Lecture 2.1 Elasticity

Lecture 2.
1 Chapter 4
Elasticity: The
Responsiveness of
Demand and Supply
Learning Objectives
1.
Define price elasticity of demand and understand how to measure

it.
2.
Understand the determinants of the price elasticity of demand.
3.
Understand the relationship between the price elasticity of

demand and total revenue.
4.
Define cross-price elasticity of demand and income elasticity of

demand, and understand their determinants and how they are
measured.
5.
Use price elasticity and income elasticity to analyse economic

issues.
6.
Define price elasticity of supply, and understand its main

determinants and how it is measured.
Copyright 2013 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442558069/Hubbard and O'Brien/Essentials of Economics/2e
The Price Elasticity Of Demand

And Its Measurement
Elasticity: A measure of how much one economic
variablesuch as the quantity demanded of a product
responds to changes in another economic variable
such as the products price.
Price elasticity of demand: The responsiveness of
the quantity demanded of a good to a change in its
price.
Price of Coffee
Comparing Different Price Elasticities of Demand ...

Quantity demanded is very
A 10% price increase ...
sensitive to the price
30
Highly elastic
20
demand
lowers quantity
10
demanded by 20%
0
10
20
30
40
50
60
70
Quantity Demanded
4
Price of Coffee
Comparing Different Price

Elasticities of Demand
Quantity demanded is not
A 10% price increase ...
very sensitive to the price
30
Demand curve with

20
low price elasticity

lowers the quantity
10
demanded by 5%
0
10
20
30
40
50
60
70
Quantity Demanded
5
Price of Coffee
Importance of Price Elasticity of Demand

Snew
Small price
Sold
rise
30
20
More elastic demand
Supply declines by
10
20 thousand kgm per day

0
10
20
30
40
50
60
70
Quantity Demanded
6
Price of Coffee
Importance of Price Elasticity

of Demand
Snew
Large price
Sold
rise
30
Less elastic
20
demand
Supply declines by
10
20 thousand kgm per day

0
10
20
30
40
50
60
70
Quantity Demanded
7

And Its Measurement
Measuring the price elasticity of demand
Divide the percentage change in the quantity demanded
of a product by the percentage change in its price.
Note: The price elasticity of demand is not the

same as the slope of a demand curve.

And Its Measurement
Elastic demand and inelastic demand
Elastic demand: Demand is elastic when the
percentage change in quantity demanded is greater than
the percentage change in price.
| % Q |
| e |
| 1 |
| % P |
d
The price elasticity is greater than 1 in absolute

value.

And Its Measurement
Elastic demand and inelastic demand, cont.
Inelastic demand: Demand is inelastic when the
percentage change in quantity demanded is less than
the percentage change in price.
| % Q |
| e |
| 1 |
| % P |
d
The price elasticity is less than 1 in absolute

value.
10

And Its Measurement
Elastic demand and inelastic demand, cont.
Unit-elastic demand: Demand is unit-elastic when the
percentage change in quantity demanded is equal to the
percentage change in price.
| % Q |
| e |
| 1 |
| % P |
d
The price elasticity is equal to 1 in absolute value.
11
Elastic and inelastic demand curves: Figure 4.1

Price
D2 is inelastic
between point A
and point C.
$30
20
D2
0
12
D1 is elastic
between point A
and point B.
16
20
28
D1
Quantity

And Its Measurement
The mid-point formula
This formula is used to ensure that the value of the
price elasticity of demand between the same two points
is the same whether the price increases or decreases.
e
d
13
Q2 Q1
1
Q2 Q1
2
P2 P1
1
P2 P1
2
in absolute value

And Its Measurement
An example of calculating price elasticity
A cinema reduced the price of movie tickets from $20 to
$15, and average daily sales then increased from 5000
tickets to 7000 tickets. Calculate the price elasticity of
demand using the mid-point formula.
2000/6000
-5/17.5
= -1.17
14

And Its Measurement
Polar cases of elasticity
Perfectly inelastic demand: Demand is perfectly
inelastic when a change in price results in no change in
quantity demanded.
| e d |
| % Q |
0
| % P |
Perfectly elastic demand: Demand is perfectly elastic

when a change in price results in an infinite change in
| % Q |
d
quantity demanded.
| e |
| % P |
15
Summary of the price elasticities of demand: Table 4.1, cont.

If demand is unit elastic,
then the absolute value of
the price elasticity is equal
to 1.
If demand is perfectly
elastic, then the absolute
value of the price
elasticity is equal to
infinity.
16
Summary of the price elasticities of demand: Table 4.1, cont.
If demand is perfectly
inelastic, then the
absolute value of the price
elasticity is equal to 0.
17
The determinants of the price elasticity

of demand
1. Availability of close substitutes
2. The length of time involved
3. Luxuries versus necessities
4. Definition of the market
5. Share of expenditure on the good in the
consumers budget
18
Price Elasticity &

Total Revenue
19
The relationship between price

elasticity and total revenue
Total revenue: The total amount of funds received
by a seller of a good or service.
Total revenue is found by multiplying price per unit
by the number of units sold.
20
The relationship between price

elasticity and total revenue
When demand is price inelastic:
A decrease in price leads to a decrease in total

revenue.
An increase in price leads to an increase in total

revenue.
When demand is price elastic:
21
A decrease in price leads to an increase in total

revenue.
An increase in price leads to a decrease in total

revenue.
The relationship between price elasticity and total revenue:

Figure 4.2
22
Elasticity is not constant along a linear demand curve: Figure 4.3
23
Copyright 2013 Pearson Australia (a division of Pearson Australia

Group Pty Ltd) 9781442558069/Hubbard and O'Brien/Essentials of
Economics/2e
The relationship between price elasticity and total revenue: Table 4.2
24
If demand is
then
because
elastic
an increase in price
reduces revenue
the decrease in
quantity demanded is
proportionally greater
than the increase in
price.
elastic
a decrease in price
increases revenue
the increase in
proportionally greater
than the decrease in
price.
inelastic
increases revenue
the decrease in
proportionally smaller
than the increase in
price.
The relationship between price elasticity and total revenue: Table 4.2
25
If demand is
inelastic
then
because
a decrease in price
reduces revenue
the increase in quantity

demanded is
proportionally smaller
than the decrease in
price.
unit-elastic
does not affect
revenue
the decrease in quantity

demanded is
proportionally the same
as the increase in price..
unit-elastic
a decrease in price
does not affect
revenue
the increase in quantity

demanded is
proportionally the same
as the decrease in price.
Copyright
Copyright2013
2013Pearson
PearsonAustralia
Australia(a(adivision
divisionofofPearson
PearsonAustralia
AustraliaGroup
GroupPty
PtyLtd)
Ltd) 9781442558069/Hubbard
9781442558069/Hubbardand
andO'Brien/Essentials
O'Brien/EssentialsofofEconomics/2e
Economics/2e
Other Demand Elasticities

Cross-price elasticity of demand
Cross-price elasticity of demand: The percentage
change in the quantity demanded of one good divided
by the percentage change in the price of another good.
26

Cross-price elasticity of demand, cont.
Cross-price elasticity will be positive when the two goods
are substitutes in consumption.
e QA
% QA
0
% PB
Cross-price elasticity will be negative when the two

goods are complements in consumption.
e
27
QA
% QA
0
% PB
Summary of cross-price elasticity of demand: Table 4.3
28
If the products
are
then the crossprice elasticity of

demand will be
Example:
substitutes
positive.
Two brands of
digital music
players
complements
negative.
Digital music
players and song
downloads from
online music
stores
unrelated
zero.
Digital music
players and peanut
butter

Income elasticity of demand: A measure of the
responsiveness of quantity demanded to a change in
income.
It is measured by the percentage change in quantity
demanded divided by the percentage change in income
(disposable income).
29
Summary of income elasticity of demand: Table 4.4
30
If the income
then the good is
elasticity of demand
is
Example:
positive, but less than 1
Milk
normal and a necessity.
positive and greater than normal and a luxury.

1
Caviar
negative
High-fat mince
meat
inferior.
The Price Elasticity Of Supply

And Its Measurement
Price elasticity of supply: The responsiveness of the
quantity supplied to a change in price.
It is measured by dividing the percentage change in the
quantity supplied of a product by the percentage change
in the products price.
31

And Its Measurement
The elasticity of supply will always be positive, as price
and quantity supplied move in the same direction.
The primary determinant of the price elasticity of

supply is the amount by which production costs rise as
output levels rise.
Other key determinants are largely based upon this.
32

And Its Measurement
Key determinants of the price elasticity of supply
1. Length of time involved in production

2. Type of industry
3. Availability of inputs
4. Existing capacity
5. Inventories held
33

And Its Measurement
Polar cases of perfectly elastic and perfectly
inelastic supply
The perfectly elastic supply curve is a horizontal line.
The perfectly inelastic supply curve is a vertical line.
34
Summary of the price elasticities of supply: Table 4.5
If supply is unit-elastic,
then the value of the price
elasticity is equal to 1.
35
Summary of the price elasticities of supply: Table 4.5

If supply is perfectly
elastic, then the value of
to infinity.
If supply is perfectly
inelastic, then the value of
to 0.
36
When demand changes, the change in price

depends
onelasticity
the price elasticity
of to
supply.
Using
Price
of supply
predict
changes
in price
In panel (a), Demand
represents the typical demand for

parking spaces on a summer weekday at a beach resort.
Demandweekend represents the demand for parking spaces at the
beach resort on weekends.
weekday
Because supply is inelastic, the shift in equilibrium from point A to

point B results in a large increase in price from $2.00 per hour to
$4.00but only a small increase in the quantity suppliedfrom
1200 to 1400. In panel (b), supply is elastic.
As a result, the shift in equilibrium from point A to point B results in
a smaller increase in price and a larger increase in the quantity
supplied. An increase in price from $2.00 per hour to $2.50 is
sufficient to increase the quantity of parking supplied from 1200 to
2100.
37
Changes in price depend on the price elasticity of supply: Figure 4.5
38
Copyright
Copyright2013
2013Pearson
PearsonAustralia
Australia(a(adivision
divisionofofPearson
PearsonAustralia
AustraliaGroup
GroupPty
PtyLtd)
Ltd) 9781442558069/Hubbard
9781442558069/Hubbardand
andO'Brien/Essentials
O'Brien/EssentialsofofEconomics/2e
Economics/2e
Key Terms
Cross-price elasticity of
demand
Perfectly inelastic
demand
Elastic demand
Price elasticity of
demand
Elasticity
Income elasticity of
demand
Inelastic demand
Perfectly elastic
demand
39
Price elasticity of
supply
Total revenue
Unit-elastic demand

Lecture 2.1 Elasticity

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Lecture 2.

Define price elasticity of demand and understand how to measure

Understand the determinants of the price elasticity of demand.

Understand the relationship between the price elasticity of

Define cross-price elasticity of demand and income elasticity of

Use price elasticity and income elasticity to analyse economic

Define price elasticity of supply, and understand its main

The Price Elasticity Of Demand

Comparing Different Price Elasticities of Demand ...

sensitive to the price

Comparing Different Price

very sensitive to the price

Demand curve with

low price elasticity

Importance of Price Elasticity of Demand

More elastic demand

20 thousand kgm per day

Importance of Price Elasticity

20 thousand kgm per day

The Price Elasticity Of Demand

Note: The price elasticity of demand is not the

The Price Elasticity Of Demand

The price elasticity is greater than 1 in absolute

The Price Elasticity Of Demand

The price elasticity is less than 1 in absolute

The Price Elasticity Of Demand

The price elasticity is equal to 1 in absolute value.

Elastic and inelastic demand curves: Figure 4.1

The Price Elasticity Of Demand

The Price Elasticity Of Demand

The Price Elasticity Of Demand

Perfectly elastic demand: Demand is perfectly elastic

Summary of the price elasticities of demand: Table 4.1, cont.

Summary of the price elasticities of demand: Table 4.1, cont.

The determinants of the price elasticity

Price Elasticity &

The relationship between price

The relationship between price

A decrease in price leads to a decrease in total

An increase in price leads to an increase in total

When demand is price elastic:

A decrease in price leads to an increase in total

An increase in price leads to a decrease in total

The relationship between price elasticity and total revenue:

Elasticity is not constant along a linear demand curve: Figure 4.3

Copyright 2013 Pearson Australia (a division of Pearson Australia

the increase in quantity

the decrease in quantity

the increase in quantity

Other Demand Elasticities

Other Demand Elasticities

Cross-price elasticity will be negative when the two

Summary of cross-price elasticity of demand: Table 4.3

then the crossprice elasticity of

Other Demand Elasticities

Summary of income elasticity of demand: Table 4.4

positive, but less than 1

normal and a necessity.

positive and greater than normal and a luxury.

The Price Elasticity Of Supply

The Price Elasticity Of Supply

The primary determinant of the price elasticity of

The Price Elasticity Of Supply

1. Length of time involved in production