Principles of Microeconomics

Thirteenth Edition

Chapter 5
Elasticity

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Chapter Outline and Learning
Objectives (1 of 2)
5.1 Price Elasticity of Demand
• Understand why elasticity is preferable as a measure of
responsiveness to slope and how to measure it.
5.2 Calculating Elasticities
• Calculate elasticities using several different methods and
understand the economic relationship between revenues
and elasticity.
5.3 The Determinants of Demand Elasticity
• Identify the determinants of demand elasticity.

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Chapter Outline and Learning
Objectives (2 of 2)
5.4 Other Important Elasticities
• Define and give examples of income elasticity, crossprice
elasticity, and supply elasticity.

5.5 What Happens When We Raise Taxes: Using

Elasticity
• Understand the way excise taxes can be shifted to
consumers.
Looking Ahead

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Chapter 5 Elasticity (1 of 2)
• The model of supply and demand tells us a good deal
about how a change in the price of a good affects
behavior.
• But knowing the direction of a change is not enough.
• Economists measure market responsiveness using the
concept of elasticity.

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Chapter 5 Elasticity (2 of 2)
• elasticity A general concept used to quantify the response
in one variable when another variable changes.

%A
elasticity of A with respect to B =
%B

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Price Elasticity of Demand
• price elasticity of demand The ratio of the percentage
change in quantity demanded to the percentage change in
price; measures the responsiveness of quantity demanded
to changes in price.

% changein quantity demanded

price elasticity of demand =
% changein price

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Figure 5.1 Slope Is Not a Useful
Measure of Responsiveness

• Changing the unit of measure from pounds to ounces

changes the numerical value of the demand slope
dramatically, but the behavior of buyers in the two
diagrams is identical.
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Types of Elasticity (1 of 4)
• perfectly inelastic demand Demand in which quantity
demanded does not respond at all to a change in price.
• perfectly elastic demand Demand in which quantity
drops to zero at the slightest increase in price.

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Types of Elasticity (2 of 4)
• A good way to remember the difference between the two
perfect elasticities is:

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Figure 5.2 Perfectly Inelastic and
Perfectly Elastic Demand Curves

• Panel (a) shows a perfectly inelastic demand curve for insulin. Price elasticity of demand
is zero. Quantity demanded is fixed; it does not change at all when price changes.

• Panel (b) shows a perfectly elastic demand curve facing a wheat farmer. A tiny price
increase drives the quantity demanded to zero. In essence, perfectly elastic demand
implies that individual producers can sell all they want at the going market price but
cannot charge a higher price.
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Types of Elasticity (3 of 4)
• elastic demand A demand relationship in which the
percentage change in quantity demanded is larger than
the percentage change in price in absolute value (a
demand elasticity with an absolute value greater than 1).
• inelastic demand Demand that responds somewhat, but
not a great deal, to changes in price. Inelastic demand
always has a numerical value between 0 and 1.

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Types of Elasticity (4 of 4)
• unitary elasticity A demand relationship in which the
percentage change in quantity of a product demanded is
the same as the percentage change in price in absolute
value (a demand elasticity with an absolute value of 1).
• Because it is generally understood that demand elasticities
are negative (demand curves have a negative slope), they
are often reported and discussed without the negative
sign.

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Calculating Elasticities (1 of 2)
Calculating Percentage Changes
• Here is how we calculate percentage change in quantity
demanded using the initial value as the base:

changein quantity demanded

% changein quantity demanded = ×100%
Q1

Q2 - Q1
= ×100%
Q

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Calculating Elasticities (2 of 2)
• We can calculate the percentage change in price in a
similar way.
• By using P1 as the base, the percentage of change in P is:

changeinprice
%changeinprice= ×100%
p1
p2 - p1
= ×100%
p1

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Elasticity Is a Ratio of Percentages
• Recall the formal definition of elasticity:

% changein quantity demanded

price elasticity of demand =
% changein price

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The Midpoint Formula
• midpoint formula A more precise way of calculating
percentages using the value halfway between P1 and P2
for the base in calculating the percentage change in price
and the value halfway between Q1 and Q2 as the base for
calculating the percentage change in quantity demanded.

changein quantity demanded

% changein quantity demanded = ×100%
Q1

Q2 - Q1
= ×100%
Q1

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Point Elasticity (1 of 3)
• point elasticity A measure of elasticity that uses the slope
measurement.

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Point Elasticity (2 of 3)
• Elasticity is the percentage change in quantity demanded
divided by the percentage change in price, i.e.,

ΔQ
Q1
ΔP
P1

where Δ denotes a small change and Q1 and P1 refer to the

original price and quantity demanded.

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Point Elasticity (3 of 3)
• The formula can be rearranged and written as:

Q P1

P Q1
ΔQ
• Notice that is the reciprocal of the slope.
ΔP

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Elasticity Changes along a Straight-
Line Demand Curve (1 of 4)
Table 5.1 Demand Schedule for Office Figure 5.3 Demand Curve for Lunch at the
Dining Room Lunches Office Dining Room
Price Quantity
(per Demanded
Lunch) (Lunches per Month)

$11 0
10 2
9 4
8 6
7 8
6 10
5 12
4 14
3 16
2 18
1 20
0 22

• To calculate price elasticity of demand between points A and B on the demand curve,
first calculate the percentage change in quantity demanded:
4-2 2
% change in quantity demanded = ×100 % = ×100 % = 66.7 %
(2 + 4) / 2 3
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Elasticity Changes along a Straight-
Line Demand Curve (2 of 4)

• Next, calculate the percentage change in price:

9 -10 -1
% change in price = × 100 % = × 100 % = -10.5%
(10 + 9) / 2 9.5

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Elasticity Changes along a Straight-
Line Demand Curve (3 of 4)

Finally, calculate elasticity:

66.7 %
elasticity of demand = = - 6.33
-10.5%

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Elasticity Changes along a Straight-
Line Demand Curve (4 of 4)

• Between points A and B, demand is quite elastic, at −6.33.

• Between points C and D, demand is quite inelastic, at
−.294.

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Figure 5.4 Point Elasticity Changes
along a Demand Curve

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Elasticity and Total Revenue (1 of 4)
• In any market, P × Q is total revenue (TR) received by
producers:
TR = P  Q
Total revenue = price × quantity
• Effects of price changes on quantity demanded:

P  → QD 
and
P  → QD 
• When price (P) declines, quantity demanded (QD) increases.
The two factors, P and QD, move in opposite directions.
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Elasticity and Total Revenue (2 of 4)
• Because total revenue is the product of P and Q, whether
TR rises or falls in response to a price increase depends
on which is bigger; the percentage increase in price or the
percentage decrease in quantity demanded.
• Effect of price increase on a product with inelastic demand:

 P × QD  = TR 

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Elasticity and Total Revenue (3 of 4)

• If the percentage decline in quantity demanded following a

price increase is larger than the percentage increase in
price, total revenue will fall.
• Effect of price increase on a product with elastic demand:

 P × QD  = TR 

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Elasticity and Total Revenue (4 of 4)
• The opposite is true for a price cut. When demand is
elastic, a cut in price increases total revenue.

Effect of price cut on a product with elastic demand:

 P  QD  = TR 
Effect of price cut on a product with inelastic demand:

 P  QD  = TR 
• When demand is inelastic, a cut in price reduces total
revenue.

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The Determinants of Demand
Elasticity (1 of 2)
Availability of Substitutes
• Perhaps the most obvious factor affecting demand
elasticity is the availability of substitutes.
The Importance of Being Unimportant
• When an item represents a relatively small part of our total
budget, we tend to pay little attention to its price.

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The Determinants of Demand
Elasticity (2 of 2)
Luxuries versus Necessities
• Luxury goods (e.g., yachts) tend to have relatively elastic
demand, and necessities (e.g., food) have inelastic
demand.
The Time Dimension
• In the longer run, demand is likely to become more elastic
because households make adjustments over time, and
producers develop substitute goods.

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Economics In Practice (1 of 2)
Elasticities at a Delicatessen in the Short Run
and Long Run
The graph shows the expected
relationship between long-run and
short-run demand for Frank’s
sandwiches.
Notice that if you raise prices above
the current level, the expected
quantity change read from the short-
run curve is less than that from the
long-run curve.
CRITICAL THINKING
1. Provide an example of a purchasing situation in which you think your
own short- and long-run elasticities differ a lot and a second in which
they are similar. What drives those differences?
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Other Important Elasticities (1 of 2)

Income Elasticity of Demand

• income elasticity of demand A measure of the
responsiveness of demand to changes in income.

% changein quantity demanded

income elasticity of demand =
% change in income

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Other Important Elasticities (2 of 2)

Cross-Price Elasticity of Demand

• cross-price elasticity of demand A measure of the
response of the quantity of one good demanded to a
change in the price of another good.

% change in quantity of Y demanded

cross - price elasticity of demand =
% change in price of X

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Elasticity of Supply
• 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.

% change in quantity supplied

elasticity of supply =
% change in price

• elasticity of labor supply A measure of the response of

labor supplied to a change in the price of labor.
% changein quantity of labour supplied
elasticity of labour supply =
% changein the wage rate

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Economics In Practice (2 of 2)
Tax Rates and Migration in Europe

Denmark is part of the European

Union (EU).
In 2009, Denmark enacted a tax
relief law aimed at luring highly
skilled immigrants.
Researchers found an elasticity of
almost 2 for the increase in
migration to the reduction in the tax
rate.

CRITICAL THINKING
1. What features of the EU do you think increase the labor elasticity?
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What Happens When We Raise
Taxes: Using Elasticity

• excise tax A per-unit tax on a specific good.

• In the United States, we have excise taxes on gasoline
and cigarettes.
• Example: A mayor of a city imposes a tax of $1.00 per
avocado in a city where 1,000 avocados are sold per day.
Will the city add $365,000 per year in taxes?

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Figure 5.5 Original Equilibrium in the
Avocado Market

• Store owners in the city sells 1,000 avocados per day at

the market price of $2.00.
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Figure 5.6 Equilibrium in the Avocado
Market after the $1.00 Tax

• After the mayor imposes a tax of $1.00 per avocado, the supply curve
shifts up by $1.00, and there is a new equilibrium where supply equals
demand at point B.
• At the new equilibrium, 500 avocados are sold; the equilibrium price
rises to $2.50, and storeowners receive $1.50 per avocado.
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Looking Ahead
• The purpose of this chapter is to convince you that
measurement is important.
• The most commonly used tool of measurement is
elasticity, and we will use it many times as we explore
economics in more depth.
• We now return to the study of basic economics by looking
in detail at household behavior.

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Review Terms and Concepts
• cross-price elasticity of demand
• elastic demand
• elasticity
• elasticity of labor supply
• elasticity of supply
• excise tax
• income elasticity of demand
• inelastic demand
• midpoint formula
• perfectly elastic demand
• perfectly inelastic demand
• point elasticity
• price elasticity of demand
• unitary elasticity
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