ECO100 INTRODUCTION TO ECONOMCS

§ Week 2

§ Topic: ELASTICITY

§ LECTURER: Atta Adu-Osae

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 After studying this topic, you will be able to:
§ calculate elasticity using the midpoint method.
§ distinguish between the price elasticity of demand for necessities and
luxuries.

§ calculate the price elasticity of supply and demand.

§ distinguish between an inelastic and elastic supply and demand curve.
§ demonstrate the impact of the price elasticity of demand on total expenditure
and total revenue under conditions of different demand elasticities.

§ calculate different elasticities: price, income and cross.

For use with Business Economics 3e ISBN: 978-1-4737-6277-0 2Chapter

of 38 1 Slide 2
By N. Gregory Mankiw, Mark P. Taylor, and Andrew Ashwin © Cengage Learning
Module 1: Price Elasticity of Demand

For use with Business Economics 3e ISBN: 978-1-4737-6277-0 3Chapter

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By N. Gregory Mankiw, Mark P. Taylor, and Andrew Ashwin © Cengage Learning
 The Price Elasticity of Demand

§ The price elasticity of demand measures how much

the quantity demanded responds to changes in the price.

• Inelastic: Demand isn’t very responsive to changes in price.

• Elastic: Demand is responsive to changes in price.

§ Elasticity ≧ 0
§ Elasticity can take any value greater than or equal to zero.
• Closer to zero = more inelastic.
• Closer to infinity = more elastic.

For use with Business Economics 3e ISBN: 978-1-4737-6277-0 4Chapter

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By N. Gregory Mankiw, Mark P. Taylor, and Andrew Ashwin © Cengage Learning
The Determinants of Price Elasticity of Demand
§ The price elasticity of demand for a good measures how
willing consumers are to move away from the good as its
price rises.

§ This depends on:

• Availability of close substitutes.

• Necessities versus luxuries.

• Definition of the market.

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The Determinants of Price Elasticity of Demand

• Narrow markets face more elastic demand.

• Proportion of income devoted to the product.

• Time horizon.

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Computing the Price Elasticity of Demand

§ Price elasticity of demand = percentage change in quantity

demanded divided by the percentage change in price.

For use with Business Economics 3e ISBN: 978-1-4737-6277-0 7Chapter

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Computing the Price Elasticity of Demand
v A Units-Free Measure
§ Elasticity is a ratio of percentages, so a change in the
units of measurement of price or quantity leaves the
elasticity value the same.

v Minus Sign and Elasticity

§ The formula yields a negative value, because price and
quantity move in opposite directions.

§ But it is the magnitude, or absolute value, that reveals

how responsive the quantity change has been to a price
change.

For use with Business Economics 3e ISBN: 978-1-4737-6277-0 8Chapter

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By N. Gregory Mankiw, Mark P. Taylor, and Andrew Ashwin © Cengage Learning
 Using the Midpoint Method
§ The midpoint method gives the same
elasticity regardless of the direction of change.

Price elasticity of demand =

( Q – Q ) (P – P )
÷ 2 1 2 1

⎛1 ⎞ ⎛1 ⎞
⎜⎝ 2 ( Q + Q )⎟⎠ ⎜⎝ 2 ( P + P )⎟⎠ 2 1 2 1

For use with Business Economics 3e ISBN: 978-1-4737-6277-0 9Chapter

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By N. Gregory Mankiw, Mark P. Taylor, and Andrew Ashwin © Cengage Learning
Computing the Price Elasticity of Demand
§ Calculate the price elasticity of demand
of the following points:

A: Price = $4; Quantity Demanded = 100

B: Price = $5; Quantity demanded = 80

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 The Variety of Demand Curves
Two extremes: Elasticity changes along the supply curve
Vertical curve is a perfectly Horizontal curve is perfectly price
price inelastic demand: elastic demand: A decrease in price
An increase in price leaves leads to the quantity demanded
quantity demanded unchanged. becoming zero.

For use with Business Economics 3e ISBN: 978-1-4737-6277-0 11Chapter

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For use with Business Economics 3e ISBN: 978-1-4737-6277-0 12Chapter
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By N. Gregory Mankiw, Mark P. Taylor, and Andrew Ashwin © Cengage Learning
For use with Business Economics 3e ISBN: 978-1-4737-6277-0 13Chapter
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By N. Gregory Mankiw, Mark P. Taylor, and Andrew Ashwin © Cengage Learning
 Module 1.2:
Total Revenue and the Price Elasticity of Demand
§ The total revenue (TR) received by sellers is P x Q, the price of
the good times the quantity of the good sold.
§ The change in TR as one moves along the demand curve
depends on the elasticity of a demand.
Example 1

If demand is
inelastic, then an
increase in the
price causes an
increase in TR
despite a fall in
demand.

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Total Revenue and the Price Elasticity of Demand
Example 2

§ If the demand is elastic, then an increase in price leads to a

decrease in TR.

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Module 2: Price Elasticity of Supply

For use with Business Economics 3e ISBN: 978-1-4737-6277-0 16Chapter

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By N. Gregory Mankiw, Mark P. Taylor, and Andrew Ashwin © Cengage Learning
 Price Elasticity of Supply
The price elasticity of supply measures how much the
quantity supplied responds to changes in the price.

• Inelastic: Supply isn’t very responsive to changes in price.

• Elastic: Supply is responsive to changes in price.
• Elasticity ≧ 0

• Elasticity can take any value greater than or equal to zero.

o Closer to zero = more inelastic.
o Closer to infinity = more elastic.

For use with Business Economics 3e ISBN: 978-1-4737-6277-0 17Chapter

of 38 5 Slide 17
By N. Gregory Mankiw, Mark P. Taylor, and Andrew Ashwin © Cengage Learning
Computing the Price Elasticity of Supply
§ Price elasticity of supply =
percentage change in
quantity supplied divided by
the percentage change in
price.

§ Elasticity changes along the

supply curve.

For use with Business Economics 3e ISBN: 978-1-4737-6277-0 18Chapter

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By N. Gregory Mankiw, Mark P. Taylor, and Andrew Ashwin © Cengage Learning
 The Midpoint Method

§ The midpoint method gives the same elasticity

regardless of the direction of change.

Price elasticity of supply =

( Q – Q)
÷
( P – P) 2 1 2 1

⎛1 ⎞ ⎛1 ⎞
⎜⎝ 2 ( Q + Q )⎟⎠ ⎜⎝ 2 ( P + P )⎟⎠ 2 1 2 1

For use with Business Economics 3e ISBN: 978-1-4737-6277-0 19Chapter

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By N. Gregory Mankiw, Mark P. Taylor, and Andrew Ashwin © Cengage Learning
Computing the Price Elasticity of Supply
§ Calculate the price elasticity of supply of
the following points:

A: Price = $3; Quantity Supplied = 100

B: Price = $4; Quantity Supplied = 200

A: Price = $12; Quantity Supplied = 500

B: Price = $25; Quantity Supplied = 525

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The Determinants of Price Elasticity of Supply

§ The time period

• Supply is usually more elastic in the long run.
• In the short run firms cannot easily change productive
capacity.

§ Productive capacity
• Firms are more likely to operate at full capacity when there is
economic growth.

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The Determinants of Price Elasticity of Supply

§ The size of the firm/industry

§ The mobility of factors of production

§ Ease of storing stock/inventory

For use with Business Economics 3e ISBN: 978-1-4737-6277-0 22Chapter

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For use with Business Economics 3e ISBN: 978-1-4737-6277-0 24Chapter
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By N. Gregory Mankiw, Mark P. Taylor, and Andrew Ashwin © Cengage Learning
 Total Revenue and the Price Elasticity of Supply
§ The total revenue (TR) received by sellers is P x Q, the price of
the good times the quantity of the good sold.
§ The change in TR as one moves along the supply curve depends
on the elasticity of a supply.

Example 1

• If supply is inelastic,
then an increase in
the price causes an
increase in TR that
is proportionately
less than the price
change.

For use with Business Economics 3e ISBN: 978-1-4737-6277-0 25Chapter

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Module 2.2: Total Revenue and the Price Elasticity of Supply

Example 2

§ If the supply is elastic, then an increase in price leads to a much

greater increase in TR.

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 Module 3: Cross elasticity

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 The Cross-Price Elasticity of Demand
§ The cross-price elasticity of demand measures how the quantity
demanded of one good changes as the price of another good
changes.

§ Cross-price elasticity of demand = Percentage change in quantity

demanded of good 1 divided by the percentage change in the price of
good 2.

§ The cross-elasticity of demand is:

• Positive for substitutes. (eD > 0)
• Negative for complements. (eD < 0)

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 The Income Elasticity of Demand

§ The income elasticity of demand measures how the quantity

demanded changes as consumer income changes.

§ Income elasticity of demand = Percentage change in quantity

demanded divided by Percentage change in income.

• A few goods, such as bus rides, are inferior goods:

Higher income lowers the quantity demanded.
• Luxuries tend to have high income elasticities.

•Normal goods: Y e > 0; D shifts to the right

D

•Inferior goods: Ye < 0; D shifts to the left

D

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 SUMMARY

§ Price elasticity of demand: Elastic, perfectly elastic,

inelastic and perfectly inelastic

§ Price elasticity of supply: Elastic and perfectly elastic,

inelastic and perfectly inelastic

§ Price elasticity of demand & total consumer expenditure &

Total expenditure

§ Cross elasticities: substitutes and complements; normal

and inferior goods.

For use with Business Economics 3e ISBN: 978-1-4737-6277-0 30Chapter

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