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Chapter 5
The Price System, Demand
and Supply, and Elasticity

Elasticity
Elasticity is a concept borrowed from physics
Elasticity is the concept economists use to describe the
steepness or flatness of curves or functions.
Elasticity is a measure of how responsive a dependent
variable is to a small change in an independent
variable(s)
Elasticity is defined as a ratio of the percentage change
in the dependent variable to the percentage change in
the independent variable
Elasticity can be computed for any two related variables

Slide 2

Elasticity [cont. . . ]
Elasticity can be computed to show the effects of:
a change in price on the quantity demanded
a change in income on the demand function for a
good
a change in the price of a related good on the
demand function for a good
a change in the price on the quantity supplied
a change of any independent variable on a
dependent variable

Slide 3

Elasticity

Elasticity is a general concept that can be

used to quantify the response in one
variable when another variable changes.

% A
e la s tic ity o f A w ith re s p e c t to B
% B

Price elasticity of demand measures how

responsive consumers are to changes in the
price of a product.

Price Elasticity of Demand

Sometimes called own price elasticity
can be computed at a point on a demand function or
as an average [arc] between two points on a
demand function

p,ep, h, e are common symbols used to represent

price elasticity
Price elasticity [p,ep] is related to revenue

How will a change in price effect the total revenue?

is an important question.

Slide 5

PRICE ELASTICITY OF DEMAND

Measures the responsiveness of quantity demanded
to changes in a goods own price.
The price elasticity of demand is the percent change
in quantity demanded divided by the percent change
in price that caused the change in quantity
demanded.

Slide 6

FACTS ABOUT ELASTICITY

Its always a ratio of percentage changes.
That means it is a pure number -- there are no units
of measurement on elasticity.
Price elasticity of demand is computed along a
demand curve.

Elasticity is not the same as slope.

Slide 7

Price Elasticity of Demand

Measures the responsiveness of demand to
changes in price.
It is the ratio of the percentage change in
quantity demanded to the percentage change
in price.
% c h a n g e in q u a n tity d e m a n d e d
p ric e e la s tic ity o f d e m a n d
% c h a n g e in p ric e

Its value is always negative, but stated in

absolute terms.
The value of the line of the slope and the
value of elasticity are not the same.

A Question for Thought and Discussion

(Elasticity Conceptually)

Think of two different products

and write them down:
1.

2.

One in which you are highly price

sensitive. For example, you are always
checking prices to see when it goes on
sale. You will not buy it at any price.
Another in which you are not price
sensitive. You need this product on a
regular basis. You may be loyal to a
particular brand. If the price increases,
you are likely to buy it anyway.

Slope and Elasticity

slope

23
1

10 5
5
slope

23
1

160 80
80

Changing the units of measure yields a

very different value of the slope, yet
the behavior of buyers in both
diagrams is identical.
10 of

Slope and Elasticity

slope

23
1

10 5
5
slope

23
1

160 80
80

Changing the units of measure yields a

very different value of the slope, yet
the behavior of buyers in both
diagrams is identical.
11 of

Characteristics of Demand Elasticity

Value of
Elasticity

Type of Demand
Elastic

Magnitudes of
Change

Response to Price
Changes

> |1|

Inelastic

%Qd > %P

Responsive

< |1|

Unitary elastic

%Qd < %P

Unresponsive

%Qd = %P

Proportional

= |1|

Type of
Elasticity

Substitutes
Available

Elastic

Many

Inelastic

Few

Elastic Demand

When Demand is
Elastic, price has a
large impact on the
demand for a good.
This is generally true
for luxury items, such
as Jewelry, as they
are not required to
exist.
Examples Include:

Jewelry
Houses
Cars

Inelastic Demand
Inelastic Demand
indicates that price
has very little impact
on the demand for a
good.
This is generally true
for essentials, such as
Food, as they are
required to exist.
Examples Include:

Food
Clothing
Utilities

Unitary Elastic Demand

Unitary Elastic
Demand indicates
that the
percentage change
in the price of the
good will equal the
percentage change
in the demand for
the good.
Examples Include:

Any good with an

Elasticity of Demand
Calculation equaling
1!

Shape of Demand According to Elasticity

Type of Demand

Inclination

Elastic

Relatively Flat

Inelastic

Relatively Steep

Extreme Elasticities

Elasticity Value

Type of Elasticity

Substitutes Available

=0

Perfectly Inelastic

None

Perfectly Elastic

Infinite

Perfectly Elastic and

Perfectly Inelastic Demand Curves

When demand does not

Demand is perfectly elastic
respond at all to a
when quantity demanded
change in price, demand
drops to zero at the
is perfectly inelastic.
slightest increase in price.
18 of

Relative Elasticity of Demand Curves

Relatively Inelastic Demand Curve

Relatively Elastic Demand Curve

5
4
3
2
1

Quantity in pounds

10

11

12

Hypothetical Demand Elasticities

for Four Products

Hypothetical Demand Elasticities for Four Products

PRODUCT
Insulin
Basic telephone service
Beef
Bananas

% CHANGE
IN PRICE
(% P)
10%
10%
10%
10%

% CHANGE IN
QUANTITY
DEMANDED
(% Qd)
0%
-1%
-10%
-30%

ELASTICITY
(% Qd/% P)
0
-0.1
-1
-3

Perfectly inelastic
Inelastic
Unitary elastic
Elastic

Calculating Percentage Changes

Elasticity is a ratio of percentages, and it
involves computing percentage changes.
P2 P1
% c h a n g e in p ric e
x 100%
P1
Q2 Q1
% c h a n g e in q u a n tity d e m a n d e d
x 100%
Q1
Using the values on the graph to
compute elasticity, then:

100%
p ric e e la s tic ity o f d e m a n d
3 .0
3 3 .3 %

Constant Elasticity Demand Curves

(a) Perfectly elastic
demand curve

(b) Perfectly inelastic

demand curve

(c) Unit elastic

demand curve

E D= 0

Price per unit

E D=

Price per unit

Price per unit

D'
E D=
a

$10

Quantity
per period

This demand curve

indicates consumers will
demand all that is offered
at the given price, p. If the
price rises above p,
quantity demanded drops
to zero.

Quantity
per period

This demand curve

indicates that quantity
demanded does not vary
when the price changes; no
matter how high the price,
consumers will purchase the
same quantity.

D"
60

100

Quantity
per period

This demand curve is

unit-elastic everywhere:
any percent change in
price results in an
identical offsetting
percent change in
quantity demanded.
24

Computing the Value of Elasticity

The midpoint formula to compute

elasticity is:

Q2 Q1
x 100%
% Qd
(Q 1 Q 2 ) / 2

P2 P1
% P
x 100%
( P1 P2 ) / 2

10 5
5
x 100%
x 100%
% Qd
(5 1 0 ) / 2

7 .5
2 3
-1
% P
x 100%
x 100%
(3 2 ) / 2
2 .5

6 6 .7 %
=
1 .6 7
-4 0 .0 %

e
or, ep

% change in quantity demanded

% change in price
%DQ
% P

At a point on a demand function this can be

calculated by:

ep =

Q22 -- Q
Q11 = Q
Q
Q1
=

P2P- 2P-1P=1 P
P1

Q
Q1
P
P1

Slide 26

+2
Q

ep =

[2/3 = .66667]

Q31

% Q = 67%

P
-2

P71

[-2/7=-.28571]

% P = -28.5%

[rounded]

The own price elasticity of demand

at a price of 7 is -2.3

Price decreases from 7 to 5

This is point price elasticity. It is calculated at a point

on a demand function. It is not influenced by the direction
or magnitude of the price change.

Px
P1 = 7

= -2.3

A
P = -2

P2- P1 = 5 - 7 = P = -2

P2 = 5

Q2 - Q1 = 5 - 3 = Q = +2
D

Q = +2

Q1 = 3

Q2 = 5

There is a problem! If the

price changes from 5 to
7 the coefficient of
elasticity is different!

Qx/ut
Slide 27

ep =

Q
-2

[-2/5 = -.4]

5Q1

+2
P

% Q = -40%

= -1

% P = 40%

[+2/5 = .4]
P51
When the price increases from 5 to 7,

[this is called unitary elasticity]

the ep = -1 [unitary]

In the previous slide, when the price decreased from 7 to 5, ep

The point price elasticity is

different at every point!

Px

P2 = 7

There is an
easier way!

= -2.3

P1 = 5

ep = -2.3

P = +2

ep = -1
D

Q = -2

Q2= 3

Q1= 5
Slide 28

Qx/ut

By rearranging terms

An easier way!
Q
Q1
Q1
P

ep =

Q1

P1
P

P1

ep

Q2= 5

P2- P1 = 5 - 7 = P = -2

+2
-2

Q1

= -1

P71
*

P1 = 7,

Q2 - Q1 = 5 - 3 = Q = +2

Then,

this is the
slope of the
demand function

Given that when:

P1 = 7, Q1 = 3
P2 = 5,

P1

this is a point on
the demand
function

= -1

Q
31

= -2.33

Q1 = 3

On linear demand functions the

slope remains constant so you
just put in P and Q

This is the slope of the demand Q = f(P)

Slide 29

The following information was

given

P1 = 7,
P2 = 5,

Q1 = 3
Q2= 5

+2
-2

The equation for the demand

function we have been using is
Q = 10 - 1P. A table can be
constructed.

What is the Q
intercept?

B
Px must decrease
by 5.

The slope of the demand function

Q

Q2 - Q1 = 5 - 3 = Q = +2
P2- P1 = 5 - 7 = P = -2

[Q = f(P)] is

Q = f (P)

Px

Q increases by 5

= -1

Q = 10
Qx ut

The slope [-1] indicates that for every

1 unit increase in Q, Px will decrease by 1.
Since Px must decrease by 5, Q must
increase by 5

Q = 10 when Px = 0

The slope-intercept form

Q = 10
a + -m
1 P
Slide 30

The slope is -1

The intercept is 10

For a simple demand function: Q = 10 - 1P

price

quantity

10

10

ep

Total
Revenue

using our formula,

ep

P
the slope is -1,
Q

P1
Q1
price is 7
P71

0
-.11

ep

-.25
-.43
-.67
-1.

at a price of $7, Q = 3

-1.5
-2.3
-4.
-9
undefined

= (-1)
P

Q31

Calculate ep at P = $9
Q=1
9

ep = (-1)

= -2.3

= -9

Calculate ep for all other

price and quantity
combinations.
Slide 31

To solve the problem of a point elasticity that is different for every price quantity
combination on a demand function, an arc price elasticity can be used. This arc price
elasticity is an average or midpoint elasticity between any two prices. Typically,
the two points selected would be representative of the usual range of prices in the
time frame under consideration.

The formula to calculate the average or arc price

elasticity is:
Q
P1 + P2
ep =
*

P1 + P 2 =
12

P1 = 7,
P2 = 5,

Q1 = 3
Q2 = 5

Q1 + Q 2 =
8

Q2 - Q1 = 5 - 3 = Q = +2
P2- P1 = 5 - 7 = P = -2

Px

The average or arc ep between

5 and 7 is calculated,

ep

-1
P

The average

P1 12
+ P2
Q1 8+ Q2

Slope of demand

5
Q

Q1 + Q 2

=-1
D

= - 1.5

ep between 5 and 7 is -1.5

5
Slide 32

Qx/ut

Interpreting the Value of Elasticity

Here is how to interpret two different
values of elasticity:
When = 0.2, a 10% increase
in price leads to a 2%
decrease in quantity
demanded.
When = 2.0, a 10% increase
in price leads to a 20%
decrease in quantity
demanded.

Elasticity of Demand of Selected

Goods and Services

Household electricity 0.13

Bread
0.15
Telephone service
0.26
Medical care
0.31
Legal services
0.37
Clothing
0.49

Gasoline
0.60
Milk
0.63
Beer
0.90
Motor Vehicles
1.14
Restaurant meals 2.27

Elasticity Changes along a Straight-Line Demand Curve

Price elasticity of
demand decreases as
we move downward
along a linear
demand curve.
Demand is elastic on
the upper part of the
demand curve and
inelastic on the lower
part.

Elasticity of Straight-Line Demand Curve

Elasticity Changes along a Straight-Line Demand Curve

Along the elastic

range, elasticity
values are greater
than one.

6.4

.29

Along the inelastic range,

elasticity values are less than
one.

Elasticity and Total Revenue

Total revenue (TR) is the price (p) multiplied by
the quantity demanded (q) at that price TR = p
xq
What happens to total revenue when price
decreases?
Lower price producers get less for each unit sold
total revenue declines
Lower price increases quantity demanded total
revenue increases

Overall impact of lower price on total revenue

depends on the net result of these opposite effects
38

Elasticity and Total Revenue

When demand is elastic, the percent increase in
quantity demanded exceeds the percent
decrease in price total revenue increases
When demand is unit elastic, the two are equal
total revenue remains unchanged
When demand is inelastic, the percent increase
in quantity demanded is more than offset by
the percent decrease in price total revenue
decreases

39

Elasticity and Total Revenue

Value of Ed

Change in quantity
versus change in
price

Effect of an
increase in
price on total
revenue

Effect of a
decrease in price
on total revenue

Elastic

Greater than
1.0

Larger percentage change

in quantity

Total revenue
decreases

Total revenue
increases

Inelastic

Less than 1.0

Smaller percentage
change in quantity

Total revenue
increases

Total revenue
decreases

Unitary
elastic

Equal to 1.0

Same percentage change

in quantity and price

Total revenue
does not change

Total revenue does

not change

Type of
demand

When demand is inelastic, price and total revenues

are directly related. Price increases generate higher

revenues.
When demand is elastic, price and total revenues are
indirectly related. Price increases generate lower
revenues.

Given: Q = 120 - 4 P

Price

Quantity

TR

10
20
25
28

Calculate the point ep at each

price on the table.
Calculate the TR at each price
on the table.
Calculate arc ep at between
10 and 20.
Calculate arc ep at between
25 and 28.

Calculate arc ep at between 20 and 28.

Graph the demand function [labeling all axis and functions], identify
which ranges on the demand function are price elastic and which are
price inelastic.
Slide 41

Given: Q = 120 - 4 P

Price

Quantity

ep

TR

10

80

-.5

20

40

-2

800

25

20

-5

500

28

-14

224

800

Calculate the point ep at each

price on the table.
Calculate the TR at each price
on the table. TR = PQ
Calculate arc ep at between
10 and 20.
ep = -1
Calculate arc ep at between
25 and 28.
ep = -7.6

ep = -4
Calculate arc ep at between 20 and 28.
Graph the demand function [labeling all axis and functions], identify
which ranges on the demand function are price elastic and which are
price inelastic. At what price will TR by maximized?
P = 15
Slide 42

For a simple demand function: Q = 10 - 1P

price

quantity

10

10

ep

0
-.11
-.25
-.43
-.67
-1.
-1.5
-2.3
-4.
-9
undefined

Total
Revenue

Notice that at higher prices

the absolute value of the price
elasticity of demand, ep is
greater.
Total revenue is price times
quantity; TR = PQ.
Where the total revenue [TR]
is a maximum, ep is equal
to 1

9
16
21
24
25
24

In the range where ep < 1, [less

than 1 or inelastic], TR increases as
price increases, TR decreases as P
decreases.

21
16
9
0

In the range where ep > 1,

[greater than 1 or elastic], TR
decreases as price increases, TR
increases as P decreases.
Slide 43

Graphing Q = 120 - 4 P,

TR is a maximum
where ep is -1 or TRs
slope = 0

Price

When ep is -1 TR is a maximum.
When |ep | > 1 [elastic], TR and P
move in opposite directions. (P has
a negative slope, TR a positive slope.)
When |ep | < 1 [inelastic], TR and P
move in the same direction. (P and TR
both have a negative slope.)
Arc or average ep is the average
elasticity between two point [or prices]

The top half of the demand

function is elastic.

30

|ep | > 1 [elastic]

TR

ep = -1
|ep | < 1

15

pointep is the elasticity at a point or price.

inelastic
120 Q/ut

60

The bottom half of the demand

function is inelastic.

Price elasticity of demand describes

how responsive buyers are to change
in the price of the good. The more elastic, the more responsive to P.

Slide 44

Summary of Elasticity and TR

If demand is elastic:

When P goes up, TR goes down.

When P goes down, TR goes up.

If demand is inelastic:

When P goes up, TR goes up.

When P goes down, TR goes down.

Exhibit 2: Demand, Price Elasticity and Total

Revenue

46

Price

Elasticity and price reductions

Elastic

Unit elasticity
Inelastic

Total
Revenue

Quantity

(+)TR< (-)TR
(+)TR< (-)TR

Quantity
47

For a price fall: if

demand is elastic,
revenue from new
sales will exceed the
fall in revenue from
existing sales - total
revenue will rise;
if demand is inelastic,
revenue from new
sales will be less than
the fall in revenue
from existing sales total revenue will fall

$100
90
80
70
60
50
40
30
20
10
0

(a) Demand and Price Elasticity

Elastic ED > 1

a
b

Unit elastic ED = 1
c

Inelastic ED < 1
d

100 200

500

800 900 1,000

Quantity per period

(b) Total Revenue

TR = p x q

$25,000
Total revenue

When demand is
elastic, a decrease in
price (from a to b) will
increase total revenue
because the gain in
revenue from selling
more units (blue box)
exceeds the loss in
revenue from selling all
units at a lower price
(red box)
When demand is
elastic, a price decrease
(from d to e) reduces
total revenue because
the gain in revenue
from selling more units
(blue box) is less than
the loss in revenue at
the lower price (red
box)

Price per unit

Exhibit 2: Demand, Price Elasticity and Total Revenue

Total
revenue

Quantity per period

500

48

1,000

Use of Price Elasticity

Ruffin and Gregory [Principles of Economics, AddisonWesley, 1997, p 101] report that:

epof gasoline is = .15 (inelastic)

long run epof gasoline is = .78
(inelastic)
short run epof electricity is = . 13
(inelastic)
long run epof electricity is = 1.89 (elastic)
Why is the long run elasticity greater than short
run?
What are the determinants of elasticity?

short run

Slide 49

Determinants of Demand Elasticity

Availability of substitutes -- demand is

more elastic when there are more

substitutes for the product.
Importance of the item in the budget -demand is more elastic when the item is a
more significant portion of the consumers
budget.
Time frame -- demand becomes more
elastic over time.

Availability of Substitutes
The greater the availability of substitutes for a
good and the closer the substitutes, the greater
the goods price elasticity of demand
The number and similarity of substitutes
depend on how we define the good the more
broadly we define a good, the fewer the
substitutes and the less elastic the demand
51

Proportion of Consumers Budget

Because spending on some goods represents a large
share of the consumers budget, a change in the
price of such a good has a substantial impact on
the amount consumers are able to purchase
Generally, the more important the item is as a
share of the consumers budget, other things
constant, the greater will be the income effect of a
change in price, the more price elastic will be the
demand for the item
52

Suppose the price

increases from the initial
price of $1.00 to $1.25.
Dw shows that one week
after the price increase,
the quantity demanded
has not changed much,
from 100 to 95
After one month, Dm, it
has declined to 75, and
after one year, Dy, to 50
The longer the time
period the larger the
response to a given price
change

Price per unit

Exhibit 5: Demand Becomes More Elastic over Time

$1.25
1.00
Dy

Dw
0

50

Dm

75 95 100

Quantity per period

53

Other Important Elasticities

Income elasticity of demand

measures the responsiveness of

demand to changes in income.
% c h a n g e in q u a n tity d e m a n d e d
in c o m e e la s tic ity o f d e m a n d
% c h a n g e in in c o m e

Income Elasticity
[normal goods]

ey

% Qx
% Y

Income elasticity is a measure of the change in

demand [a shift of the demand function] that is
caused by a change in income.

[Where Y = income]

The increase in income, Y, increases demand

to D2. The increase in demand results in a
larger quantity being purchased at the
same Price [P1]..

At a price of P1 , the quantity demanded

given the demandDDisisthe
Q1 .

demand function when the income is Y1 .

For a normal good an increase
in income to Y2 will shift the
demand to the right. This is an
increase in demand to D2.

Due to increase
in income,
demand
increases

P1

D2
D

% Y > 0; % Q> 0; therefore,

ey >0

[it is positive]

Q1
.

Slide 55

Q2

Q/ut

Income Elasticity
[normal goods]

% Qx
ey
% Y

[continued. . .]

A decrease in income is associated with a decrease in

the demand for a normal good.

At income Y1, the demand D1 represents

the relationship between P and Q. At
a price [P1] the quantity [Q1] is
demanded.
% Y < 0 [negative];

For a decrease in income [-Y],

the demand decreases; i.e. shifts
at the price [P1 ], a
to the left,
smaller Q2 will be purchased.

A decrease in income,

% Q < 0 [negative];

decreases
demand

so, ep > 0 [ positive]

P1
For either an increase or decrease in income
the ep is positive. A positive relationship
[positive correlation] between Y and Q
is evidence of a normal good.

D2
Q2

Q1
Slide 56

D1
Q/ut

When income elasticity is positive, the good is considered a normal

good. An increase in income is correlated with an increase in the
demand function.
A decrease in income is associated with a
decrease in the demand function.
For both increases

The greater the value of y,

the more responsive buyers
are to a change in their incomes.

eeyy

-%
Q
x
+%%
Q
Q
xx

and decreases in
income, ey is positive

+%-%Y
%Y
Y

When the value of y is greater than 1, it is called a superior good.

The |% Qx| is greater than the |% Y|.
Buyers are very responsive to changes in
income. Sometimes superior goods are
called luxury goods.

% Qx
ey
% Y

Slide 57

Income Elasticity

[inferior goods]

There is another classification of goods where changes in income

shift the demand function in the opposite direction.
An increase in income [+Y] reduces demand.
An increase in income reduces
the amount that individuals
are willing to buy at each price
of the good. Income elasticity
is negative: - ey

-eyy=

-%%Q
Q

xx

%
Y
+Y

decreases
demand

P1
The greater the absolute value
of - ey, the more responsive buyers
are to changes in income

- %Qx

Q2
.

D2
Q1

Slide 58

D1
Q/ut

Income Elasticity

[inferior goods]

Decreases in income increase the demand for inferior goods.

A decrease in income [-Y] increases demand.
A decrease in income [-Y]
results in an increase in demand,
the income elasticity of demand
is negative
For both increases and decreases in
income the income elasticity is negative
for inferior goods. The greater the
absolute value of ey, the more responsive
buyers are to changes in income

- ey

+%Qx
%
Qx
e y
% Y
-Y

P1

D2

+%Q
Q1

. .

Slide 59

D1
x

Q2 Q/ut

Income Elasticity
Income elasticity [ey] is a measure of the effect
of an income change on demand. [Can be
calculated as point or arc.]

ey > 0,

[positive] is a normal or superior

good an increase in income increases demand,
a decrease in income decreases demand.

ey < 1 is a normal good

1 < ey is a superior good
0<

ey < 0, [negative] is an inferior good

Slide 60

Income Elasticity of Demand

Measures how responsive demand is to a
change in income
Equals the percent change in demand divided
by the percent change in income
Categories
Goods with income elasticities less than zero are called
inferior goods demand declines when income
increases
61

Income Elasticity of Demand

Normal goods have income elasticities greater
than zero demand increases when income
increases
Normal goods with income elasticities greater than
zero but less than 1 are called income inelastic goods
demand increases but not as much as does
income
Goods with income elasticity greater than 1 are
called income elastic demand not only increases
when income increases but increases by more than
does income
62

Cross-Price Elasticity of Demand

Since firms often produce an entire line of

products, it has a special interest in how a
change in the price of one product will affect
the demand for another
The responsiveness of the demand for one good
to changes in the price of another good is called
the cross-price elasticity of demand
63

Cross-price elasticity of demand , [ xy]

[substitutes]

Pp
2

When pork is $1.50, Qp pork

is purchased.
price of pork increases
The quantity demanded
of pork decreases.

[price of beef]

[price of pork]

When the price of pork increases, it will tend to increase the demand
for beef. People will substitute beef, which is relatively cheaper, for
pork, which is relatively more expensive.

for an increase

1.50

in Ppork,

-Qp

Qp

Qp

Dp

pork/ut

Pb

When beef is $2, Qb beef

is purchased.
at Pb = $2 more
increase
beef will be bought
demand
to substitute for
the smaller
quantity of
pork.
demand for
Db
beef increases
Db

Qb

Qb
Slide 64

beef/ut

Other Important Elasticities

Cross-price elasticity of demand:

measure of the response of the

quantity of one good demanded to a
change in the price of another good.

% c h a n g e in q u a n tity o f Y d e m a n d e d
c ro s s - p ric e e la s tic ity o f d e m a n d
% c h a n g e in p ric e o f X

Cross-Price Elasticity
Cross-price elasticity [exy] is a measure of how
responsive the demand for a good is to changes in the
prices of related goods.
Given a change in the price of good Y [Py ], what is the
effect on the demand for good X [Qy ]?
exy is defined as:

xy

%Q
%

Slide 66

Cross-price elasticity
In the case of beef and pork

the ebp is not the same as epb

ebp is the % change in the demand for beef with
respect to a % change in the price of pork
epb is the % change in the demand for pork with
respect to a % change in the price of beef
beef may not be a good substitute for pork
pork may not be a good substitute for beef

Slide 67

Cross-price elasticity of demand , [ xy]

[substitutes]

The cross elasticity of the demand for beef with respect to the
price of pork, ebeef-pork or ebp can be calculated:

+ebp
ebp =
positive

+ Q
Qof
b beef
%

%P+ of
Ppork
p

An increase in the price of pork,

causes an increase in the demand
for beef.

cross elasticity is positive

+ebp
ebp =

Q
%- Q
ofbbeef

A decrease in the price of pork,

causes a decrease in the demand

%P- P
of pork
positive
for beef.
p
If goods are substitutes, exy will be positive. The greater the
coefficient, the more likely they are good substitutes.
Slide 68

Cross-price elasticity of demand , [exy]

[complements]

Pc

a decrease in the price

of crayons,

P1
Po

Pc

as more crayons are

purchased, the
demand for colour
books increases.

increase
demand

At the same
price a larger
quantity will
be bought

-Pc

Dp
Dc

Q2

Q1

crayons

increases the quantity demanded

of crayons

Q
- ebc
%+ Q
ofb b
negativebc =

%P of c

- Pc

2000

2500

+ Qb

Dc
colour books

for compliments, the cross

elasticity is negative for price
increase or decrease.

Slide 69

Cross-Price Elasticity

exy > 0 [positive], suggests substitutes, the higher the

coefficient the better the substitute
exy < 0 [negative], suggests the goods are
complements, the greater the absolute value the
more complimentary the goods are
exy = 0, suggests the goods are not related
exy can be used to define markets in legal
proceedings

Slide 70

Other Important Elasticities

Elasticity of supply: A measure of

the response of quantity of a good

supplied to a change in price of that
good. Likely to be positive in output
markets.
% c h a n g e in q u a n tity s u p p lie d
e la s tic ity o f s u p p ly
% c h a n g e in p ric e

Price Elasticity of Supply

The price elasticity of supply measures how
responsive producers are to a price change
Equals the percent change in quantity supplied
divided by the percent change in price
Since the higher price usually results in an
increased quantity supplied, the percent change
in price and the percent change in quantity
supplied move in the same direction the
price elasticity of supply is usually a positive
number
72

Elasticity of Supply
Elasticity of supply is a measure of how
responsive sellers are to changes in the price of
the good.
Elasticity of supply [ep] is defined:

% Quantity Supplied

% price
Slide 73

The supply function is a

model of sellers behavior.
Sellers behavior is influenced by:
1. technology
2. prices of inputs
3. time for adjustment

Si

a perfectly inelastic
supply, es = 0

tal es
n
o
iz
r
o
h
s
e
h
proac
as supply ap
finity
approaches in

market period
short run
long run
very long run

Se

a perfectly
elastic supply
[es is undefined.]

Q /ut

4. expectations
5. anything that influences costs of production
taxes
regulations, . . .
Slide 74

Cross-Price Elasticity

exy > 0 [positive], suggests substitutes, the higher the

coefficient the better the substitute
exy < 0 [negative], suggests the goods are
complements, the greater the absolute value the
more complimentary the goods are
exy = 0, suggests the goods are not related
exy can be used to define markets in legal
proceedings

Slide 75

Elasticity of Supply
Elasticity of supply is the
responsiveness of quantity to
changes in price.
Elastic when E > 1

An elasticity of 10 means a 1% change in price brings about a

10% change in quantity supplied.

Inelastic when E < 1

An elasticity of 0.2 means a 1% change in price gives rise to

just a .2% change in quantity supplied.

Unit elastic when E = 1

Other Important Elasticities

Elasticity of labor supply: A measure

of the response of labor supplied to a

change in the price of labor.
% c h a n g e in q u a n tity o f la b o r s u p p lie d
e la s tic ity o f la b o r s u p p ly
% c h a n g e in th e w a g e ra te

Questions for Thought and Discussion:

How Elastic is Your Demand for Food?

No matter how low your income, you still have to eat.

If your income went down significantly, you would
buy less expensive food.
Higher priced foods become luxuries.
Lower priced foods become necessities.
The bottom line is
A good or service is a necessity if its share of your
budget falls as your income rises.
It is a luxury if its share of your budget rises as income
rises.