6

Elasticity

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 WHAT YOU WILL LEARN IN THIS CHAPTER

• Why is elasticity used to measure the response to

changes in prices or income?
• What are the different elasticity measures, and what do
they mean?
• What factors influence the size of these various
elasticities?
• Why is it vitally important to determine the size of the
relevant elasticity before setting prices or government
fees?

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 TAKEN FOR A RIDE

• Taken for a ride: $1,772.41 for driving nine miles in an

ambulance for a nonemergency treatment.
• How are ambulance services able to charge thousands of
dollars whether or not an ambulance is actually needed?
• The answer is price responsiveness of consumers to price
—the price elasticity of demand.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 PRICE ELASTICITY OF DEMAND

Price elasticity of demand is the measure of price

responsiveness:
• A demand is elastic when an increase in price reduces
the quantity demanded a lot.
• A demand is inelastic when an increase in price reduces
quantity demanded just a little.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 CALCULATING THE PRICE ELASTICITY OF
DEMAND (1 of 2)

• Price elasticity of demand = the percentage change in

quantity demanded divided by the percentage change in
price.

% change in quantity demanded

Price elasticity of demand 
% change in price

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 CALCULATING THE PRICE ELASTICITY OF
DEMAND (2 of 2)

• Example:
– If the price of oil increases by 10% and the quantity
demanded falls by 5%, then the price elasticity of demand
for oil is:
 5%
 0.5
10%

– Note: since we know that price and quantity demanded will

always move in opposite directions (law of demand) we
usually drop the minus sign (for price elasticity of demand
only).
Krugman, Economics, 7e,
6e, © 2024
2020 Worth Publishers
 THE MIDPOINT METHOD (1 of 3)
• There is a problem: Our percent change calculation depends
on our choice of starting point.
• Example: Gasoline costs three times as much per gallon in
Europe as it does in the United States. What is the percent
difference between American and European gas prices? It
depends on which way you measure it:
• European prices are 200% higher;
• American prices are 66.67% lower.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 THE MIDPOINT METHOD (2 of 3)
• To solve this problem, we calculate the price elasticity of
demand using the midpoint formula for percentage
changes.
• Instead of dividing by the initial quantity or price, we’ll use the
average quantity or price.
Change in X
% change in X  100
Average value of X

Average value of X
Starting value of X  Final value of X 
2

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 THE MIDPOINT METHOD (3 of 3)

• Example: At the initial price of $10, the quantity demanded

is 100. When the price rises to $20, the quantity
demanded is 90.

20  10
% change in price  100 66.6%
10  20  2
90  100
% change in quantity demanded  100  10.5%
100  90  2
10.5%
Price elasticity of demand  0.16
66.6%

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
LEARN BY DOING: PRACTICE QUESTION 1

• If the price of a sushi roll drops from $8 to $4 and sales

rise from 20 to 40 units, what is the absolute value of the
price elasticity of demand using the midpoint formula?
a) 0.5
b) 0.66
c) 1
d) 2

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
LEARN BY DOING: PRACTICE QUESTION 1
(Answer)

• If the price of a sushi roll drops from $8 to $4 and sales

rise from 20 to 40 units, what is the absolute value of the
price elasticity of demand using the midpoint formula?
a) 0.5
b) 0.66
c) 1 (correct answer)
d) 2

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 ESTIMATING ELASTICITIES
Price elasticity of
Good
demand
• Economists (and many others) Inelastic demand

are interested in price elasticity Gasoline (short-run) 0.09

of demand.
Gasoline (long-run) 0.24

• Estimating elasticity is crucial to

College (in-state 0.60–0.75
understanding and predicting tuition)

market outcomes. Airline travel

(business)
0.80

TABLE 1 Some Estimated Soda 0.80

Price Elasticities of Demand Elastic demand

Housing 1.2

College (out-of-state 1.2

tuition)

Airline travel (leisure) 1.5

Coke/Pepsi 3.3

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
TWO EXTREME CASES OF PRICE
ELASTICITY OF DEMAND

Figure 2

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
INTERPRETING THE PRICE ELASTICITY OF
DEMAND

• Classification of price elasticity of demand:

• A good can have a price elasticity as low as zero or as
high as infinity.
• If a price elasticity <1, the demand curve is inelastic.
• If a price elasticity >1, the demand curve is elastic.
• If a price elasticity =1, the demand curve is unit-elastic.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
UNIT-ELASTIC DEMAND

Figure 3(a)

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
INELASTIC DEMAND

Figure 3(b)

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
ELASTIC DEMAND
Figure 3(c)

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 ELASTICITY AND TOTAL REVENUE PART 1

• Total revenue: price times quantity sold.

TR = P × Q
• Sellers need to know how elastic demand is so they can
plan.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
TOTAL REVENUE BY AREA
Figure 4(a)

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 PRICE EFFECT AND QUANTITY EFFECT

• When a seller raises the price of a good, there are two

countervailing effects:
– A price effect: After a price increase, each unit sells at
a higher price, which tends to raise revenue.
– A quantity effect: After a price increase, fewer units are
sold, which tends to lower revenue.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
EFFECT OF A PRICE INCREASE ON TOTAL
REVENUE
Figure 4(b)

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 ELASTICITY AND TOTAL REVENUE PART 2

• When demand is inelastic, the price effect dominates the

quantity effect.
• So an increase in price will cause only a slight
reduction in the quantity demanded.
• In this instance, total revenue will rise when the price
rises (and vice versa).
• What happens if salt prices go up? TR will likely rise.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 ELASTICITY AND TOTAL REVENUE PART 3

• When demand is elastic, the quantity effect dominates the

price effect.
– So an increase in price will cause significant reduction in the
quantity demanded.
– In this instance, total revenue will fall when the price rises.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 ELASTICITY AND TOTAL REVENUE PART 4

• When demand is unit-elastic, the quantity effect equals the

price effect.
• So an increase in price exactly balances the reduction
in the quantity demanded.
• In this instance, total revenue doesn’t change.
• What happens if tire prices go up? TR will not change.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
DEMAND SCHEDULE AND TOTAL REVENUE
• The price elasticity of demand changes along the demand curve.
Figure 5

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
LEARN BY DOING: PRACTICE QUESTION 2

• The elasticity of demand for eggs has been estimated to

be 0.1. If egg producers raise their prices by 10%, what
will happen to their total revenue?
a) It will increase.
b) It will decrease.
c) It won’t change.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
LEARN BY DOING: PRACTICE QUESTION 2
(ANSWER)

• The elasticity of demand for eggs has been estimated to

be 0.1. If egg producers raise their prices by 10%, what
will happen to their total revenue?
a) It will increase. (correct answer)
b) It will decrease.
c) It won’t change.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
LEARN BY DOING: PRACTICE QUESTION 3

• The price of t-shirts increases by 25%. As a result, t-shirt

manufacturers experience an increase in total revenue.
What does this tell you about the demand for t-shirts over
the range of prices?
a) Demand is inelastic.
b) Demand is elastic.
c) Demand is unit elastic.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
LEARN BY DOING: PRACTICE QUESTION 3
(ANSWER)

• The price of t-shirts increases by 25%. As a result, t-shirt

manufacturers experience an increase in total revenue.
What does this tell you about the demand for t-shirts over
the range of prices?
a) Demand is inelastic. (correct answer)
b) Demand is elastic.
c) Demand is unit elastic.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 WHAT FACTORS DETERMINE THE PRICE
ELASTICITY OF DEMAND PART 1

1. Whether the good is a necessity or a luxury:

– For necessities, quantity demanded does not change
much in response to a change in P.
– For luxuries, quantity demanded is more sensitive to a
change in price.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 WHAT FACTORS DETERMINE THE PRICE
ELASTICITY OF DEMAND PART 2

2. The availability of close substitutes:

– Fewer substitutes make it harder for consumers to adjust Q
when P changes, so demand is inelastic.
– Many substitutes make it easier for consumers to switch
brands when prices change, so demand is elastic.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
LEARN BY DOING: PRACTICE QUESTION 4

• When the patent expires on a brand-name drug and five

generic drugs come on the market, what happens to
elasticity of demand for the original drug?
a) It rises.
b) It falls.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
LEARN BY DOING: PRACTICE QUESTION 4
(ANSWER)

• When the patent expires on a brand-name drug and five

generic drugs come on the market, what happens to
elasticity of demand for the original drug?
a) It rises. (correct answer)
b) It falls.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 WHAT FACTORS DETERMINE THE PRICE
ELASTICITY OF DEMAND PART 3

3. The share of income spent on the good:

– It feels cheaper when we spend a smaller share of income
on the good.
– It feels more expensive when we spend a greater share of
income on the good.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 WHAT FACTORS DETERMINE THE PRICE
ELASTICITY OF DEMAND PART 4

4. Time elapsed since the price change:

– Less time to adjust means lower elasticity.
– Over time consumers can adjust their behavior by finding
substitutes (making demand more elastic).

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
APPLICATIONS OF ELASTICITY OF DEMAND

• Why the war on drugs is hard to win:

– Because demand for most illegal drugs is inelastic, drug
dealers earn greater revenue and gain more power as
the war on drugs reduces the supply.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 OTHER DEMAND ELASTICITIES

• The cross-price elasticity of demand measures how

sensitive the quantity demanded of good A is to the price
of good B.
• Cross-price elasticity of demand =

% change in quantity of A demanded

% change in price of B

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 CROSS-PRICE ELASTICITY OF DEMAND
• For substitutes, cross-price elasticity of demand is
positive.
– An increase in the price of one brand of cookies will increase
the demand for other brands.
– The size of the cross-price elasticity shows how closely
substitutable the two goods are.
• For complements, cross-price elasticity of demand is
negative.
– An increase in the price of milk causes a decrease in
demand for Oreos.
– The size of the cross-price elasticity shows how closely
complementary the two goods are.
Krugman, Economics, 7e,
6e, © 2024
2020 Worth Publishers
LEARN BY DOING: PRACTICE QUESTION 5

• The price of good B increases by 4%, causing the quantity

demanded of good A to decrease by 6%. The cross-price
elasticity of demand is _____, and the goods are ______.
a) 1.5; substitutes
b) –1.5; complements
c) 0.67; complements
d) –2.4; substitutes

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
LEARN BY DOING: PRACTICE QUESTION 5
(ANSWER)

• The price of good B increases by 4%, causing the quantity

demanded of good A to decrease by 6%. The cross-price
elasticity of demand is _____, and the goods are ______.
a) 1.5; substitutes
b) –1.5; complements (correct answer)
c) 0.67; complements
d) –2.4; substitutes

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 INCOME ELASTICITY OF DEMAND PART 1

• The income elasticity of demand measures how

sensitive the quantity demanded of a good is to changes
in income.
• Income elasticity of demand =

% change in quantity demanded

% change in income

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 INCOME ELASTICITY OF DEMAND PART 2

• The income elasticity of demand can be used to

distinguish normal from inferior goods.
– For normal goods, income elasticity is positive.

– For inferior goods, income elasticity is negative.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 INCOME ELASTICITY OF DEMAND PART 3

• Normal goods can be income-elastic or not.

• For income-elastic goods, income elasticity is greater
than 1.
• For income-inelastic goods, income elasticity is positive
but less than 1.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
LEARN BY DOING: PRACTICE QUESTION 6

• Tonya consumes 10 boxes of ramen noodles a year when

her yearly income is $40,000. After her income falls to
$30,000 a year, she consumes 40 boxes of ramen noodles
a year. Calculate her income elasticity of demand for
ramen noodles using the midpoint method.
a) 4.2
b) –4.2
c) –2.25
d) 2.25

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
LEARN BY DOING: PRACTICE QUESTION 6
(ANSWER)

• Tonya consumes 10 boxes of ramen noodles a year when

her yearly income is $40,000. After her income falls to
$30,000 a year, she consumes 40 boxes of ramen noodles
a year. Calculate her income elasticity of demand for
ramen noodles using the midpoint method.
a) 4.2
b) –4.2 (correct answer)
c) –2.25
d) 2.25

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 MEASURING THE PRICE ELASTICITY OF
SUPPLY

• Usually, sellers offer more when prices are higher, but how
strong is that relationship?

• Similar to price elasticity of demand:

% change in quantity supplied

Price elasticity of supply 
% change in price

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 TWO EXTREME CASES OF PRICE
ELASTICITY OF SUPPLY

• Elasticity of supply captures the sensitivity of quantity

supplied to changes in price.
Figure 6 (a,b)

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 ELASTICITY OF SUPPLY

• Supply curve is elastic if a rise in price increases the

quantity supplied a lot.
• Supply curve is inelastic if a rise in price increases the
quantity supplied just a little.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 WHAT FACTORS DETERMINE THE PRICE
ELASTICITY OF SUPPLY (1 of 2)

1. Availability of inputs
– If an increase in production is very expensive (inputs are
not easily available or cannot be shifted), then the supply
will be inelastic.
– If production can be increased cheaply, then the supply will
be elastic.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
 WHAT FACTORS DETERMINE THE PRICE
ELASTICITY OF SUPPLY (2 of 2)

2. Time
– Price elasticity of supply increases as producers have more
time to respond to price changes.
– Long-run price elasticity of supply is usually higher than the
short-run elasticity.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers
LEARN BY DOING: PRACTICE QUESTION 7

• A computer manufacturer makes an experimental

computer chip that critics praise, leading to a huge
increase in the demand for the chip. How elastic is supply
in the short run? What about the long run? Graph both.

Krugman, Economics, 7e,

6e, © 2024
2020 Worth Publishers