Mankiw PrinciplesOfEconomics 10e PPT CH05

Principles of
Economics, 10e
Chapter 5: Elasticity and Its
Application
Mankiw, Principles of Economics, Tenth 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
Chapter Objectives (1 of 3)
By the end of this chapter, you should be able to:

• Calculate price elasticity of demand in a given scenario.
• Identify regions of the demand curve as elastic, inelastic, or unit elastic using price
elasticity of demand.
• List the factors that influence price elasticity of demand.
• Describe the relationship between price elasticity of demand and the slope of a demand
curve.
• Explain how changes in supply impact market equilibrium.
• Analyze the relationship between price elasticity of demand and total revenue.
• Calculate income elasticity of demand in a given scenario.
• Determine whether a good is inferior or normal using income elasticity of demand.
• Calculate cross-price elasticity of demand in a given scenario.
• Determine if two goods are complements or substitutes using cross-price elasticity of demand.
• Calculate price elasticity of supply in a given scenario.
• List the factors that influence price elasticity of supply.
• Identify regions of the supply curve as elastic, inelastic, or unit elastic using price
elasticity of supply.
• Explain how changes in demand impact market equilibrium.
5-1
The Elasticity of Demand
The Price Elasticity of Demand
• Elasticity*
• Measure of the responsiveness of quantity demanded or quantity supplied to a
change in one of its determinants
• Price elasticity of demand*
• Measures how much the quantity demanded responds to a change in the price
*Words accompanied by an asterisk are key terms from the chapter.
Elastic and Inelastic Demand
• Elastic demand
• Quantity demanded responds substantially to price changes
• Inelastic demand
• Quantity demanded responds only slightly to price changes
Determinants of Price Elasticity of Demand (1 of
2)
• Availability of close substitutes
• Elastic demand: Goods with close substitutes
• Inelastic demand: Goods with no close substitute
• Necessities and luxuries
• Elastic demand: Luxuries
• Inelastic demand: Necessities
Determinants of Price Elasticity of Demand
(2 of 2)
• Defining the market broadly or narrowly
• Elastic demand: Narrowly defined markets
• Inelastic demand: Broadly defined markets
• Time horizon
• More elastic demand: Longer time horizons
• Less elastic demand: Shorter time horizons
Computing the Price Elasticity of Demand
• Computing the price elasticity of demand

• Percentage change in quantity demanded divided by percentage change in price
• Use absolute value (drop the minus sign)
Pe rc e n t a ge c h a n ge in q u a n t it y d e m a n d e d
Pric e e la s t ic it y of d e m a n d 
Pe rc e n t a ge c h a n ge in p ric e
The Midpoint Method
• The standard procedure for calculating a percentage change is to divide the change by
the initial level
• The midpoint method divides the change by the midpoint (or average) of the initial and
final levels
(Q2  Q1 )[(Q2  Q1 ) / 2
Pric e e la s t ic it y of d e m a n d 
(P2  P1 )[(P2  P1 ) / 2
Active Learning 1: Calculate an Elasticity
Use the following information to calculate the price elasticity of demand for iPhones:
• P = $400, Qd = 10,600
• 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)
The Variety of Demand Curves (1 of 2)
• 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 of 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
Figure 1 The Price Elasticity of Demand (1 of
2)
The price elasticity of demand determines whether the demand curve is steep or flat. Note that all percentage changes
are calculated using the midpoint method.
Figure 1 The Price Elasticity of Demand (2 of
2)
Total Revenue
• Total revenue*
• Amount paid by buyers and received by sellers of a good
• Price of the good times the quantity sold (P × Q)
Figure 2 Total Revenue
• The area of the box under the demand

curve, P × Q, equals the total amount
paid by buyers as well as the total
revenue received by sellers.
• Here, at a price of $4, the quantity

demanded is 100, and total revenue is
$400.
Total Revenue and the Price Elasticity of Demand
• Elastic demand
• Price and total revenue move in opposite directions
• Inelastic demand
• Price and total revenue move in the same direction
• Unit elastic demand
• When price changes, total revenue remains constant
Figure 3 How Total Revenue Changes When Price
Changes
The impact of a price change on total revenue
(price times quantity) depends on the elasticity of
demand. In panel (a), the demand curve is inelastic.
A price increase leads to a proportionately smaller
decrease in quantity demanded, so total revenue
increases. Here, the price increases from $4 to $5,
and the quantity demanded falls from 100 to 90.
Total revenue rises from $400 to $450. In panel (b),
the demand curve is elastic. A price increase leads
to a proportionately larger decrease in quantity
demanded, so total revenue decreases. Here, the
price increases from $4 to $5, and the quantity
demanded falls from 100 to 70. Total revenue falls
from $400 to $350.
Elasticity and Total Revenue along a Linear
Demand Curve
• If demand curve is linear, it has a constant slope
• “Rise over run”
• Elasticity changes
• Elastic demand: Points with high price and low quantity
• Inelastic demand: Points with low price and high quantity
Figure 4 Elasticity along a Linear Demand Curve
(1 of 2)
• The slope of a linear demand curve is constant,
but its elasticity is not.
• The price elasticity of demand is calculated
using the demand schedule and the midpoint
method.
• At points with a low price and high quantity, the
demand curve is inelastic.
• At points with a high price and low quantity, it is
elastic.
Figure 4 Elasticity along a Linear Demand Curve
(2 of 2)
Price Quantity Total Revenue Percentage Percentage Elasticity Description
(Price × Change in Change in
Quantity) Price Quantity
$7 0 $0
6 2 12 15 200 13.0 Elastic
5 4 20 18 67 3.7 Elastic
4 6 24 22 40 1.8 Elastic
3 8 24 29 29 1.0 Unit elastic
2 10 20 40 22 0.6 Inelastic
1 12 12 67 18 0.3 Inelastic
0 14 0 200 15 0.1 Inelastic
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. Expenditure = Total Revenue = P × Q

• Insulin is a necessity
• Since demand for insulin is inelastic, Q will fall less than 10%, so expenditure rises
B. Revenue = P × Q
• The fall in P reduces revenue, but Q increases, which increases revenue
• Since demand is elastic, Q will increase more than 20%, so revenue rises
The Income Elasticity of Demand
• Income elasticity of demand*

• A measure of how much the quantity demanded of a good responds to a change in
consumers’ income
• Normal goods have a positive income elasticity
• Inferior goods have a negative income elasticity
Pe rc e n t a ge c h a n ge in q u a n t it y d e m a n d e d
In c om e e la s t ic it y of d e m a n d 
Pe rc e n t a ge c h a n ge in in c om e
The Cross-Price Elasticity of Demand
• Cross-price elasticity of demand*

• A measure of how much the quantity demanded of one good responds to a change in
the price of another good
• Substitutes have a positive cross-price elasticity
• Complements have a negative cross-price elasticity
Pe rc e n t a ge c h a n ge in q u a n t it y d e m a n d e d o f good on e
Cros s - p ric e e la s t ic it y of d e m a n d 
Pe rc e n t a ge c h a n ge in t h e p ric e of good t w o
5-2
The Elasticity of Supply
The Price Elasticity of Supply
• Price elasticity of supply*

• Measures how much the quantity supplied of a good responds to a change in the
price of that good
Elastic and Inelastic Supply
• Elastic supply
• Quantity supplied responds substantially to price changes
• Inelastic supply
• Quantity supplied responds only slightly to price changes
Determinants of Price Elasticity of Supply
• Depends on the flexibility of sellers to change the amount they produce

• Short run
• Quantity supplied is not very responsive to changes in price
• Long run
• Quantity supplied responds substantially to price changes
Computing the Price Elasticity of Supply
• Computing the price elasticity of demand

• Percentage change in quantity supplied divided by percentage change in price
• Use midpoint method
Pe rc e n t a ge c h a n ge in q u a n t it y s u p p lie d
Pric e e la s t ic it y of s u p p ly 
Pe rc e n t a ge c h a n ge in p ric e
The Variety of Supply Curves (1 of 2)
• Supply is elastic
• Price elasticity of supply > 1
• Supply is inelastic
• Price elasticity of supply < 1
• Supply has unit elasticity

• Price elasticity of supply = 1
The Variety of Supply Curves (2 of 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
Figure 5 The Price Elasticity of Supply (1 of 3)
The price elasticity of supply determines whether the supply curve is steep or flat. Note
that all percentage changes are calculated using the midpoint method.
The price elasticity of supply determines whether the supply curve is steep or flat. Note
that all percentage changes are calculated using the midpoint method.
Figure 6 How the Price Elasticity of Supply Can
Vary
• Because firms often have a maximum capacity for
production, the elasticity of supply may be very high at low
levels of quantity supplied and very low at high levels of
quantity supplied.
• Here, an increase in the price from $3 to $4 increases the
quantity supplied from 100 to 200. Because the 67%
increase in quantity supplied (calculated with the midpoint
method) is larger than the 29% increase in price, the supply
curve in this range is elastic.
• By contrast, when the price rises from $12 to $15, the
quantity supplied rises only from 500 to 525. Because the 5
percent increase in quantity supplied is smaller than the
22% increase in price, the supply curve in this range is
inelastic.
5-3
Three Applications of Supply, Demand, and Elasticity
Can Good News for Farming Be Bad News for
Farmers?
• New hybrid of wheat increases production per acre by 20%
• 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
Figure 7 A Supply Increase in the Market for
Wheat
• When a technological advance increases the
wheat supply from S1 to S2, the price falls.
• Because the demand for wheat is inelastic, the

increase in quantity from 100 to 110 is
proportionately smaller than the decrease in the
price from $3 to $2.
• As a result, farmers’ total revenue falls from $300
($3 × 100) to $220 ($2 × 110).
Why Has OPEC Failed to Keep the Price of Oil
High?
• Increase in prices: 1973–1974, 1971–1981
• 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
Figure 8 A Reduction in Supply in the World
Market for Oil
When the supply of oil falls, the response depends on the time horizon. In the short run, supply and demand are
relatively inelastic, as in panel (a). The shift in the supply curve from S1 to S2 leads to a substantial price increase. In the
long run, however, supply and demand are relatively elastic, as in panel (b). In this case, the same size shift in the
supply curve (S1 to S2) causes a smaller price increase.
Does Drug Interdiction Increase or Decrease Drug-
Related Crime? (1 of 2)
• Increase the number of federal agents devoted to the war on drugs
• Supply curve shifts left
• Lower quantity and higher price
• Demand is inelastic: Total revenue rises
Does Drug Interdiction Increase or Decrease Drug-
Related Crime? (2 of 2)
• Drug interdiction would increase drug-related crime in the short run but decrease it in
the long run
• Demand is probably inelastic over short periods because higher prices do not
substantially affect drug use by addicts
• Demand may be more elastic over longer periods because higher prices would
discourage experimentation and lead to fewer drug addicts
5-4
Conclusion
Conclusion
• The tools of supply and demand are useful for analyzing the events and policies that
shape the economy
Think-Pair-Share Activity
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
Self-Assessment
• What is the relationship between price and quantity demanded for inelastic demand and
for elastic demand?
• A storm destroys half the oranges crop. Is this event more likely to hurt orange growers
if the demand for oranges is very elastic or very inelastic? Explain.
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Principles of

By the end of this chapter, you should be able to:

*Words accompanied by an asterisk are key terms from the chapter.

• Computing the price elasticity of demand

A. Use the midpoint method to calculate percentage change in price

Using the midpoint method to calculate percentage changes:

C. Price elasticity of demand

• Demand is perfectly inelastic

*Words accompanied by an asterisk are key terms from the chapter.

• The area of the box under the demand

• Here, at a price of $4, the quantity

A. Expenditure = Total Revenue = P × Q

• Income elasticity of demand*

*Words accompanied by an asterisk are key terms from the chapter.

• Cross-price elasticity of demand*

*Words accompanied by an asterisk are key terms from the chapter.

• Price elasticity of supply*

*Words accompanied by an asterisk are key terms from the chapter.

• Depends on the flexibility of sellers to change the amount they produce

• Computing the price elasticity of demand

• Supply has unit elasticity

• Supply is perfectly inelastic

• Supply is perfectly elastic

• Because the demand for wheat is inelastic, the

Click the link to review the objectives for this presentation.

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