• According to the law of demand, whenever

the price rises, the quantity demanded falls. Thus the price elasticity of demand is always negative.

• Because it is always negative, economists usually state the value without the sign.

Graphs of ElasticitiesP

rice

Quantity of software (in hundred thousands)

$26242220181614

0

D

B

A

10 12 14

C (midpoint)

Elasticity of demand between A and B = 1.27

Calculating Elasticities: Price elasticity of Demand

D

P

Q

What is the price elasticity of demand between A and B?

$20

10

$26

14

MidpointB

A

ED = %ΔQ%ΔP

Q2–Q1

½(Q2+Q1)P2–P1

½(P2+P1)

=

C

12

$23

=

10–14½(10+14)

26–20½(26+20)

-.33.26 = 1.27 =

4.2 Price Elasticity Ranges

• Demand is elastic if the percentage change in quantity is greater than the percentage change in price.

ED > 1Change in price (0.5%) will lead to a larger

change in demand (0.8%)

ie. 0.5% < 0.8% so EDChoc = 1.6

where 1.6 > 1

Classifying Demand and Supply as Elastic or Inelastic

• Demand is inelastic if the percentage change in quantity is less than the percentage change in price.

ED < 1

Change in price will lead to a smaller change in demand - unresponsive

Defining Elasticities• When price elasticity is = 1, we say

demand is unit elastic.

• Eg. Chocolate bar Say if, change in price = 0.5%And, change in demand = 0.5%

What is EDChoc? = 0.5% / 0.5% = 1

Extreme Elasticities

• Perfectly Elastic Demand Curve– The demand curve is horizontal, any change in price can and

will cause consumers to change their consumption.

• Perfectly Inelastic Demand Curve– The demand curve is vertical, the quantity demanded is totally

unresponsive to the price. Changes in price have no effect on consumer demand.

• In between the two extreme shapes of demand curves are the demand curves for most products.

Perfectly inelastic demand curve

Change in price leads to NO change in quantity

Eg. insulin

Pric

e

0Quantity

Perfectly Inelastic Demand Curve

D

Perfectly elastic demand curve

When price changes even just a little, quantity demanded changes a lot (to zero)

Perfectly Elastic Demand CurveP

rice

0Quantity

P0

S0

P1

4.3 Determinants of the Price Elasticity of Demand

• The degree to which the price elasticity of demand is inelastic or elastic depends on:– How many substitutes there are, the more the

more elastic ie quickly jump to another product, no loyalty

– The importance of the product in the consumer’s total budget, the more important the more elastic eg pepper are inelastic and cars are elastic so price changes to car will affect your budget and therefore demand for other things

Determinants of the Price Elasticity of Demand

• The degree to which the price elasticity of demand is inelastic or elastic depends on:– The time period under consideration. If the

price change is over a long period of time people have time to adjust or find substitutes so they are more elastic in demand

Pric

e

0Quantity

Long Run Elastic Demand Curve

DEg. If you expected gas prices went up by $0.50 how do you adjust? Turn lights off, switch to solar energy ie. demand goes down, qty demanded for gas goes down!

4.4 Cross-Price Elasticity of Demand

• Cross-price elasticity of demand – the percentage change in demand divided by the percentage change in the price of another good. Eg. Margarine prices go up, what is effect on butter demand?

Complements and Substitutes

• Substitutes are goods that can be used in place of another. Eg. Butter and margarine!

• Substitutes have positive cross-price elasticities.

• As margarine price goes up, demand for butter goes up too!!!

Complements and Substitutes

• Complements are goods that are used in conjunction with other goods.

• Complements have negative cross-price elasticities.

• Eg. Peanut butter and jelly...when the price of up, demand for jelly goes down.

Calculating Cross-Price Elasticity

D0

P0

D1

P0

104Quantity of Beef

108

Shift due to 33% rise in price of pork, a substitute

12.33.

038.

33.

)104108(104)-(108

E 21

cross

Income Elasticity of Demand

• Income elasticity of demand – the percentage change in demand divided by the percentage change in income.


• Income elasticity of demand tells us the responsiveness of demand to changes in income. Represents a shift in demand.

Eg. In market for one Honda, then win lottery, income goes up, and now buy one+


• An increase in income generally increases one’s consumption of almost all goods.

• The increase may be greater for some goods than for others.


• Normal goods are those whose consumption increases with an increase in income.

• They have income elasticities greater than zero or positive


• Normal goods are divided into luxuries and necessities.


• Luxuries are goods that have an income elasticity greater than one.

• Their percentage increase in demand is greater than the percentage increase in income.


• A necessity has an income elasticity less than 1.

• The consumption of a necessity rises by a smaller proportion than the rise in income.


• Inferior goods are those whose consumption decreases when income increases.

• Inferior goods have income elasticities less than zero.

Calculating Income Elasticity

P0

D0 D1

P0

20 Quantity26

Shift due to 20% rise in

income

3.120

26

20

)2026(20)-(26

E 21

income

4.5 Price Elasticity: Supply

• Price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in

• This tells us exactly how quantity supplied responds to a change in price

ES = % change in Quantity Supplied% change in Price

Price Elasticity: Supply

• Supply is elastic if the percentage change in quantity is greater than the percentage change in price

Elastic supply is when ES > 1

• Supply is inelastic if the percentage change in quantity is less than the percentage change in price

Inelastic supply is when ES < 1

Calculating Elasticities: Price elasticity of Supply

P

Q

What is the price elasticity of supply between A and B?

$4.50

476

$5.00

485

B

A

ES = %ΔQ%ΔP

Q2–Q1

½(Q2+Q1)P2–P1

½(P2+P1)

=

=

485–476½(485+476)

5–4.50½(5+4.50)

Midpoint

C

480.5

$4.750.01870.105 = 0.18 =

S

7-34

Determinants of the Elasticity of Supply

• The shape of the supply curve depends primarily on the length of time being considered.– In the short run, suppliers don’t have

time to expand or contract production in response to price changes eg. House prices go up and house builders order supplies but wait for supplies before can build more


• The shape of the supply curve depends primarily on the length of time being considered.– In the long run, the builder has long

enough to have all supplies delivered and starts building houses for sale ie increases supply of houses


• The shape of the supply curve depends primarily on the availability of raw material– Easier to get raw materials, more elastic ie

can respond to changes in price


• The shape of the supply curve depends primarily on the Complexity of Production– Easier to get make product, the more elastic

ie can respond to changes in price– Eg. Paper air planes


• The shape of the supply curve depends primarily on the Excess Capacity and Inventories– Producers have a large number of empty

houses for sale the more elastic the supply ie can respond to changes in price

chapter 4: elasticity. 4.1 price elasticity elasticity is a measure of the responsiveness of one...

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