ECO2011 Basic Microeconomics

ECO2011 Basic Microeconomics
Fall 2020
Emily Zheng
Total Revenue and the Price Elasticity of Demand
• Total revenue is the amount paid by buyers and

received by sellers of a good.
• Computed as the price of the good times the
quantity sold.
TR = P  Q
Price
When the price is $4, consumers

will demand 100 units, and spend
$400 on this good.
$4
P × Q = $400
P
(revenue) Demand
0 100 Quantity
Q
The Relationship
between Price Elasticity
and Total Revenue
When demand is
inelastic, a cut in price
will decrease total
revenue.
At point A, the price is
$4.00, 1,000 gallons
are sold, and total
revenue received by the
service station equals
$4.00 × 1,000 gallons,
or $4,000.
At point B, cutting the
price to $3.70 increases
the quantity demanded
to 1,050 gallons, but the
fall in price more than
offsets the increase in
quantity.
As a result, revenue
falls to $3.70 × 1,050
gallons, or $3,885.
The Relationship
between Price Elasticity
and Total Revenue
When demand is
elastic, a cut in the
price will increase total
revenue.
At point A, the area of
rectangles C and D is
still equal to $4,000.
But at point B, the
area of rectangles D
and E is equal to
$3.70 × 1,200 gallons,
or $4,440.
In this case, the
increase in the
quantity demanded is
large enough to offset
the fall in price, so
total revenue
increases.
The Relationship between Price Elasticity and Revenue
If demand is ... then ... because ...

elastic an increase in price the decrease in quantity demanded is
reduces revenue proportionally greater than the
increase in price.
elastic a decrease in price the increase in quantity demanded is
increases revenue proportionally greater than the
decrease in price.
inelastic an increase in price the decrease in quantity demanded is
increases revenue proportionally smaller than the
increase in price.
inelastic a decrease in price the increase in quantity demanded is
reduces revenue proportionally smaller than the
decrease in price.
unit elastic an increase in price does the decrease in quantity demanded is
not affect revenue proportionally the same as the
increase in price.
unit elastic a decrease in price does the increase in quantity demanded is
not affect revenue proportionally the same as the
decrease in price.
Elasticity and Revenue with a Linear Demand Curve
Elasticity Is Not Constant along a

Linear Demand Curve
The data from the table are
plotted in the graphs.
Panel (a) shows that as we
move down the demand curve
for gasoline, the price elasticity
of demand declines.
In other words, at higher prices,
demand is elastic, and at lower
prices, demand is inelastic.
Panel (b) shows that as the
quantity of gasoline purchased
increases from 0, revenue will
increase until it reaches a
maximum of $32 when 8 gallons
are purchased.
As purchases increase beyond 8
gallons, revenue falls because
demand is inelastic on this
portion of the demand curve.
Cross-price elasticity of demand
Substitutes: Goods and services that can be used for the same
purpose.
Complements: Goods and services that are used together.
Cross-price elasticity of demand measures the strength of

substitute or complement relationships between goods.
Percentage change in quantity demanded of one good

Cross - price elasticity of demand =
Percentage change in price of another good
Summary of cross-price elasticity of demand
then the cross-

If the price elasticity of
products are… demand will be… Example
substitutes positive Two brands of tablet

computers
complements negative Tablet computers and
applications downloaded from
online stores
unrelated zero Tablet computers and peanut
butter
Income elasticity of demand
Normal goods: Goods and services for which the quantity

demanded increases as income increases
Inferior goods: Goods and services for which the quantity

demanded falls as income increases
Income elasticity of demand measures the strength of the

effect of income on quantity demanded.
Percentage change in quantity demanded

Income elasticity of demand =
Percentage change in income
Summary of income elasticity of demand
If the income elasticity

of demand is… then the good is… Example
positive but less than 1 normal and a necessity Bread
positive and greater than 1 normal and a luxury Caviar
High fat
negative inferior
meat
Necessity: A normal good with a quantity demanded that

responds less than proportionally to an income change.
Luxury: A normal good with a quantity demanded that

responds more than proportionally to an income change.
Price elasticity of supply
Price elasticity of supply is very much analogous to price

elasticity of demand:
Percentage change in quantity supplied
Price elasticity of supply =
Percentage change in price
Price elasticity of demand =
So the same sort of calculation methods apply (midpoint formula,

etc.)
(a) Perfectly Inelastic Supply: Elasticity Equals 0
Price
Supply
$5
4
1. An
increase
in price . . .
0 100 Quantity
2. . . . leaves the quantity supplied unchanged.

(b) Inelastic Supply: Elasticity Is Less Than 1
Price
Supply
$5
4
1. A 22%
increase
in price . . .
0 100 110 Quantity
2. . . . leads to a 10% increase in quantity supplied.

(c) Unit Elastic Supply: Elasticity Equals 1
Price
Supply
$5
4
1. A 22%
increase
in price . . .
0 100 125 Quantity

(d) Elastic Supply: Elasticity Is Greater Than 1
Price
Supply
$5
4
1. A 22%
increase
in price . . .
0 100 200 Quantity

(e) Perfectly Elastic Supply: Elasticity Equals Infinity
Price
1. At any price
above $4, quantity
supplied is infinite.
$4 Supply
2. At exactly $4,
producers will
supply any quantity.
0 Quantity
3. At a price below $4,
quantity supplied is zero.
Determinants of the price elasticity of supply
• Ability of sellers to change the amount of the good they produce.

• Beach-front land is inelastic.
• Books, cars, or manufactured goods are elastic.
• Time period
• Supply is more elastic in the long run.
Making Why Are Oil Prices So Unstable?
the
Connection
Oil producers cannot change On the other hand, during a

output very quickly. recession, demand for oil
When demand increases falls.
suddenly, price rises, acting as Oil producers cannot adjust
a rationing mechanism for the their output quickly, so the
increased demand. price falls dramatically.
Practice
• Using the midpoint method, what is the price elasticity of supply
between points D and E?
• a. 1.89
• b. 1.26
• c. 0.53
• d. 0.34
Summary of Elasticities
Price Elasticity of Demand

Formula :
(Q 2 − Q1 ) (P 2 − P1 )
MidpointFormula : 
 Q 2 + Q1   P1 + P2 
   
 2   2 
Absolute Value Effect on Total Revenue

of Price Elasticity of an Increase in Price
Elastic Greater than 1 Total revenue falls
Inelastic Less than 1 Total revenue rises
Unit elastic Equal to 1 Total revenue unchanged
Cross-Price Elasticity of Demand
Percentage change in quantity demanded of one good

Formula :
Percentage change in price of another good
Types of Products Value of Cross-Price Elasticity

Substitutes Positive
Complements Negative
Unrelated Zero
Income Elasticity of Demand

Formula :
Percentage change in income
Types of Products Value of Income Elasticity

Normal and a necessity Positive but less than 1
Normal and a luxury Positive and greater than 1
Inferior Negative
Price Elasticity of Supply
Percentage change in quantitysupplied

Formula :
Value of Price Elasticity

Elastic Greater than 1
Inelastic Less than 1
Unit elastic Equal to 1
Common misconceptions to avoid
While price elasticity of demand is strictly negative, we often

refer to it as a positive number. Don’t think because of this that
quantity demanded and price move in the same direction.
For cross-price elasticity of demand, negative means

complements, positive means substitutes.
Inelastic refers to quantity (demanded or supplied) not changing

much in response to price. Don’t confuse this with inferior, which
refers to a good with a negative income elasticity of demand.

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• Total revenue is the amount paid by buyers and

When the price is $4, consumers

If demand is ... then ... because ...

Elasticity Is Not Constant along a

Complements: Goods and services that are used together.

Cross-price elasticity of demand measures the strength of

Percentage change in quantity demanded of one good

then the cross-

substitutes positive Two brands of tablet

Normal goods: Goods and services for which the quantity

Inferior goods: Goods and services for which the quantity

Income elasticity of demand measures the strength of the

Percentage change in quantity demanded

If the income elasticity

positive but less than 1 normal and a necessity Bread

positive and greater than 1 normal and a luxury Caviar

Necessity: A normal good with a quantity demanded that

Luxury: A normal good with a quantity demanded that

Price elasticity of supply is very much analogous to price

So the same sort of calculation methods apply (midpoint formula,

2. . . . leaves the quantity supplied unchanged.

0 100 110 Quantity

2. . . . leads to a 10% increase in quantity supplied.

0 100 125 Quantity

0 100 200 Quantity

2. . . . leads to a 67% increase in quantity supplied.

• Ability of sellers to change the amount of the good they produce.

Oil producers cannot change On the other hand, during a

Price Elasticity of Demand

Percentage change in quantity demanded

Absolute Value Effect on Total Revenue

Cross-Price Elasticity of Demand

Percentage change in quantity demanded of one good

Types of Products Value of Cross-Price Elasticity

Percentage change in quantity demanded

Types of Products Value of Income Elasticity

Price Elasticity of Supply

Percentage change in quantitysupplied

Value of Price Elasticity

While price elasticity of demand is strictly negative, we often

For cross-price elasticity of demand, negative means

Inelastic refers to quantity (demanded or supplied) not changing

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