Elasticities and the Quantitative

Analysis of Supply and Demand

 Elasticity is a measure of responsiveness
to a stimulus.

 What is the responsiveness of your grade-point

average to hours of study time?
 What is the responsiveness of wheat
production to rain fall?
 What is the responsiveness of electricity usage
to the average daily temperature?
 The quantity demanded by a consumer
will depend upon the following factors:

 The good’s own price.

 The consumer’s income.
 Prices of related goods.
 The consumer’s tastes and and preferences.
 Expectations and other special influences.
The quantity supplied will depend upon:
 the good’s own price
 prices of inputs used in producing the good.
 technology
 prices of other goods the seller could supply
 expectations and other factors
 The price elasticity of demand, ED, measures the
responsiveness of the quantity demanded to changes in
the good's own price.

percent change in the quantity demanded

ED 
percent change in price
6 percent change in Qd 3 percent changein Qd
ED  
2 percent change in P 1 percent change in P

ED is the percentage change in the quantity demanded that

results per one percent change in price.
 Suppose that a 10% increase in the price of
cigarettes results in a 4% decrease in the
quantity demanded.

4%
ED   0.4
10 %

For each 1% increase in price, the quantity

demanded goes down 0.4%.
 Suppose that a 10% increase in the price of tickets
to a Ry Cooder concert results in a 25% decrease
in the quantity demanded.

25 %
ED   2.5
10 %

The demand for concert tickets is more responsive to

price than is the demand for cigarettes.
We say the demand for concert tickets is more elastic
(w.r.t. price) than is the demand for cigarettes.
 Calculating the Price Elasticity of Demand

P
P1  P2
P1
Q1  Q2
P2

Q1 Q2 Q

percent change in the quantity demanded

ED 
percent change in price
Qd
 100
Qd Q2  Q1 
%  Qd Qd Qd Qd
   
%P P P ( P2  P1 )
 100
P P P

Qd  (Q1  Q2 ) / 2 Pd  ( P1  P2 ) / 2
 Qd (100 50) 50 2
Qd 75  75  3 2 4.5 9
ED         3
P ( 4  5) 1 1 3 1 3
P 4.5 4.5 4.5

Important points:
The minus sign is dropped when calculating ED.
The formula is based on percentage changes, not unit changes.
The average price and quantity (midpoints) are used.
 ED = 4.33

P
8 a ED > 1
7 ED = 1
6
5
4 ED < 1
b ED = 0.23
3
2
1
c
1 2 3 4 5 6 7 8 Q
 % Qd
ED 
% P

Demand is said to be elastic with respect to price

if ED > 1. %Qd > %P

Demand is said to be inelastic with respect to

price if ED < 1. %Qd < %P

Demand is said to be unit elastic with respect to

price if ED = 1. %Qd = %P
 Goods that are necessities typically have price
elasticities of demand that are relatively smaller.

Example:
ED = 0.58 for food
ED = 1.26 for furniture.
 Goods having ready substitutes typically have
higher price elasticities of demand.

Example:
ED = 0.4 for gasoline
ED = 1.4 for natural gas
ED typically will be larger as the market/good is
more narrowly defined.

Example:
The price elasticity of demand for food will be smaller than the
price elasticity of demand for ice cream.
ED typically will be larger as buyers have a
longer period of time to respond to price
changes.
Inferences that can be made when the
price elasticity of demand is known.

%Qd
ED 
%P

%Qd  E D  %P
 Inferences that can be made when the
price elasticity of demand is known.

%Qd
ED 
%P

%Qd  E D  %P
Example 1:
Suppose that ED = 2.5 and that there is a 5% increase in price. What
will be the percentage increase in the quantity demanded?

%Qd  E D  %P
 2.5  5%  12.5%
 %Qd
ED 
%P
Example 2:
Suppose that the price elasticity of demand for cigarettes
is 0.7 for teens. How much would the price have to
increase in order for teen smoking to be reduced 35%?

35%
0. 7 
?
 %Qd
ED 
%P
Example 2:
Suppose that the price elasticity of demand for cigarettes
is 0.7 for teens. How much would the price have to
increase in order for teen smoking to be reduced 35%?

35%
0. 7 
?

%Qd 35%
%P    50%
ED 0.7
The relationship between price and revenue changes:
The importance of ED
The relationship between price and revenue changes:
The importance of ED

ED = 4.33 Demand is elastic

P
8 a ED > 1
7 ED = 1
Demand is inelastic
6
5
4 ED < 1
b ED = 0.23
3
2
1
c
1 2 3 4 5 6 7 8 Q
 ED = 4.33 Demand is elastic

P
8 a ED > 1
7 ED = 1
Demand is inelastic
6
5
4 ED < 1
b ED = 0.23
3
2
1
c
1 2 3 4 5 6 7 8 Q

When demand is elastic (ED > 1), there is an inverse relationship

between changes in price and changes in total revenue.
P  TR P  TR

ED > 1 implies that %Qd > %P.

TR = P • Q
  
 ED = 4.33 Demand is elastic

P
8 a ED > 1
7 ED = 1
Demand is inelastic
6
5
4 ED < 1
b ED = 0.23
3
2
1
c
1 2 3 4 5 6 7 8 Q

When demand is inelastic (ED < 1), there is a direct relationship

between changes in price and changes in total revenue.
P  TR P  TR

ED < 1 implies that %Qd < %P.

TR = P • Q
  
 “Good weather is often bad for farmers' incomes."

This follows from the “total revenue test” and demand for many
farm products being price inelastic.

S1
P D
TR1 = P1  Q1
S2
P1 TR2 = P2  Q2
P2 P  TR

Q
Q1 Q2
 P P
Figure 1a Figure 1b

Q Q

Consider two alternative demand curves for a particular good.

P
Figure 2 ED = .8182

ED =1.5
1.00
0.80
D2

D1
10 12 14 Q

At the point where two demand curves intersect, the flatter demand curve is
relatively more elastic with respect to price, as compared to the steeper
demand curve.
 Figure 4
D1
P Sa Sb

P0
D2

P1

Q0 Q2 Q

D1
P Sa P Sa
Sb Sb

P0 P0
D2

P1

Q0 Q2 Q0 Q2
Q Q
 Figure 3
Figure 3
P Sa
P S a

Sb
P0
P0

P2 P2
P1 P1
D2 D2

D1 D1
Q0 Q1 Q2 Q0 Q1 Q2
Q Q

P Sa P Sa
Sb Sb
P0 P0

P2
P1
D2

D1 D1
Q0 Q1 Q0 Q2
Q Q
 FACT: For a given increase in supply the increase in
equilibrium quantity will be larger and the decrease in
equilibrium price will be smaller as the demand is more
elastic with respect to price.

Figure 3 Figure 3
P Sa P Sa
Sb Sb
P0 P0

P2 P2
P1 P1
D2 D2

D1 D1
Q0 Q1 Q2 Q0 Q1 Q2
Q Q
 FACT: For a given increase in demand, the increase in
equilibrium quantity will be larger and the decrease in
equilibrium price will be smaller as supply is more elastic
with respect to price.

S2
Sb
P
P P2
S1
Sa P1
P0 P0
Db

D1 Da1
Q0 Q Q0 Q2 Q1 Q