Session 3 Ch 05 Elasticity and Its Application 10e_edited

Chapter
5
Elasticity and
Its Application
Interactive PowerPoint Slides by:
V. Andreea Chiritescu
TENTH EDITION Eastern Illinois University
Mankiw, Principles of Economics, 10th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part. 1
IN THIS CHAPTER
• What is elasticity?
• What kinds of issues can elasticity help us
understand?
• What is the price elasticity of demand?
How is it related to the demand curve?
How is it related to revenue and expenditure?
• What are the income and cross-price elasticities
of demand?
• What is the price elasticity of supply?
How is it related to the supply curve?
Mankiw, Principles of Economics, 10th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 2
Our Scenario
You maintain the social media accounts for local
businesses. You charge P = $2,000 per business, and
currently maintain the social media accounts for Q = 12
businesses per year.
• Your costs are rising (including the opportunity cost
of your time). You consider raising the price to
$2,500.
• The law of demand: if you raise your price, you will
not have as many accounts to maintain.
– How many fewer accounts?
– How much will your revenue fall, or might it
increase?
The Elasticity of Demand
• Elasticity
– Measure of how much buyers and seller respond
to changes in market conditions
– Measure of the responsiveness of Qd or Qs to a
change in one of its determinants
• Price elasticity of demand
– How much the quantity demanded of a good
responds to a change in its price
– Loosely speaking, it measures the price-
sensitivity of buyers’ demand
Mankiw, Principles of Economics, 10th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 4
website, in whole or in part.
The Price Elasticity of Demand
Price elasticity of demand is
P 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑑
=
𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃
15%
P rises P2 = = 1.5
by 10% P1 10%
Along a D curve, P and D

Q Q move in opposite
Q2 Q 1 directions, which would
Q falls make price elasticity
by 15% negative.
We will drop the minus sign and report all price
elasticities as positive numbers (absolute values).
Calculating Percentage Changes
Demand for maintaining Standard method of
social media accounts computing the percentage (%)
P change in a variable:
B
$2500 𝑒𝑛𝑑 𝑣𝑎𝑙𝑢𝑒 −𝑠𝑡𝑎𝑟𝑡 𝑣𝑎𝑙𝑢𝑒
A = ×100
$2000 𝑠𝑡𝑎𝑟𝑡 𝑣𝑎𝑙𝑢𝑒
D
Going from A to B:
Q • the % change in P = 25%
8 12
• the % change in Q = - 33%
Going from B to A: Price elasticity = 33/25 = 1.33
• % change in P = - 20%
• % change in Q = 50% We get different values!
Price elasticity =50/20 = 2.5
The Price Elasticity of Demand
• Midpoint method
– The midpoint is the number halfway between the start and
end values
• The average of those values
end value − start value

percentage change = × 100
midpoint
(𝑄2 − 𝑄1 )/[(𝑄2 + 𝑄1 )/2]

Price elasticity of demand =
(𝑃2 − 𝑃1 )/[(𝑃2 + 𝑃1 )/2]
Our Scenario: Calculating Percentage Changes
Demand for maintaining
social media accounts Using the midpoint method
of computing percentage
P
B changes:
$2500
A
$2000
40%
D Price elasticity = = 1.8
22.2%
Q
8 12
$2,500 − $2,000
% change in P = × 100 = 22.2%
$2,250
12 − 8
% change in Q = × 100 = 40%
10
Active Learning 1: Calculate an elasticity
Use the following information to calculate the
price elasticity of demand for iPhones:
• if P = $400, Qd = 10,600
• if P = $600, Qd = 8,400
A. Use the midpoint method to calculate percentage change
in price
B. Use the midpoint method to calculate percentage change
in quantity
C. Calculate the price elasticity of demand
Active Learning 1: Answers
Using the midpoint method to calculate percentage
changes:
A. % change in P =
[($600 - $400)/$500] ×100 = 40%
B. % change in Qd =
[(8,400 – 10,600)/9,500] ×100 = - 23.16%
C. Price elasticity of demand =
= % change in Qd / % change in P
= 23.16 / 40 = 0.58 (ignoring the minus sign)
Determinants of Price Elasticity of Demand
We look at a series of examples comparing two common
goods.
• In each example:
– Suppose prices of both goods rise by 20%
– Which good has the highest price elasticity of demand?
Why?
– What lesson we learn about the determinants of price
elasticity of demand?
EXAMPLE 1: Cheerios vs. Airfare
Prices of both of these goods rise by 20%.
For which good does Qd drop the most?
Why?
• Cheerios has many close substitutes, so
buyers can easily switch if the price rises
• Traveling by airplanes has no close
substitutes, so a price increase would not
affect demand very much
Price elasticity is higher when close substitutes
are available.
EXAMPLE 2: Mountain Dew vs. Soda (pop)
For which good does Qd drop the most? Why?
• For a narrowly defined good, Mountain Dew,

there are many substitutes
• There are fewer substitutes available for
broadly defined goods (soda / pop)
Price elasticity is higher for narrowly defined
goods than for broadly defined ones.
EXAMPLE 3: Insulin vs. Rolex watches
For which good does Qd drop the most?
Why?
• Insulin is a necessity to diabetics. A rise in
price would cause little or no decrease in
quantity demanded
• A Rolex watch is a luxury. If the price rises,
some people will forego it.
Price elasticity is higher for luxuries than for
necessities.
EXAMPLE 4: Gasoline, Short Run vs. Long Run
The price of gasoline rises 20%. Does Qd drop more in the
short run or the long run? Why?
• There’s not much people can do in the

short run, other than ride the bus or carpool.
• In the long run, people can buy smaller cars
or live closer to work.
Price elasticity is higher in the long run.
The Variety of Demand Curves – 1
• Demand is elastic
– Price elasticity of demand > 1
• Demand is inelastic
– Price elasticity of demand < 1
• Demand has unit elasticity
– Price elasticity of demand = 1
The Variety of Demand Curves – 2
• Demand is perfectly inelastic
– Price elasticity of demand = 0
– Demand curve is vertical
• Demand is perfectly elastic
– Price elasticity of demand = infinity
– Demand curve is horizontal
• The flatter the demand curve
– The greater the price elasticity of demand
Perfectly Inelastic Demand
Price elasticity % change in Q 0%
= = =0
of demand % change in P 10%
P
D • D curve:
Vertical
P1
• Consumers’
P2 price sensitivity:
None
P falls
by 10% Q1 Q • Elasticity:
Q changes 0
by 0%
Inelastic Demand
Price elasticity % change in Q <10%
= = <1
P
• D curve
P1 relatively steep
P2
• Consumers’ price
D sensitivity:
P falls relatively low
by 10% Q1 Q2 Q
• Elasticity:
Q rises less
than 10%
<1
Unit Elastic Demand
= = =1
P • D curve
intermediate
P1 slope
P2 • Consumers’ price
D
sensitivity:
P falls intermediate
by 10% Q1 Q2 Q
Q rises • Elasticity:
by 10% =1
Elastic Demand
Price elasticity % change in Q >10%
= = >1
P • D curve
relatively flat
P1
• Consumers’ price
P2 D sensitivity:
P falls
relatively high
by 10% Q1 Q2 Q • Elasticity:
Q rises more >1
than 10%
Perfectly Elastic Demand
Price elasticity % change in Q any %
= = = infinity
P • D curve
D horizontal
P2 = P1
P changes
• Consumers’
by 0% price sensitivity:
extreme
Q1 Q2 Q • Elasticity:
Q changes infinity
by any %
A Few Elasticities from the Real World
Elasticity Along a Linear Demand Curve
The slope of a
P
200% linear demand
$30 E = = 5.0 curve is constant,
40%
but its elasticity
67%
20 E = = 1.0 is not.
67%
40%
10 E = = 0.2
200%
$0 Q
0 20 40 60
Our Scenario: Total Revenue
Continuing our scenario, if you raise your price
from $2,000 to $2,500, would your revenue rise
or fall?
Total Revenue (TR) = P x Q
• A price increase has two effects on revenue:
– Higher revenue: because of the higher P
– Lower revenue: you maintain fewer accounts
(lower Q)
• Which of these two effects is bigger?
– It depends on the price elasticity of demand
Our Scenario: Elastic Demand (E = 1.8)
Demand for maintaining Price elasticity of
social media accounts demand = 1.8
increased revenue • If P = $2,000,
due to higher P
P Q = 12, then TR =
lost revenue $24,000
due to lower Q
• If P = $2,500,
$2500
Q = 8, then TR =
$2000
$20,000
D
When D is elastic,
a price increase
Q causes revenue to fall.
8 12
Our Scenario: Inelastic Demand (E = 0.82)
Demand for maintaining Price elasticity of
social media accounts demand = 0.82
increased revenue • If P = $2,000,
due to higher P
P Q = 12, then TR =
lost revenue $24,000
due to lower Q
• If P = $2,500,
$2500
Q = 10, then TR=
$2000 $25,000
D When D is inelastic,
a price increase causes
revenue to rise.
Q
10 12
Price Elasticity and Total Revenue
• For a price increase, if demand is elastic
▪ E > 1: % change in Q > % change in P
▪ TR decreases: the fall in revenue from lower Q > the increase in
revenue from higher P
▪ The extra revenue from selling units at a higher price is smaller than the
decline in revenue from selling fewer units
▪ For a price increase, if demand is inelastic
▪ E < 1: % change in Q < % change in P
▪ TR increases: the fall in revenue from lower Q < the increase in
revenue from higher P
▪ The extra revenue from selling units at a higher price more than offsets
the decline in revenue from selling fewer units
Active Learning 2: Elasticity and total revenue
A. Pharmacies raise the price of insulin by 10%.
– Does total expenditure on insulin rise or fall?
B. As a result of a fare war, the price of a luxury cruise falls
20%.
– Does luxury cruise companies’ total revenue rise or fall?
Active Learning 2: Answers, A
A. Pharmacies raise the price of insulin by 10%.
– Does total expenditure on insulin rise or fall?
• Expenditure = total revenue = P x Q

• Insulin is a necessity
• Since demand for insulin is inelastic, Q will fall less than
10%, so expenditure rises.
Active Learning 2: Answers, B
B. As a result of a fare war, the price of a luxury cruise falls
20%.
– Does luxury cruise companies’ total revenue rise or fall?
• Revenue = P x Q
• The fall in P reduces revenue, but Q increases,
which increases revenue. Which effect is
bigger?
• Since demand is elastic, Q will increase more
than 20%, so revenue rises.
Does Drug Interdiction Increase or Decrease
Drug-related Crime?
1. Policy: Drug Interdiction
Increase the number of federal agents
devoted to the war on drugs
– Illegal drugs: supply curve shifts left
• Higher price and lower quantity
– Amount of drug-related crimes
• Inelastic demand for drugs
• Higher drugs price: higher total revenue
• Increase drug-related crime
Policy 1: Drug Interdiction
Interdiction reduces Price of
the supply of drugs. Drugs new value of drug-
related crime
• Demand for
D1 S2
drugs is inelastic: S1
P rises P2
proportionally
more than Q falls. P initial value
1
Result: an increase of drug-
related
in total spending on crime
drugs, and in drug-
related crime. Q2 Q1 Quantity
of Drugs
Does Drug Interdiction Increase or Decrease
Drug-related Crime?
2. Policy: Drug Education
– Reduce demand for illegal drugs
– Left shift of demand curve
– Lower quantity
– Lower price
– Reduce drug-related crime
Policy 2: Drug Education
Price of new value of drug-
Drugs related crime
Education reduces D2 D1
the demand for S
drugs.
• P and Q fall. P1 initial value
of drug-
Result: P2 related
A decrease in total crime
spending on drugs,
and in drug-related Q2 Q 1 Quantity
of Drugs
crime.
Income Elasticity of Demand
• Income elasticity of demand

– How much the quantity demanded of a good responds
to a change in consumers’ income
• Percentage change in quantity demanded divided by the
percentage change in income
– Normal goods: income elasticity > 0
– Inferior goods: income elasticity < 0
Percentage change
in quantity demanded
Income elasticity of demand =
Percentage change
in income
Cross-Price Elasticity of Demand
• Cross-price elasticity of demand
– How much the Qd of one good responds to a change in
the price of another good
• Percentage change in Qd of the first good divided by the
percentage change in price of the second good
– Substitutes: cross-price elasticity > 0
– Complements: cross-price elasticity < 0
Cross-Price Elasticity of Demand
QX / QX QX PY
Point Definition E XY = = 
PY / PY PY QX
Linear Function PY
E XY = a4 
QX
QX 2 − QX 1 PY 2 + PY 1
Arc Definition E XY = 
PY 2 − PY 1 QX 2 + QX 1
Substitutes Complements
EXY  0 EXY  0
The Price Elasticity of Supply
• Price elasticity of supply
– How much the quantity supplied of a good responds to a change
in its price
• Percentage change in quantity supplied divided by the
percentage change in price
– Loosely speaking, it measures sellers’
price-sensitivity
• Elastic supply: the quantity supplied responds substantially to
price changes
• Inelastic supply: if the quantity supplied responds only slightly
Calculating Price Elasticity of Supply
percentage change in Q 𝑠
𝑃𝑟𝑖𝑐𝑒 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑠𝑢𝑝𝑝𝑙𝑦 =
percentage change in P
16%
= =2 P
8% S
P rises P2
Again, we use the by 8% P
1
midpoint method to
compute the
Q
percentage Q1 Q2
changes. Q rises
by 16%
EXAMPLE 5: Price elasticity of supply
The price of pizza increased from $12 to $14 per
pie, and increased the quantity produces in your
town from 150 to 170 pies per day.
$14 − $12
P % change in P = × 100
S $13
= 15.4%
$14 170 − 150
$12
% change in QS= × 100
160
= 12.5%
Price elasticity of supply =
150 170 Q % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑆 12.5
= = 0.8
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃 15.4
The Variety of Supply Curves – 1
• Supply is unit elastic
– Price elasticity of supply = 1
• Supply is elastic
– Price elasticity of supply > 1
• Supply is inelastic
– Price elasticity of supply < 1
The Variety of Supply Curves – 2
• Supply is perfectly inelastic
– Price elasticity of supply = 0
– Supply curve is vertical
• Supply is perfectly elastic
– Price elasticity of supply = infinity
– Supply curve is horizontal
• The flatter the supply curve
– The greater the price elasticity of supply
Perfectly Inelastic Supply
= = =0
of supply % change in P 10%
• S curve: P
S
vertical
P
• Sellers’ price P rises 2
sensitivity: by 10% P
1
none
• Elasticity: Q1
Q
0 Q changes
by 0%
Inelastic Supply
Price elasticity % change in Q < 10%
= = <1
• S curve: P
S
relatively steep
• Sellers’ price P rises
P2
sensitivity: by 10% P1
relatively low
• Elasticity: Q 1 Q2
Q
<1 Q rises less

than 10%
Unit Elastic Supply
= = =1
• S curve: P
intermediate slope S
• Sellers’ price P2
sensitivity: P1
intermediate P rises
• Elasticity: by 10%
Q1 Q2
Q
=1 Q rises
by 10%
Elastic Supply
Price elasticity % change in Q > 10%
= = >1
• S curve: P
relatively flat S
• Sellers’ price P rises P2
sensitivity: by 10%
P1
relatively high
• Elasticity: Q1 Q2
Q
>1 Q rises more

than 10%
Perfectly Elastic Supply
Price elasticity % change in Q any %
= = = infinity
• S curve:
P
horizontal
• Sellers’ price P2 = P1 S
sensitivity: P changes
extreme by 0%
• Elasticity: Q
Q1 Q2
infinity Q changes
by any %
The Determinants of Supply Elasticity
• Greater price elasticity of supply
– The more easily sellers can change the quantity they
produce
• Price elasticity of supply is greater in the long run than in
the short run
– In the long run: firms can build new factories, or new firms
may be able to enter the market
Active Learning 3: Elasticity and changes in equilibrium
Assume the supply of parking spots is inelastic
and the supply of wheat is elastic. Suppose
population growth causes demand for both goods
to double (at each price, Qd doubles).
• For which product will P change the most?
• For which product will Q change the most?
A. Draw a graph with the new equilibrium in the
market for parking
B. Draw a graph with the new equilibrium in the
market for wheat
Active Learning 3A: Parking spots
Parking spots
When supply is (inelastic supply):
inelastic, an P S
increase in D1 D2
demand has a
P2 B
bigger impact on
price than on
P1 A
quantity.
Q
Q1 Q2
Active Learning 3B: Wheat
Wheat
When supply
P (elastic supply):
is elastic,
an increase in D1 D2
demand has a
bigger impact on B S
quantity than on P2
A
P1
price.
Q
Q1 Q2
How the Price Elasticity of Supply can Vary
Price Supply
Elasticity is small
$15 (less than 1).
12
Elasticity is large
(greater than 1).
4
3
0 100 200 500 525 Quantity
• Supply often becomes less elastic as Q rises, due

to capacity limits.
More Applications – 1
1. Can Good News for Farming Be Bad News for
Farmers?
– New hybrid of wheat: 20% increased production per acre
• Supply curve shifts to the right
• Higher quantity and lower price
• Demand is inelastic: total revenue falls
– Paradox of public policy: induce farmers not to plant crops
A Supply Increase in the Market for Wheat
1. When demand is inelastic,

Price of an increase in supply . . .
Wheat
S1
S2
2. … leads
$3
to a large 3. … and a proportionately
fall in 2 smaller increase in quantity
price. . . sold. As a result, revenue
falls from $300 to $220.
Demand
0 100 110 Quantity of Wheat
More Applications – 2
2. Why Has OPEC Failed to Keep the Price of Oil High?
– Increase in prices 1973-1974, 1979-1981
– Short-run: supply and demand are inelastic
• Decrease in supply: large increase in price
– Long-run: supply and demand are elastic
• Decrease in supply: small increase in price
A Reduction in Supply in the World Market for Oil
(a) The Oil Market in the Short Run (b) The Oil Market in the Long Run
1. In the short run, when supply and 1. In the long run, when
demand are inelastic, a shift in supply and demand are
supply. . . elastic, a shift in supply. . .
Price
Price
S2
S1 2. … leads to a
small increase S2 S1
P2 in price
P2
P1 P1
2. … leads to a
large increase in Demand
price Demand
0 Quantity 0 Quantity
THINK-PAIR-SHARE
In order to reduce teen smoking, the government
places a $2 per pack tax on cigarettes. After one
month, the quantity demanded of cigarettes has been
reduced only slightly. Discuss the following:
A. What conclusion can you draw about the one-
month demand for cigarettes?
B. Caleb suggests that the cigarette industry should
get together and raise the price of cigarettes further
to increase total revenue .
C. Keisha suggests that only your firm should raise the
price of your cigarettes to increase total revenue.
CHAPTER IN A NUTSHELL
• The price elasticity of demand
– Measures how much the quantity demanded responds to price
changes.
– Is the percentage change in quantity demanded divided by the
percentage change in price.
– If < 1, inelastic demand: quantity demanded moves proportionately
less than the price
– If > 1, elastic demand: quantity demanded moves proportionately
more than the price
• Demand tends to be more elastic if
– Close substitutes are available
– The good is a luxury rather than a necessity
– The market is narrowly defined
– If buyers have substantial time to react to a price change.
• Total revenue (P × Q), total amount paid for a good
– Moves in the same direction as P (inelastic D)
– Moves in the opposite direction as P (elastic D)
• The income elasticity of demand
– Measures how much the quantity demanded responds to changes
in consumers’ income
• The cross-price elasticity of demand
– Measures how much the quantity demanded of one good
responds to changes in the price of another
• The tools of supply and demand can be applied to many different
kinds of markets (in this chapter: the market for wheat, the market for
oil, and the market for illegal drugs)
• The price elasticity of supply
– Measures how much the quantity supplied responds to changes in the
price.
– Is the percentage change in quantity supplied divided by the
percentage change in price
– If < 1, inelastic supply: quantity supplied moves proportionately less
than the price
– If > 1, elastic supply: quantity supplied moves proportionately more than
the price
– Depends on the time horizon under consideration. In most markets,
supply is more elastic in the long run than in the short run.

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Chapter

Along a D curve, P and D

end value − start value

(𝑄2 − 𝑄1 )/[(𝑄2 + 𝑄1 )/2]

• For a narrowly defined good, Mountain Dew,

• There’s not much people can do in the

• Expenditure = total revenue = P x Q

• Income elasticity of demand

<1 Q rises less

>1 Q rises more

0 100 200 500 525 Quantity

• Supply often becomes less elastic as Q rises, due

1. When demand is inelastic,

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