ELASTICITY

3
CHAPTER
Objectives

After studying this chapter, you will be able to

▪ Define, calculate, and explain the factors that influence
the price elasticity of demand
▪ Define, calculate, and explain the factors that influence
the cross elasticity of demand and the income elasticity
of demand
▪ Define, calculate, and explain the factors that influence
the elasticity of supply
Price Elasticity of Demand

The price elasticity of demand is a units-free measure

of the responsiveness of the quantity demanded of a
good to a change in its price when all other influences
on buyers’ plans remain the same.
Calculating Elasticity
The price elasticity of demand is calculated by using the
formula:
Percentage change in quantity demanded
Percentage change in price
Price Elasticity of Demand
Price Elasticity of Demand

Figure 4.2 calculates the

price elasticity of demand
for pizza.
The price initially is
$20.50 and the quantity
demanded is 9 pizzas an
hour.
Price Elasticity of Demand

The price falls to $19.50

and the quantity
demanded increases to 11
pizzas an hour.
The price falls by $1 and
the quantity demanded
increases by 2 pizzas an
hour.
Price Elasticity of Demand
Price Elasticity of Demand

By using the average elasticity, we get the same elasticity

value regardless of whether the price rises or falls.
The ratio of two proportionate changes is the same as the
ratio of two percentage changes.
The measure is units free because it is a ratio of two
percentage changes and the percentages cancel out.
Changing the units of measurement of price or quantity
leave the elasticity value the same.
Price Elasticity of Demand

Inelastic and Elastic Demand

Demand can be inelastic, unit elastic, or elastic, and can
range from zero to infinity.
If the quantity demanded doesn’t change when the price
changes, the price elasticity of demand is zero and the
good as a perfectly inelastic demand.
Price Elasticity of Demand

Figure illustrates the case

of a good that has a
perfectly inelastic demand
and that has a vertical
demand curve.
Price Elasticity of Demand

If the percentage change

in the quantity demanded
equals the percentage
change in price, the price
elasticity of demand
equals 1 and the good has
unit elastic demand.
Figure illustrates this
case—a demand curve
with ever declining slope.
(Note that the demand
curve is not linear.)
Price Elasticity of Demand

If the percentage change in the quantity demanded is

infinitely large when the price barely changes, the price
elasticity of demand is infinite and the good has perfectly
elastic demand.
Price Elasticity of Demand

Figure illustrates the case

of perfectly elastic
demand—a horizontal
demand curve.
Price Elasticity of Demand

The percentage change in the quantity demanded is

smaller than the percentage change in price so that the
price elasticity of demand is less than 1 and the good has
inelastic demand. Demand curve is more steep

The percentage change in the quantity demanded is

greater than the percentage change in price so that the
price elasticity of demand is more than 1 and the good has
elastic demand. Demand curve is more flat
Price Elasticity of Demand

Elasticity Along a
Straight-Line Demand
Curve
Figure shows how demand
becomes less elastic as
the price falls along a
linear demand curve.
Price Elasticity of Demand

At prices above the mid-

point of the demand curve,
demand is elastic.
At prices below the mid-
point of the demand curve,
demand is inelastic.

At prices the mid-point of

the demand curve,
demand is unit elastic.
Price Elasticity of Demand
Price Elasticity of Demand
Price Elasticity of Demand

Total Revenue and Elasticity

The total revenue from the sale of good or service equals
the price of the good multiplied by the quantity sold.
When the price changes, total revenue also changes.
But a rise in price doesn’t always increase total revenue.
Price Elasticity of Demand

The change in total revenue due to a change in price

depends n the elasticity of demand:
▪ If demand is elastic, a 1 percent price cut increases the
quantity sold by more than 1 percent, and total revenue
increases.
▪ If demand is inelastic, a 1 percent price cut increases the
quantity sold by less than 1 percent, and total revenues
decreases.
▪ If demand is unitary elastic, a 1 percent price cut
increases the quantity sold by 1 percent, and total
revenue remains unchanged.
Price Elasticity of Demand

The total revenue test is a method of estimating the price

elasticity of demand by observing the change in total
revenue that results from a price change (when all other
influences on the quantity sold remain the same).
▪ If a price cut increases total revenue, demand is elastic.
▪ If a price cut decreases total revenue, demand is
inelastic.
▪ If a price cut leaves total revenue unchanged, demand is
unit elastic.
Price Elasticity of Demand

Figure shows the

relationship between
elasticity of demand for
pizzas and the total
revenue from pizzas.
In part a (shown here),
as the price falls from
$25 to $12.50, demand
is elastic, and total
revenue increases.
Price Elasticity of Demand

At $12.50, demand is
unit elastic and total
revenue stops
increasing.

As the price falls from

$12.50 to zero, demand
is inelastic, and total
revenue decreases.
Price Elasticity of Demand
In part b (shown here), as
the quantity increases
from zero to 25, demand
is elastic, and total
revenue increases.
At 25, demand is unit
elastic, and total revenue is
at its maximum.
As the quantity increases
from 25 to 50, demand is
inelastic, and total
revenue decreases.
Price Elasticity of Demand

The Factors That Influence the Elasticity of Demand

The elasticity of demand for a good depends on:
▪ The closeness of substitutes
▪ The proportion of income spent on the good
▪ The time elapsed since a price change
Price Elasticity of Demand

The closeness of substitutes

For goods and services with many substitutes, demand is
more elastic because consumer are very responsive to
change in the price.
For goods and services with low substitutes, demand is
inelastic because consumer have no choice and less
responsive toward price change.
The proportion of income spent on the good.
The greater the proportion of income consumers spent on
a good, the larger is its elasticity of demand.
Price Elasticity of Demand

The proportion of income spent on the good.

The greater the proportion of income consumers spent on
a good, the larger is its elasticity of demand.
The smaller the proportion of income consumers spent on
a good, the smaller is its elasticity of demand.
Price Elasticity of Demand

The time elapsed since a price change

The more time consumers have to adjust to a price
change, the more elastic is the demand for that good.
Prices changes in the long term will have an elastic
demand because consumer will have more information on
the availability of substitute goods
Short term price changes will have an inelastic demand
because is not enough time to look for substitutes and
consumer respond less to these price changes.
More Elasticities of Demand

Cross Elasticity of Demand

The cross elasticity of demand is a measure of the
responsiveness of demand for a good to a change in the
price of other good, other things remaining the same.
The formula for calculating the cross elasticity is:
Percentage change in quantity demanded
Percentage change in price of other good
More Elasticities of Demand
More Elasticities of Demand
More Elasticities of Demand

Income Elasticity of Demand

The income elasticity of demand measures how the
quantity demanded of a good responds to a change in
income, other things equal.
The formula for calculating the income elasticity of
demand is:
Percentage change in quantity demanded
Percentage change in income
More Elasticities of Demand
More Elasticities of Demand
Elasticity of Supply

The elasticity of supply measures the responsiveness of

the quantity supplied to a change in the price of a its good
when all other influences on selling plans remain the
same.
Calculating the Elasticity of Supply
The elasticity of supply is calculated by using the formula:
Percentage change in quantity supplied
Percentage change in price
Price Elasticity of Supply
Elasticity of Supply

Figure on the next slide shows three cases of the elasticity

of supply.
Supply is perfectly inelastic if the supply curve is vertical
and the elasticity of supply is 0.
Supply is unit elastic if the supply curve is linear and
passes through the origin. (Note that slope is irrelevant.)
Supply is perfectly elastic if the supply curve is horizontal
and the elasticity of supply is infinite.
Elasticity of Supply
Elasticity of Supply

The percentage change in the quantity supplied is smaller

than the percentage change in price so that the elasticity
of supply is less than 1 and the good has inelastic
supply. supply curve is more steep

The percentage change in the quantity supplied is greater

than the percentage change in price so that the elasticity
of supply is more than 1 and the good has elastic supply.
Supply curve is more flat
Elasticity of Supply
Elasticity of supply

The Factors That Influence the Elasticity of Supply

The elasticity of supply for a good depends on:
▪ Resource substitution possibilities
▪ The time frame for supply decision
▪ Perishability
Elasticity of Supply

The Factors That Influence the Elasticity of Supply

The elasticity of supply depends on
Resource substitution possibilities
The easier it is to substitute among the resources used to
produce a good or service, the greater is its elasticity of
supply.
The time frame for supply decisions
The more time that passes after a price change, the
greater is the elasticity of supply.
Elasticity of Supply

Perishability
There are perishable good is inelastic because changes in
price do not effect supply and the seller cannot store
perishable goods for long period of time.
THE END