Thai Nguyen University

Thai Nguyen University of Technology

Faculty of International Training

(ECEN 4503)
Engineering Economics
Lecture #5:

Elasticity and Its Application

Sunday May 31st 2015
Lecturer: Nguyen Minh Y, Ph.D.

Reviewing

Ten
principles
of
economics
- How people
make
decision
- How they
interact
- How they
organized

Think like
an
economist
- Scientists
- Policymakers

Interdepend
ence and
the gains
from trade
- Specialize
and trade
- Absolute
advantage
- Comparative
advantage

Department of Electrical Engineering taught in English

Supply and
Demand:
How
market
works
- The market
forces of
supply and
demand

1/1/16

1. The Elasticity of Demand

Previously
Law of demand
Determinants of demand
Demand schedule and demand curve
Etc.

How to measure relationship of demand and price?

Elasticity a measure of the responsiveness of quantity demanded

or quantity supplied to one of its determinants.

Department of Electrical Engineering taught in English

1/1/16

1. The Elasticity of Demand

The price elasticity of demand and its determinants
Price elasticity of demand
A measure of how much the quantity demanded of a good respond to

a change in the price of that good

Price elasticity of demand =

Percentage change in quantity demanded

Percentage change in price

Example:
Catherines demand for ice cream
What is the price elasticity of

Catherines demand?
Is the price elasticity constant?
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Department of Electrical Engineering taught in English

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1. The Elasticity of Demand

Determinants of the elasticity
Necessities versus luxuries
Necessity goods tend to have inelastic demand, whereas luxuries have

elastic demand.
Example:
Visiting the doctor.
Sailboat.
Availability of close substitutes
Goods with close substitutes tent to have more elastic demand.

Example:
Tea and coffee are close substitutes
Cola and Pepsi are also close substitutes
Eggs ???
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Department of Electrical Engineering taught in English

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1. The Elasticity of Demand

Determinants of the elasticity
Definition of the market
Narrowly defined markets (for goods or services) tend to have more

elastic demand than broader defined markets.

Example:
Market for foods
Market for ice cream
Time horizon (long run vs. short run)
Goods tend to have more elastic demand over longer time horizons.

Example:
When the price of gasoline rises
In short run
In long run
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1. The Elasticity of Demand

Computing the price elasticity of demand
Price elasticity of demand =

Percentage change in quantity demanded

Percentage change in price

Example:
Market for ice cream:
10 percent increase in the price of an ice cream
20 percent fall in the amount consumed

Price elasticity of demand

7

20 percent
2
10 percent

Department of Electrical Engineering taught in English

Is it correct from the

definition???
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1. The Elasticity of Demand

The midpoint method:
Price elasticity of demand =

Percentage change in quantity demanded

Percentage change in price

Example:
Market for ice cream:
Point A:
Point B:

Price = $4
Price = $6

Elasticity from A to B:

Elasticity from B to A:

Quantity = 120
Quantity = 80

120 80 120 0.66

6 4 4
120 80 80 1.5
6 4 6

Department of Electrical Engineering taught in English

1/1/16

1. The Elasticity of Demand

The midpoint method:
The price elasticity of demand is calculated from the midpoint, it

is the same regardless the directions of changes.

Q2 Q1 Q2 Q1 2
Price elasticity of demand
P2 P1 P2 P1 2
Example:
Market for ice cream:
Point A:
Point B:

Price = $4
Price = $6

Elasticity by midpoint:
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Quantity = 120
Quantity = 80

120 80 120 80 / 2
6 4 6 4 / 2

Department of Electrical Engineering taught in English

1
1/1/16

1. The Elasticity of Demand

The variety of demand curve
According to their elasticity, demand can be classified as:
Demand is elastic when the elasticity is greater than 1, so that the

quantity moves proportionally more than the price.

Luxury/necessity

good, closed substitutes or not, etc.

The demand is said to be unit elasticity if the elasticity is exactly 1,

thus, the quantity and price move proportionately with the same
amount.
The demand is inelastic if the elasticity is smaller than 1, the quantity
moves less than the price.
Luxury/necessity

goods, closed substitutes or not, etc.

In extreme cases,
If

the elasticity is infinite, the demand is said to be perfectly elastic.

If the elasticity is zero, the demand is said to be perfectly inelastic.
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Department of Electrical Engineering taught in English

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1. The Elasticity of Demand

Total revenue and the price elasticity of demand
Total revenue
The amount paid by buyers and received by sellers of a good
Computed as the price of the good times the quantity sold

Total revenue = Price Quantity

How the total revenue changes along the demand curve?
If demand is inelastic (the elasticity is smaller than 1),
An

increase in the price will cause an increase in total revenue, and vice
versus.
If the demand curve is elastic (greater than 1),
An increase in price will reduce total revenue, and vice versus.
In case of unit elastic demand,
A change in price does not affect total revenue.
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Department of Electrical Engineering taught in English

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Elasticity and total revenue along a linear demand

curve?
Price

Quantity Total revenue

($/unit)

12

($)

12

20

24

24

10

20

12

12

14

Percent

Percent

change in

change in

price

quantity

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Elasticity

Description

13

Elastic

18

200
67

3.7

Elastic

22

40

1.8

Elastic

29

29

1.0

Unit elastic

40

22

0.6

Inelastic

67

18

0.3

Inelastic

200

15

0.1

Inelastic

Q2 Q1 Q2 Q1 2
Price elasticity of demand
P2 P1 P2 P1 2

Department of Electrical Engineering taught in English

1/1/16

1. The Elasticity of Demand

Elasticity and total revenue along a linear demand curve

FIGURE: THE DEMAND CURVE AND THE PRICE ELASTICITY

OF DEMAND AND TOTAL REVENUE. ALONG THE DEMAND
CURVE, THE ELASTICITY CHANGES SINCE IT IS THE RATIO
OF PERCENTAGE CHANGE.
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Department of Electrical Engineering taught in English

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1. The Elasticity of Demand

Other elasticity of demand
Income elasticity of demand
Measures of how much the quantity demanded of a good responds to

a change in consumers income

Income elasticity of demand

Percentage change in quantity demanded

Percentage change in income

Normal goods vs. inferior goods

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Department of Electrical Engineering taught in English

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1. The Elasticity of Demand

Other elasticity of demand
The cross-price elasticity of demand
Measures of how much the quantity demanded of a good responds to

a change in the price of another good

Cross-price elasticity of demand

Percentage change in quantity demanded of good 1

Percentage change in price of good 2

Substitute goods vs. complement goods

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Department of Electrical Engineering taught in English

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2. The Elasticity of Supply

The price elasticity of supply and it determinant
Price elasticity of supply
A measure of how much the quantity supplied of a good responds to a

change in the price of that good

Computed as the percentage change in quantity supplied divided by
change in price

Example:
Bens supply for ice cream
What is the price elasticity of

Bens supply?
Is the price elasticity constant?

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Department of Electrical Engineering taught in English

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2. The Elasticity of Supply

Determinants of the elasticity
Time horizons
The supply is more elastic in the long run than in the short run.
In short run,
Firms

can not change

o The size of factory
o The number of worker
o Technologies
In long run,
Firms can build new factory and close old one
New firms enter the market and old firms shut down
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Department of Electrical Engineering taught in English

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2. The Elasticity of Supply

Computing the price elasticity of supply
Price elasticity of supply

Percentage change in quantity supplied

Percentage change in price

Example:
Market for ice cream:
10 percent increase in the price of an ice cream
20 percent fall in the amount consumed

Price elasticity of supply

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Department of Electrical Engineering taught in English

20 precent
2
10 precent
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2. The Elasticity of Supply

The variety of supply curve
Economists classify supply curve according to their elasticity
In the extreme case
Zero

elasticity,

o Supply is perfectly inelastic, and the supply curve is vertical. The

supply is the same regardless of the price.
Infinite

elasticity,

o Supply is perfectly elastic, and the supply curve is horizontal. A very

small change in price causes large change in the quantity supplied.
If the elasticity is greater than 1,
The

supply is said to be elastic;

Otherwise, it is inelastic.

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Department of Electrical Engineering taught in English

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2. The Elasticity of Supply

The price elasticity along the supply curve
The price elasticity of supply varies over the supply curve

Example:
Firms with limited capacity for production (factory size, machine,
worker, etc.)
At low level of quantity supplied
The

firm responds substantially to the change in the price

Close to the limit
Increase in price causes small change in quantity supplied
At maximum capacity
No increase is allowed even the price increases
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Department of Electrical Engineering taught in English

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Application of Supply, Demand and Elasticity

Can good news for farming be bad news for farmer?
Suppose that
Agronomists discover a new wheat that is more productive than

current ones.
Will farmers be beneficial?
Three steps:
How the new discovery affect

supply?
The supply curve shifts to left or
right?
The new market equilibrium?
If farmers worse off, why do they
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ignore it?

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Application of Supply, Demand and Elasticity

Why did the organization of petroleum exporting countries

(OPEC) fail to keep the price of oil high?

Suppose that
OPEC tries to reduce the supply to boost the price of oil.

Three steps:
How the policy affect supply?
The supply curve shifts to left or

right?
The new market equilibrium?

Long run versus short run?

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Department of Electrical Engineering taught in English

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Application of Supply, Demand and Elasticity

Does drug interdiction increase or decrease drug-related

crime?
Drug interdiction
Drug education

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Department of Electrical Engineering taught in English

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Summary
Elasticity
Elasticity of demand
Kind of goods and services
Necessary versus luxuries
Substitutes versus

complement
Short run versus long run

Homework #4. Due on Tue.

Elasticity of supply
Short run versus long run

Total revenue
Applications
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Department of Electrical Engineering taught in English

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Practice
Ex1. Suppose that business travelers and vacationers have the
following demand for airline tickets from New York to Boston:
Price

Quantity demanded
(business travelers)

Quantity demanded
(vacations)

$150
200
250
300

2,100 tickets
2,000
1,900
1,800

1,000 tickets
800
600
400

As the price of tickets rises from $200 to $250, what is the price
elasticity of demand for (i) business travelers and (ii) vacationers?
b) Why might vacations have a different elasticity from business
travelers?
a)

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Department of Electrical Engineering taught in English

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Practice
Ex4. Maria has decided always to spend one-third of her income
on clothing.
What is her income elasticity of clothing demand?
b) What is her price elasticity clothing demand?
c) If Marias tastes change and she decides to spend only onefourth of her income on clothing, how does her demand curve
change? What is her income elasticity and price elasticity now?
a)

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Department of Electrical Engineering taught in English

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