Chapter 6 PDF

ECON 202:
Principles of
Microeconomics
Chapter 6
Elasticity: The Responsiveness of
Demand and Supply

Demand and Supply
1.
2.
3.
4.
5.
Price elasticity of demand.

Determinants of the price elasticity of demand.
Price elasticity of demand and total revenue.
Other demand elasticities.
Price elasticity of supply.
ECON 202: Princ. of Microeconomics
Elasticity: The Responsiveness of Demand and Supply
Whats elasticity?
A measure of how much one economic variable

responds to changes in another economic variable.
Price elasticity of demand.
How much quantity demanded varies when price changes.
It is an important tool for economic analysis.
Valuable information for producers.

How quantity demanded reacts to changes in own prices,
competitors prices or income.
Useful to explain magnitudes of changes in price and quantity
after a shift in demand or supply curve.
1. Price Elasticity of Demand
From law of demand:
Price falls, quantity demanded increases.

But, how much?
To avoid problems of comparability between different

goods (tons vs. gallons), we use percentages:
Case A:
Price is 10, quantity 50.

Price goes up to 12, quantity goes down to 45.
Price elasticity of demand: -10% / 20% = - 0.5
Case B:
Price is 20, quantity 100.

Price goes down to 18, quantity goes up to 85.
Price elasticity of demand: 15% / -10% = - 1.5
But, what happens if we start from the end point?
11.1% / -16.6% = - 0.66

17.6% / 11.1% = - 1.58
Midpoint formula
Case A: ( -5 / 47.5 ) / ( 2 / 11 ) = - 0.58

Case B: ( 15 / 92.5 ) / ( -2 / 19 ) = - 1.54
Q2 Q1
Q1 + Q2
Perc. change in quantity demanded 2

Price elast. dmd. =
=
P2 P1
Perc. change in price
P1 + P2
If elasticity is between 0 and -1:
Change in price causes a change less than proportional in

quantity demanded.
Demand is inelastic.
If elasticity is smaller than -1:
Change in price causes a change more than proportional in

quantity demanded.
Demand is elastic.
If elasticity is equal to -1:
Change in price cause a change proportional in quantity

demanded.
Demand is unit-elastic.
Price elast. of demand 1:

(40/60)/(-10/30) = -2
Price elast. of demand 2:

(10/45)/(-10/30) = -.67
The bigger the elasticity

in absolute value, the
more elastic the demand.
The flatter the curve, the

more elastic the demand.

Polar cases:
Perfectly inelastic demand.
Quantity demanded is
completely unresponsive to
price.
Price elasticity of demand
equals zero.
Perfectly elastic demand.
Quantity demanded is
infinitely responsive to price
Price elasticity of demand
equals infinity.
2. Determinants of the Price Elasticity

of Demand
Availability of close substitutes.
When more substitutes available, more elastic demand.

Movie theaters in CS and movie theaters in Houston.
Passage of time.
Reaction to price changes can take some time.

The more time passes, the more elastic the demand for a
product becomes.
Change of vehicle before a rise in gasoline price.
Luxuries vs. Necessities.
Demand curve for a luxury is more elastic than the demand

curve for a necessity.
Demand for necessities (food, clothes, gasoline) does not
depend much on price.
10
2. Determinants of the Price Elasticity

of Demand
Definition of the market.
The more narrowly defined a market, the more substitutes

available, and the more elastic the demand.
Apple Cinnamon Cheerios vs. breakfast cereal.
Share of a good in a consumers budget.
The bigger the share in the consumers budget, the more elastic
the good.
Increases in price affect considerably purchasing power, then
reaction to this change can be significant.
Houses, cars.
11
Goods or services with Elastic Demand
Metals
Electrical engineering products
Mechanical engineering products
Furniture
Motor vehicles
Instrument engineering products
Professional services
Transportation services
1.52
1.39
1.30
1.26
1.14
1.10
1.09
1.03
12
Goods or services with Inelastic Demand
Gas, electricity, and water

Drinks (all types)
Clothing
Tobacco
Banking and insurance services
Agricultural and fish products
Books, magazines and newspapers
Food
Oil
0.92
0.78
0.64
0.61
0.56
0.42
0.34
0.12
0.05
13
3. Price Elasticity of Demand and Total

Revenue
Total revenue: price x units sold
14

Revenue
When demand inelastic:
A cut in price increases quantity demanded less than
proportionally.
Total revenue decreases.
When demand elastic:

A cut in price increase quantity demanded more than
proportionally.
Total revenue increases.
When demand unit-elastic:

A cut in price increase quantity demanded proportionally.
Total revenue does not change.
15

Revenue
Price elasticity is not constant along a linear demand

Price elast. of demand at:
p = 7 : (2/3)/(-1/6.5) = - 4.3
p = 2 : (2/13)/(-1/1.5) = - 0.23
p = 4 : (2/8)/(1/4) = -1
16

Revenue
17
4. Other Demand Elasticities

Cross-Price Elasticity of Demand
If products are substitutes:
Cross-price elasticity of demand is positive.

Summer vacation destinations: Cancun vs. Puerto Vallarta.
If products are complements
Cross-price elasticity of demand is negative.

Airline tickets and hotel rooms.
If products are unrelated
Cross-price elasticity of demand is zero.
18

Income Elasticity of Demand
If the income elasticity is positive and smaller than 1:
Good is normal and necessity.

Food expenses.
If the income elasticity is positive and greater than 1:
Good is normal and luxury.

Designer clothing.
If the income elasticity is negative
Good is inferior.
Inter-city bus service.
19
The level of income has a important effect on income

elasticities of demand.
Income elasticity of demand for food.
20
Goods or services Income Elastic:
Airline travel
Movies
Foreign travel
Electricity
Restaurant meals
Local buses and trains
Haircuts
Cars
5.82
3.41
3.08
1.94
1.61
1.38
1.36
1.07
21
Goods or services Income Inelastic:
Tobacco
Alcoholic beverages
Furniture
Clothing
Newspapers
Telephone
Food
0.86
0.62
0.53
0.51
0.38
0.32
0.14
22

Elasticities in the Market for Alcoholic Beverages
Price elasticity of demand for beer
-0.23
Cross-price elasticity of demand between beer and wine
0.31
Cross-price elasticity of demand between beer and spirits
0.15
Income elasticity of demand for beer
-0.09
Income elasticity of demand for wine
5.03
Income elasticity of demand for spirits
1.21
23
4. Price Elasticity of Supply
In an analogous way to demand
Because supply curves are upward sloping, Price

Elasticity of Supply is positive.
If smaller than 1: inelastic.
If greater than 1: elastic.
If equal to 1 : ?
24
4. Price Elasticity of Supply
Price elasticity of supply depends on the availability of

inputs and capital to increase production.
In a short period of time, supply will be inelastic.
After some time has passed, supply will become more
elastic, as more resources can be dedicated to
production.
If a necessary input is not available, supply can be
inelastic.
25
Using Price Elasticity of Supply to

Predict Changes in Price
Effect on market price of a shift in demand depends on

elasticity of the supply curve.
26

In the last 30 years prices of oil have fluctuated

considerably.
From $11 per barrel to $75 per barrel.
Supply of oil is relatively inelastic, since exploring, drill

and start exploiting new reserves is a lengthy process.
Demand of oil derivatives (gasoline) is inelastic.
Shifts in supply were common because of the
coordination of oil producers countries. (OPEC)
27

With more elastic supply curves, changes in prices are

more moderate.
28
ECON 202:
Principles of
Microeconomics
Chapter 6
Demand and Supply

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ECON 202:

Elasticity: The Responsiveness of

Price elasticity of demand.

ECON 202: Princ. of Microeconomics

Elasticity: The Responsiveness of Demand and Supply

A measure of how much one economic variable

How much quantity demanded varies when price changes.

It is an important tool for economic analysis.

Valuable information for producers.

ECON 202: Princ. of Microeconomics

Elasticity: The Responsiveness of Demand and Supply

1. Price Elasticity of Demand

From law of demand:

Price falls, quantity demanded increases.

To avoid problems of comparability between different

ECON 202: Princ. of Microeconomics

Elasticity: The Responsiveness of Demand and Supply

1. Price Elasticity of Demand

Price is 10, quantity 50.

Price is 20, quantity 100.

But, what happens if we start from the end point?

11.1% / -16.6% = - 0.66

Elasticity: The Responsiveness of Demand and Supply

1. Price Elasticity of Demand

Case A: ( -5 / 47.5 ) / ( 2 / 11 ) = - 0.58

Perc. change in quantity demanded 2

ECON 202: Princ. of Microeconomics

Elasticity: The Responsiveness of Demand and Supply

1. Price Elasticity of Demand

If elasticity is between 0 and -1:

Change in price causes a change less than proportional in

If elasticity is smaller than -1:

Change in price causes a change more than proportional in

If elasticity is equal to -1:

Change in price cause a change proportional in quantity

ECON 202: Princ. of Microeconomics

Elasticity: The Responsiveness of Demand and Supply

1. Price Elasticity of Demand

Price elast. of demand 1:

Price elast. of demand 2:

ECON 202: Princ. of Microeconomics

The bigger the elasticity

The flatter the curve, the

Elasticity: The Responsiveness of Demand and Supply

1. Price Elasticity of Demand

Perfectly elastic demand.

Elasticity: The Responsiveness of Demand and Supply

2. Determinants of the Price Elasticity

Availability of close substitutes.

When more substitutes available, more elastic demand.

Reaction to price changes can take some time.

Luxuries vs. Necessities.

Demand curve for a luxury is more elastic than the demand

Elasticity: The Responsiveness of Demand and Supply

2. Determinants of the Price Elasticity

Definition of the market.

The more narrowly defined a market, the more substitutes

Share of a good in a consumers budget.

ECON 202: Princ. of Microeconomics

Elasticity: The Responsiveness of Demand and Supply

Goods or services with Elastic Demand

ECON 202: Princ. of Microeconomics