ELASTICITIES OF

DEMAND AND SUPPLY

 THE PRICE ELASTICITY OF DEMAND

Price elasticity of demand

A measure of the extent to which the quantity
demanded of a good changes when the price of the
good changes.
To determine the price elasticity of demand, we
compare the percentage change in the quantity
demanded with the percentage change in price.
 THE PRICE ELASTICITY OF DEMAND

Percentage Change in Price

Suppose Starbucks raises the price of a latte from $3
to $5 a cup. What is the percentage change in price?

New price – Initial price

Percent change in price = x 100
Initial Price

$5 – $3
Percent change in price = x 100 = 66.67 percent
$3
 THE PRICE ELASTICITY OF DEMAND

Suppose Starbucks cuts the price of a latte from $5 to

$3 a cup. What is the percentage change in price?

New price – Initial price

Percent change in price = x 100
Initial Price

$3 – $5
Percent change in price = x 100 = – 40 percent
$5
 THE PRICE ELASTICITY OF DEMAND

The same price change, $2, over the same interval, $3

to $5, is a different percentage change depending on
whether the price rises or falls.

We need a measure of percentage change that does

not depend on the direction of the price change.

We use the average of the initial price and the new price
to measure the percentage change.
 THE PRICE ELASTICITY OF DEMAND

The Midpoint Method

To calculate the percentage change in the price divide
the change in the price by the average price and then
multiply by 100.
The average price is at the midpoint between the
initial price and the new price, hence the name
midpoint method.

New price – Initial price

Percent change in price = x 100
(New Price + Initial Price) ÷ 2
 THE PRICE ELASTICITY OF DEMAND

$5 – $3
Percent change in price = x 100
($5 + $3) ÷ 2

Percent change in price = 50 percent

The percentage change in price calculated by the

midpoint method is the same for a price rise and a price
fall.
 THE PRICE ELASTICITY OF DEMAND

Percentage Change in Quantity Demanded

If Starbucks raises the price of a latte, the quantity of
latte demanded decreases.

Percent change New quantity – Initial quantity

in quantity = x 100
(New quantity + Initial quantity) ÷ 2

Percent change $5 – $15

in quantity = x 100 = – 100 Percent
($5 + $15) ÷ 2
 THE PRICE ELASTICITY OF DEMAND

 Minus Sign
 When the price rises, the quantity demanded decreases
along the demand curve. Price and quantity always
change in opposite directions.

 So to compare the percentage change in the price and

the percentage change in the quantity demanded, we
ignore the minus sign and use the absolute values.
 THE PRICE ELASTICITY OF DEMAND

Elastic and Inelastic Demand

Elastic demand
Demand is elastic if the percentage change in the
quantity demanded exceeds the percentage change in
price.
Unit elastic demand
If the percentage change in the quantity demanded
equals the percentage change in price.
 THE PRICE ELASTICITY OF DEMAND
Inelastic demand
If the percentage change in the quantity demanded is
less than the percentage change in price.
Perfectly elastic demand
When the quantity demanded changes by a very large
percentage in response to an almost zero percentage
change in price.
Perfectly inelastic demand
When the quantity demanded remains constant as the
price changes.
 THE PRICE ELASTICITY OF DEMAND

Figure 5.1(a) shows a

perfectly elastic
demand.
1. For a small change in
the price of spring water,

2. The quantity demanded

of spring water changes
by a large amount.
3. The demand for spring
water is perfectly elastic.
 THE PRICE ELASTICITY OF DEMAND

Figure 5.1 (b) shows

an elastic demand.

1. When the price of a

Sony Playstation rises
by 10%,
2. The quantity demanded
decreases by 20%.

3. Demand for Sony

Playstations is elastic.
 THE PRICE ELASTICITY OF DEMAND

Figure 5.1 (c) shows

a unit elastic
demand.

1. When the price of a trip

rises by 10%,
2. The quantity demand of
decreases by 10%.

3. The demand for trips is

unit elastic.
 THE PRICE ELASTICITY OF DEMAND

Figure 5.1 (d) shows

an inelastic demand.

1. When the price of gum

rises by 20%,

2. The quantity demanded

decreases by 10%.
3. The demand for gum is
inelastic.
 THE PRICE ELASTICITY OF DEMAND

Figure 5.1 (e) shows

a perfectly inelastic
demand.
1. When the price rises,

2. The quantity demanded

does not decrease.

3. Demand is perfectly
inelastic.
 THE PRICE ELASTICITY OF DEMAND

Influences on the Price Elasticity of Demand

Influences on the price elasticity of demand fall into:
• Substitution effects
• Income effects
Substitution Effects
The demand for a good is elastic if a substitute for it is
easy to find.
The demand for a good is inelastic if a substitute for it is
hard to find.
 THE PRICE ELASTICITY OF DEMAND

Three main factors influence the ability to find a

substitute for a good:
Luxury Versus Necessity
• A necessity has poor substitutes, so the demand for
a necessity is inelastic. Food is a necessity.
• A luxury has many substitutes, so the demand for a
luxury is elastic. Exotic vacations are luxuries.
Narrowness of Definition
• The demand for a narrowly defined good is elastic.
• The demand for a broadly defined good is inelastic.
 THE PRICE ELASTICITY OF DEMAND

Time Elapsed Since Price Changed

The longer the time elapsed since the price change, the
more elastic is the demand for the good.

Income Effects
The greater the proportion of income spent on a good,
the more elastic is the demand for the good.
 THE PRICE ELASTICITY OF DEMAND
Computing the Price Elasticity of Demand

Price elasticity Percentage change in quantity demanded

of demand =
Percentage change in the price
• If the price elasticity of demand is greater than 1,
demand is elastic.
• If the price elasticity of demand equals 1, demand is
unit elastic.
• If the price elasticity of demand is less than 1, demand
is inelastic.
 THE PRICE ELASTICITY OF DEMAND

 Figure 5.2 shows

the price elasticity
of demand
calculation.
By using the formula,
the price elasticity of
demand equals 100%
divided by 50%.

The price elasticity of

demand is 2.
 THE PRICE ELASTICITY OF DEMAND
Computing the Price Elasticity of Demand

Price elasticity Percentage change in quantity demanded

of demand =
Percentage change in the price

We can use this formula to calculate the price

elasticity of demand for a Starbucks latte:

100%
Price elasticity of demand = = 2
50%
 THE PRICE ELASTICITY OF DEMAND

 Slope and Elasticity

 Slope and elasticity are not the same thing!
 Slope measures how the quantity demanded changes
when the price changes.
 Slope depends on the units of measurement of price
and quantity. For example, the slope of the demand
curve for latte has the units dollars per cup.
 Slope cannot be used to compare the demands for
different goods.
 THE PRICE ELASTICITY OF DEMAND

 A Units-FreeMeasure
 Elasticity is independent of the units used to measure
price and quantity.
 Elasticity of demand is the ratio of two percentages and
so elasticity is a number with no units. For example,
the elasticity of demand for latte is 2.
 Elasticity allows us to compare the demands for
different goods. For example, we can compare the
demands for latte and baseball tickets.
 THE PRICE ELASTICITY OF DEMAND

 Elasticity Along a Linear Demand Curve

 Along a linear (straight-line) demand curve, the slope is
constant but the elasticity varies.

 Along a linear demand curve, demand is:

• Unit elastic at the midpoint of the curve.
• Elastic above the midpoint of the curve.
• Inelastic below the midpoint of the curve.
 THE PRICE ELASTICITY OF DEMAND
 Figure 5.3 shows that the
elasticity decreases along
a linear demand curve as
the price falls.

1. At any price above the

midpoint, demand is elastic.

2. At the midpoint, demand

is unit elastic.

3. At any price below the

midpoint, demand is
inelastic.
 THE PRICE ELASTICITY OF DEMAND

Total Revenue and Price Elasticity of Demand

Total revenue
The amount spent on a good and received by its sellers
and equals the price of the good multiplied by the quantity
of the good sold.

Total revenue test

A method of estimating the price elasticity of demand by
observing the change in total revenue that results from a
price change.
 THE PRICE ELASTICITY OF DEMAND

 If demand is elastic:
• A given percentage rise in price brings a larger
percentage decrease in the quantity demanded.
• And total revenue decreases.

 If demand is inelastic:
• A given percentage rise in price brings a smaller
percentage decrease in the quantity demanded.
• And total revenue increases.
 THE PRICE ELASTICITY OF DEMAND

 Total revenue test:

• If price and total revenue change in the opposite
directions, demand is elastic.

• If a price change leaves total revenue unchanged,

demand is unit elastic.

• If price and total revenue change in the same

direction, demand is inelastic.
 THE PRICE ELASTICITY OF DEMAND

Your Expenditure and Your Elasticity of

Demand
When the price of a good rises, your demand for that good
is:
• Elastic if your expenditure on it decreases.

• Unit elastic if your expenditure on it remains constant.

• Inelastic if your expenditure on it increases.

 THE PRICE ELASTICITY OF DEMAND
Figure 5.4(a) shows total
revenue and elastic demand.
At $3 a cup, the quantity
demanded is 15 cups an hour.
Total revenue is $45 an hour.
When the price rises to $5 a
cup, the quantity demanded
decreases to 5 cups an hour.

Total revenue decreases to

$25 an hour.
Demand is elastic.
 THE PRICE ELASTICITY OF DEMAND
 Figure 5.4(b) shows total
revenue and elastic
demand.
At $50 a book, the quantity
demanded is 5 million books.
Total revenue is $250 million.
When the price rises to $75 a
book, the quantity demanded
decreases to 4 million books.

Total revenue increases to

$300 million.
Demand is inelastic.
 THE PRICE ELASTICITY OF DEMAND

Applications of Price Elasticity of Demand



Farm Prices and Total Revenue

Price elasticity of demand for agricultural products is
0.4.

So a 1 percent decrease in the quantity harvested will

lead to a 2.5 percent rise in the price.

Demand is inelastic and farmers’ total revenue will

increase.
 THE PRICE ELASTICITY OF DEMAND

Addiction and Elasticity

Nonusers’ demand for addictive substances is elastic.
So a moderately higher price leads to a substantially
smaller number of people trying a drug.
Existing users’ demand for addictive substances is
inelastic.
So even a substantial price rise brings only a modest
decrease in the quantity demanded.
 THE PRICE ELASTICITY OF DEMAND

High taxes on cigarettes and alcohol limit the number of

young people who become habitual users of these
products.
High taxes have only a modest effect on the quantities
consumed by established users.
 5.2 THE PRICE ELASTICITY OF SUPPLY

Price elasticity of supply

A measure of the extent to which the quantity supplied
of a good changes when the price of the good changes.
To determine the price elasticity of supply, we compare
the percentage change in the quantity supplied with the
percentage change in price.
 5.2 THE PRICE ELASTICITY OF SUPPLY

Elastic and Inelastic Supply

Perfectly elastic supply
An almost zero percentage change in price brings a
very large percentage change in the quantity supplied.
Elastic supply
The percentage change in the quantity supplied
exceeds the percentage change in price.
 5.2 THE PRICE ELASTICITY OF SUPPLY

Unit elastic supply

The percentage change in the quantity supplied equals
the percentage change in price.

Inelastic supply
The percentage change in the quantity supplied is less
than the percentage change in price.

Perfectly inelastic supply

The percentage change in the quantity supplied is zero
when the price changes.
 5.2 THE PRICE ELASTICITY OF SUPPLY

 Figure 5.5(a) shows

perfectly elastic supply.

1. A small rise in the the price,

2. Decreases the quantity

supplied by a very large
amount,

3. Supply is perfectly elastic.

 5.2 THE PRICE ELASTICITY OF SUPPLY

 Figure 5.5 (b) shows

an elastic supply.

1. A 10% rise in the price

of a book,
2. Increases the quantity
supplied by 20%.

3. The supply of books is

elastic.
 5.2 THE PRICE ELASTICITY OF SUPPLY

 Figure 5.5(c) shows a

unit elastic supply.

1. A 10 % rise in the price

of fish,

2. Increases the quantity

supplied of fish by 10%.

3. The supply of fish is unit

elastic.
 5.2 THE PRICE ELASTICITY OF SUPPLY

 Figure 5.5(d) shows an

inelastic supply.

1. A 20% rise in the price

of a hotel room,

2. Increases the quantity

supplied of hotel rooms by
10%.
3. The supply of hotel
rooms is inelastic.
 5.2 THE PRICE ELASTICITY OF SUPPLY

 Figure 5.5(e) shows a

perfectly inelastic supply.

1. A small rise in the price of

a beachfront lot,

2. Increases the quantity

supplied by 0%.

3. The supply of beachfront

lots is perfectly inelastic.
 5.2 THE PRICE ELASTICITY OF SUPPLY

Influences on the Price Elasticity of Supply

The two main influences are:
• Production possibilities
• Storage possibilities
Production Possibilities
Goods that can be produced at a constant (or very
gently rising) opportunity cost have an elastic supply.

Goods that can be produced in only a fixed quantity

have a perfectly inelastic supply.
 5.2 THE PRICE ELASTICITY OF SUPPLY

Time Elapsed Since Price Change

As time passes after a price change, producers find it
easier to change their production plans, so supply
becomes more elastic.
Storage Possibilities
The supply of a storable good is highly elastic.

The cost of storage is the main influence on the

elasticity of supply of a storable good.
 5.2 THE PRICE ELASTICITY OF SUPPLY

Computing the Price Elasticity of Supply

Price elasticity Percentage change in quantity supplied

of supply =
Percentage change in quantity price

• If the price elasticity of supply is greater than 1,

supply is elastic.
• If the price elasticity of supply equals 1, supply is
unit elastic.
• If the price elasticity of supply is less than 1, supply
is inelastic.
 5.2 THE PRICE ELASTICITY OF SUPPLY

 Figure 5.6
shows how to
calculate the
price elasticity
of supply.
By using the formula,
the price elasticity of
supply equals 120%
divided by 66.67%.

The price elasticity

of supply is 1.8.
 5.3 CROSS AND INCOME ELASTICITIES

Cross Elasticity of Demand

Cross elasticity of demand

A measure of the extent to which the demand for a good
changes when the price of a substitute or complement
changes, other things remaining the same

Percentage change in quantity

Cross
demanded of a good
elasticity of =
demand Percentage change in the price of
one of its substitutes or
complements
 5.3 CROSS AND INCOME ELASTICITIES

Suppose that when the price of a burger falls by 10

percent, the quantity of pizza demanded decreases by 5
percent.

Cross
– 5 percent
elasticity of = = 0.5
demand – 10 percent
 5.3 CROSS AND INCOME ELASTICITIES

The cross elasticity of demand for a substitute is positive.

• A fall in the price of a substitute brings a decrease in

the quantity demanded of the good.
• The quantity demanded of a good and the price of its
substitute change in the same direction.
 5.3 CROSS AND INCOME ELASTICITIES

The cross elasticity of demand for a complement is

negative.

• A fall in the price of a complement brings an increase in

the quantity demanded of the good.
• The quantity demanded of a good and the price of one
of its complements change in opposite directions.
 5.3 CROSS AND INCOME ELASTICITIES

 Figure 5.7 shows

cross elasticity of
demand.

Pizzas and burgers are

substitutes. Cross
elasticity is positive.

Pizzas and soda are

complements. Cross
elasticity is negative.
 5.3 CROSS AND INCOME ELASTICITIES

Income Elasticity of Demand

Income elasticity of demand
A measure of the extent to which the demand for a
good changes when income changes, other things
remaining the same

Income Percentage change in quantity demanded

elasticity of =
demand Percentage change in income
 5.3 CROSS AND INCOME ELASTICITIES

Figure 5.8 shows the ranges of income elasticity of demand.