Econ Elasticity and its Applications

 Elasticity: Basic Idea – Definition – Elasticity vs. Sensitivity

 Price Elasticity of Demand
 Spectrum of Demand in Terms of Elasticity:
◦ (Perfectly inelastic demand - Inelastic demand – Unit elastic demand -
Elastic demand - Perfectly elastic demand)
 Elasticity of a Linear Demand Curve
 Price Elasticity and Total Revenue & An Application
 Price Elasticity of Supply
 Spectrum of Supply in Terms of Elasticity:
◦ (Perfectly inelastic supply - Inelastic supply – Unit elastic supply -
Elastic supply - Perfectly elastic supply)
 Other Elasticities: Income elas. of D & cross-price elas. of D
 Summary, Wrap-up, Goodbye!
The Main Source of the Slides:
Instructor: Ali Zeytoon Nejad Cengage Learning

0 1

In this chapter, look for the answers to A scenario…

these questions: You design websites for local businesses.
▪ What is elasticity? What kinds of issues can You charge $200 per website, and currently sell
elasticity help us understand? 12 websites per month.
▪ What is the price elasticity of demand? Your costs are rising (including the opp. cost of
How is it related to the demand curve? your time), so you’re thinking of raising the price
How is it related to revenue & expenditure? to $250.
▪ What is the price elasticity of supply? The law of demand says that you won’t sell as
How is it related to the supply curve? many websites if you raise your price. How
▪ What are the income and cross-price elasticities of many fewer websites? How much will your
demand? revenue fall, or might it increase?

CHAPTER 5 ELASTICITY AND ITS APPLICATION 2 CHAPTER 5 ELASTICITY AND ITS APPLICATION 3

2 3

Instructor: Ali Zeytoon-Nejad 1

Econ Elasticity and its Applications

Elasticity
▪ Basic idea: Elasticity measures how much
one variable responds to changes in another  Shift in D/S (= Change in D/S) vs. Moving along the D/S curves (= Change in Q
demanded/supplied)
variable.
• One type of elasticity measures how much  Functional forms and graphical forms:

demand for your websites will fall if you raise Q XD = f ( PX , PY , I , T , N D , E ) QXS = f ( PX , PInputs,Tech, N S , E)
your price.
▪ Definition:
Elasticity is a numerical measure of the
responsiveness of Qd or Qs to one of its
determinants.

CHAPTER 5 ELASTICITY AND ITS APPLICATION 4

4 5

Price Elasticity of Demand Price Elasticity of Demand

Price elasticity Percentage change in Qd Price elasticity Percentage change in Qd
= =
of demand Percentage change in P of demand Percentage change in P
P
▪ Price elasticity of demand measures how Example:
much Qd responds to a change in P. P rises
Price P2
by 10%
▪ Loosely speaking, it measures the price- elasticity P1
of demand
sensitivity of buyers’ demand. D
equals
Q
15% Q2 Q1
= 1.5 Q falls
10%
by 15%
CHAPTER 5 ELASTICITY AND ITS APPLICATION 6 CHAPTER 5 ELASTICITY AND ITS APPLICATION 7

6 7

Instructor: Ali Zeytoon-Nejad 2

Econ Elasticity and its Applications

Price Elasticity of Demand Calculating Percentage Changes

Price elasticity Percentage change in Qd Standard method
= of computing the
of demand Percentage change in P
Demand for percentage (%) change:
P your websites
Along a D curve, P and Q P end value – start value
x 100%
move in opposite directions, P2 start value
which would make price B
P1 $250
elasticity negative. A Going from A to B,
D $200 the % change in P equals
We will drop the minus sign
and report D
Q ($250–$200)/$200 = 25%
all price elasticities Q2 Q1 Q
as positive numbers. 8 12

CHAPTER 5 ELASTICITY AND ITS APPLICATION 8 CHAPTER 5 ELASTICITY AND ITS APPLICATION 9

8 9

Calculating Percentage Changes Calculating Percentage Changes

Problem: ▪ So, we instead use the midpoint method:
The standard method gives
different answers depending end value – start value
Demand for x 100%
your websites on where you start. midpoint
P
From A to B, ▪ The midpoint is the number halfway between
B P rises 25%, Q falls 33%, the start & end values, also the average of
$250
A elasticity = 33/25 = 1.33 those values.
$200
From B to A, ▪ It doesn’t matter which value you use as the
D
P falls 20%, Q rises 50%, “start” and which as the “end” – you get the
Q elasticity = 50/20 = 2.50 same answer either way!
8 12

CHAPTER 5 ELASTICITY AND ITS APPLICATION 10 CHAPTER 5 ELASTICITY AND ITS APPLICATION 11

10 11

Instructor: Ali Zeytoon-Nejad 3

Econ Elasticity and its Applications

Calculating Percentage Changes A C T I V E L E A R N I N G 1:

Calculate an elasticity
▪ Using the midpoint method, the % change
in P equals Use the following
information to
$250 – $200 calculate the
x 100% = 22.2%
$225 price elasticity
▪ The % change in Q equals of demand
for hotel rooms:
12 – 8
x 100% = 40.0%
10 if P = $70, Qd = 5000
▪ The price elasticity of demand equals if P = $90, Qd = 3000
40/22.2 = 1.8

CHAPTER 5 ELASTICITY AND ITS APPLICATION 12 13

12 13

A C T I V E L E A R N I N G 1: What determines price elasticity?

Answers
To learn the determinants of price elasticity,
Use midpoint method to calculate we look at a series of examples.
% change in Qd Each compares two common goods.
In each example:
• Suppose the prices of both goods rise by 20%.
% change in P • The good for which Qd falls the most (in percent)
has the highest price elasticity of demand.
Which good is it? Why?
• What lesson does the example teach us about the
The price elasticity of demand equals determinants of the price elasticity of demand?

14 CHAPTER 5 ELASTICITY AND ITS APPLICATION 15

14 15

Instructor: Ali Zeytoon-Nejad 4

Econ Elasticity and its Applications

EXAMPLE 1: EXAMPLE 2:
Rice Krispies vs. Sunscreen “Blue Jeans” vs. “Clothing”
▪ The prices of both of these goods rise by 20%. ▪ The prices of both goods rise by 20%.
For which good does Qd drop the most? Why? For which good does Qd drop the most? Why?
• Rice Krispies has lots of close substitutes • For a narrowly defined good such as
(e.g., Cap’n Crunch, Count Chocula), blue jeans, there are many substitutes
so buyers can easily switch if the price rises. (khakis, shorts, Speedos).
• Sunscreen has no close substitutes, • There are fewer substitutes available for
so consumers would probably not broadly defined goods.
buy much less if its price rises. (Can you think of a substitute for clothing,
other than living in a nudist colony?)
▪ Lesson: Price elasticity is higher when close
▪ Lesson: Price elasticity is higher for narrowly
substitutes are available.
defined goods than broadly defined ones.
CHAPTER 5 ELASTICITY AND ITS APPLICATION 16 CHAPTER 5 ELASTICITY AND ITS APPLICATION 17

16 17

EXAMPLE 3: EXAMPLE 4:
Insulin vs. Caribbean Cruises Gasoline in the Short Run vs. Gasoline in
▪ The prices of both of these goods rise by 20%. the Long Run
For which good does Qd drop the most? Why? ▪ The price of gasoline rises 20%. Does Qd drop
• To millions of diabetics, insulin is a necessity. more in the short run or the long run? Why?
A rise in its price would cause little or no • There’s not much people can do in the
decrease in demand. short run, other than ride the bus or carpool.
• A cruise is a luxury.If the price rises, • In the long run, people can buy smaller cars
some people will forego it. or live closer to where they work.
▪ Lesson: Price elasticity is higher for luxuries ▪ Lesson: Price elasticity is higher in the
than for necessities. long run than the short run.

CHAPTER 5 ELASTICITY AND ITS APPLICATION 18 CHAPTER 5 ELASTICITY AND ITS APPLICATION 19

18 19

Instructor: Ali Zeytoon-Nejad 5

Econ Elasticity and its Applications

The Determinants of Price Elasticity: The Variety of Demand Curves

A Summary
▪ Economists classify demand curves according to
The price elasticity of demand depends on: their elasticity.
▪ the extent to which close substitutes are ▪ The price elasticity of demand is closely related
available to the slope of the demand curve.
▪ whether the good is a necessity or a luxury ▪ Rule of thumb:
▪ how broadly or narrowly the good is defined The flatter the curve, the bigger the elasticity.
▪ the time horizon: elasticity is higher in the The steeper the curve, the smaller the elasticity.
long run than the short run. ▪ The next 5 slides present the different
classifications, from least to most elastic.

CHAPTER 5 ELASTICITY AND ITS APPLICATION 20 CHAPTER 5 ELASTICITY AND ITS APPLICATION 21

20 21

“Perfectly inelastic demand” (one extreme case) “Inelastic demand”

Price elasticity % change in Q 0% Price elasticity % change in Q < 10%
= = =0 = = <1
of demand % change in P 10% of demand % change in P 10%

D curve: P D curve: P
D
vertical relatively steep
P1 P1
Consumers’ Consumers’
price sensitivity: P2 price sensitivity: P2
0 relatively low D
P falls Q P falls Q
Elasticity: by 10% Q1 Elasticity: by 10% Q 1 Q2
0 Q changes
<1
Q rises less
by 0% than 10%
CHAPTER 5 ELASTICITY AND ITS APPLICATION 22 CHAPTER 5 ELASTICITY AND ITS APPLICATION 23

22 23

Instructor: Ali Zeytoon-Nejad 6

Econ Elasticity and its Applications

“Unit elastic demand” “Elastic demand”

Price elasticity % change in Q 10% Price elasticity % change in Q > 10%
= = =1 = = >1
of demand % change in P 10% of demand % change in P 10%

D curve: P D curve: P
intermediate slope relatively flat
P1 P1
Consumers’ Consumers’
price sensitivity: P2 price sensitivity: P2 D
intermediate D relatively high
P falls Q P falls Q
Elasticity: by 10% Q1 Q2 Elasticity: by 10% Q1 Q2
1 >1
Q rises by 10% Q rises more
than 10%
CHAPTER 5 ELASTICITY AND ITS APPLICATION 24 CHAPTER 5 ELASTICITY AND ITS APPLICATION 25

24 25

“Perfectly elastic demand” (the other extreme) Elasticity of a Linear Demand Curve
Price elasticity % change in Q any %
= = = infinity
of demand % change in P 0% P The slope
200% of a linear
P $30 E = = 5.0
D curve: 40% demand
horizontal curve is
67%
P2 = P1 D 20 E = = 1.0 constant,
Consumers’ 67%
price sensitivity: but its
40%
extreme 10 E = = 0.2 elasticity
200%
is not.
P changes Q
Elasticity: by 0% Q1 Q2 $0 Q
infinity 0 20 40 60
Q changes
by any %
CHAPTER 5 ELASTICITY AND ITS APPLICATION 26 CHAPTER 5 ELASTICITY AND ITS APPLICATION 27

26 27

Instructor: Ali Zeytoon-Nejad 7

Econ Elasticity and its Applications

Price Elasticity and Total Revenue Price Elasticity and Total Revenue
▪ Continuing our scenario, if you raise your price
Price elasticity Percentage change in Q
from $200 to $250, would your revenue rise or fall? =
of demand Percentage change in P
Revenue = P x Q
▪ A price increase has two effects on revenue: Revenue = P x Q
• Higher P means more revenue on each unit ▪ If demand is elastic, then
you sell.
price elast. of demand > 1
• But you sell fewer units (lower Q), due to
Law of Demand. % change in Q > % change in P

▪ Which of these two effects is bigger? ▪ The fall in revenue from lower Q is greater
It depends on the price elasticity of demand. than the increase in revenue from higher P,
so revenue falls.
CHAPTER 5 ELASTICITY AND ITS APPLICATION 28 CHAPTER 5 ELASTICITY AND ITS APPLICATION 29

28 29

Price Elasticity and Total Revenue Price Elasticity and Total Revenue
Elastic demand Price elasticity Percentage change in Q
Demand for =
(elasticity = 1.8) P of demand Percentage change in P
your websites
If P = $200, increased revenue
due to higher P Revenue = P x Q
Q = 12 and
$250
▪ If demand is inelastic, then
lost revenue
revenue = $2400. due to lower Q price elast. of demand < 1
$200 % change in Q < % change in P
If P = $250, D
Q = 8 and ▪ The fall in revenue from lower Q is smaller
revenue = $2000. than the increase in revenue from higher P,
When D is elastic, Q so revenue rises.
8 12
a price increase ▪ In our example, suppose that Q only falls to 10
causes revenue to fall. (instead of 8) when you raise your price to $250.
CHAPTER 5 ELASTICITY AND ITS APPLICATION 30 CHAPTER 5 ELASTICITY AND ITS APPLICATION 31

30 31

Instructor: Ali Zeytoon-Nejad 8

Econ Elasticity and its Applications

Price Elasticity and Total Revenue A C T I V E L E A R N I N G 2:

Now, demand is
Elasticity and expenditure/revenue
inelastic: Demand for
A. Pharmacies raise the price of insulin by 10%.
elasticity = 0.82 your websites
P Does total expenditure on insulin rise or fall?
increased revenue
If P = $200, due to higher P B. As a result of a fare war, the price of a luxury
Q = 12 and
revenue = $2400. $250 lost revenue cruise falls 20%.
$200
due to lower
Q
Does luxury cruise companies’ total revenue
If P = $250, rise or fall?
Q = 10 and D
revenue = $2500.
When D is inelastic, Q
a price increase 10 12
causes revenue to rise.
CHAPTER 5 ELASTICITY AND ITS APPLICATION 32 33

32 33

A C T I V E L E A R N I N G 2: A C T I V E L E A R N I N G 2:
Answers Answers
A. Pharmacies raise the price of insulin by 10%. B. As a result of a fare war, the price of a luxury
Does total expenditure on insulin rise or fall? s. cruise falls 20%.
Does luxury cruise companies’ total revenue
rise or fall?

34 35

34 35

Instructor: Ali Zeytoon-Nejad 9

Econ Elasticity and its Applications

Price Elasticity of Supply Price Elasticity of Supply

Price elasticity Percentage change in Qs Price elasticity Percentage change in Qs
= =
of supply Percentage change in P of supply Percentage change in P

▪ Price elasticity of supply measures how much P

Example: S
Qs responds to a change in P. P rises
Price P2
▪ Loosely speaking, it measures the price- elasticity
by 8%
P1
sensitivity of sellers’ supply. of supply
▪ Again, use the midpoint method to compute the equals
Q
percentage changes. 16% Q1 Q2
= 2.0
8% Q rises
by 16%
CHAPTER 5 ELASTICITY AND ITS APPLICATION 36 CHAPTER 5 ELASTICITY AND ITS APPLICATION 37

36 37

The Variety of Supply Curves “Perfectly inelastic” (one extreme)

▪ Economists classify supply curves according to Price elasticity
=
% change in Q
=
0%
=0
of supply % change in P 10%
their elasticity.
▪ The slope of the supply curve is closely related S curve: P
S
to price elasticity of supply. vertical
P2
▪ Rule of thumb: Sellers’
The flatter the curve, the bigger the elasticity. price sensitivity: P1
The steeper the curve, the smaller the elasticity. 0
▪ The next 5 slides present the different Elasticity:
P rises
Q1
Q
by 10%
classifications, from least to most elastic. 0
Q changes
by 0%
CHAPTER 5 ELASTICITY AND ITS APPLICATION 38 CHAPTER 5 ELASTICITY AND ITS APPLICATION 39

38 39

Instructor: Ali Zeytoon-Nejad 10

Econ Elasticity and its Applications

“Inelastic” “Unit elastic”

Price elasticity % change in Q < 10% Price elasticity % change in Q 10%
= = <1 = = =1
of supply % change in P 10% of supply % change in P 10%

S curve: P S curve: P
S S
relatively steep intermediate slope
P2 P2
Sellers’ Sellers’
price sensitivity: P1 price sensitivity: P1
relatively low intermediate
P rises Q P rises Q
Elasticity: by 10% Q1 Q2 Elasticity: by 10% Q1 Q2
<1 =1
Q rises less Q rises
than 10% by 10%
CHAPTER 5 ELASTICITY AND ITS APPLICATION 40 CHAPTER 5 ELASTICITY AND ITS APPLICATION 41

40 41

“Elastic” “Perfectly elastic” (the other extreme)

Price elasticity % change in Q > 10% Price elasticity % change in Q any %
= = >1 = = = infinity
of supply % change in P 10% of supply % change in P 0%

S curve: P S curve: P
relatively flat S horizontal
P2 P2 = P1 S
Sellers’ Sellers’
price sensitivity: P1 price sensitivity:
relatively high extreme
P rises Q P changes Q
Elasticity: by 10% Q1 Q2 Elasticity: by 0% Q1 Q2
>1 infinity
Q rises more Q changes
than 10% by any %
CHAPTER 5 ELASTICITY AND ITS APPLICATION 42 CHAPTER 5 ELASTICITY AND ITS APPLICATION 43

42 43

Instructor: Ali Zeytoon-Nejad 11

Econ Elasticity and its Applications

The Determinants of Supply Elasticity A C T I V E L E A R N I N G 3:

Elasticity and changes in equilibrium
▪ The more easily sellers can change the quantity
they produce, the greater the price elasticity of ▪ The supply of beachfront property is inelastic.
supply. The supply of new cars is elastic.

▪ Example: Supply of beachfront property is ▪ Suppose population growth causes

harder to vary and thus less elastic than demand for both goods to double
supply of new cars. (at each price, Qd doubles).

▪ For many goods, price elasticity of supply is ▪ For which product will P change the most?
greater in the long run than in the short run, ▪ For which product will Q change the most?
because firms can build new factories, or
new firms may be able to enter the market.

CHAPTER 5 ELASTICITY AND ITS APPLICATION 44 45

44 45

A C T I V E L E A R N I N G 3: A C T I V E L E A R N I N G 3:
Answers Answers
Beachfront property New cars
When supply (inelastic supply): When supply (elastic supply):
is inelastic, P is elastic, P
an increase in an increase in
demand has a D1 D2 demand has a D1 D2
bigger impact bigger impact
on price than on quantity
on quantity. than on price.

Q Q

46 47

46 47

Instructor: Ali Zeytoon-Nejad 12

Econ Elasticity and its Applications

How the Price Elasticity of Supply Can Vary Other Elasticities

▪ The income elasticity of demand measures the
P Supply often response of Qd to a change in consumer income.
S
elasticity becomes
$15 <1 less elastic Income elasticity Percent change in Qd
as Q rises, =
of demand Percent change in income
12 due to
elasticity capacity ▪ Recall from chap.4: An increase in income causes
>1 limits. an increase in demand for a normal good.
4
$3 ▪ Hence, for normal goods, income elasticity > 0.
Q
100 200
500 525 ▪ For inferior goods, income elasticity < 0.

CHAPTER 5 ELASTICITY AND ITS APPLICATION 48 CHAPTER 5 ELASTICITY AND ITS APPLICATION 49

48 49

Other Elasticities
▪ The cross-price elasticity of demand measures CHAPTER SUMMARY
the response of demand for one good to changes ▪ Elasticity measures the responsiveness of
in the price of another good. Qd or Qs to one of its determinants.

Cross-price elast. % change in Qd for good 1 ▪ Price elasticity of demand equals percentage
= change Qd in divided by percentage change in P.
of demand % change in price of good 2
When it’s less than one, demand is “inelastic.”
▪ For substitutes, cross-price elasticity > 0 When greater than one, demand is “elastic.”
E.g., an increase in price of beef causes an ▪ When demand is inelastic, total revenue rises
increase in demand for chicken. when price rises. When demand is elastic, total
▪ For complements, cross-price elasticity < 0 revenue falls when price rises.
E.g., an increase in price of computers causes
decrease in demand for software.
CHAPTER 5 ELASTICITY AND ITS APPLICATION 50 CHAPTER 5 ELASTICITY AND ITS APPLICATION 51

50 51

Instructor: Ali Zeytoon-Nejad 13

Econ Elasticity and its Applications

CHAPTER SUMMARY CHAPTER SUMMARY

▪ Demand is less elastic in the short run, ▪ The income elasticity of demand measures how
for necessities, for broadly defined goods, much quantity demanded responds to changes in
or for goods with few close substitutes. buyers’ incomes.
▪ Price elasticity of supply equals percentage ▪ The cross-price elasticity of demand measures
change in Qs divided by percentage change in P. how much demand for one good responds to
When it’s less than one, supply is “inelastic.” changes in the price of another good.
When greater than one, supply is “elastic.”
▪ Price elasticity of supply is greater in the long run
than in the short run.

CHAPTER 5 ELASTICITY AND ITS APPLICATION 52 CHAPTER 5 ELASTICITY AND ITS APPLICATION 53

52 53

 Elasticity: Basic Idea – Definition – Elasticity vs. Sensitivity

 Shift in D/S (= Change in D/S) vs. Moving along the D/S curves (= Change in Q
demanded/supplied)  Price Elasticity of Demand
 Spectrum of Demand in Terms of Elasticity:
 Functional forms and graphical forms:
◦ (Perfectly inelastic demand - Inelastic demand – Unit elastic demand -
Elastic demand - Perfectly elastic demand)
Q XD = f ( PX , PY , I , T , N D , E ) QXS = f ( PX , PInputs,Tech, N S , E)  Elasticity of a Linear Demand Curve
 Price Elasticity and Total Revenue & An Application

 Price Elasticity of Supply

 Spectrum of Supply in Terms of Elasticity:
◦ (Perfectly inelastic supply - Inelastic supply – Unit elastic supply -
Elastic supply - Perfectly elastic supply)
 Other Elasticities: Income elas. of D & cross-price elas. of D

54 55

Instructor: Ali Zeytoon-Nejad 14

Econ Elasticity and its Applications

 The slides of this course are a select collection of the slides prepared by Ron Cronovich and
Mark P. Karscig and Andreea Chiritescu and the instructor of the course (Ali Zeytoon Nejad).
In some cases, they are modified by the instructor in order to better facilitate the achievement
of the course learning objectives.

 https://www.britannica.com/plant/wheat

Questions? 


http://www.bestbuy.com/site/electronics/computers-pcs/abcat0500000.c?id=abcat0500000
http://howtoretireearly.net/a-comparison-of-the-cost-of-living-in-japan-and-the-us/
http://www.investopedia.com/articles/investing/100813/interesting-facts-about-imports-and-exports.asp
www.cengage.com/

56 57

Thanks for
your attention

58

Instructor: Ali Zeytoon-Nejad 15