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LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
NAME: ____________
SECTION: _____
ELASTICITIES
(Learning Outcome 3)
PRICE ELASTICITY OF DEMAND (PED)
When we studied demand in Learning Outcome 2, we saw that when Price rises, Quantity
demanded _______ (rises/falls) and vice versa. We call this the law of __Demand_______ and
there exists a(n) ___________(positive/ inverse) relationship between Price and Quantity
Demanded.
In order to measure how much Quantity Demanded changes when there is a change in Price, we
use a concept called Price Elasticity of Demand.
Price Elasticity of Demand (PED): measures the responsiveness of quantity demanded to a
change in price.
Let’s look at two cases in the following diagrams
P
Diagram A
P
Diagram B
1) Elastic Demand
a. Which curve has the flatter slope? ____
b. If there is a price change, in which diagram will Quantity demanded change by
the greatest amount? ______
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LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
c. If Quantity demanded is very responsive to a change in Price, the good is
elastic.
2) Inelastic Demand
a. Which curve has the steeper slope? _B___
b. If there is a price change, in which diagram will Quantity demanded change by
the smallest amount? ___B___
c. If Quantity demanded is NOT very responsive to a change in Price, the good is
inelastic.
There are 3 ways we can decide how responsive quantity demanded is to a change in the
Price:
1) Characteristics of Price Elasticity of Demand (PED)
2) PED Formula
3) TR test
1) Characteristics of Price Elasticity of Demand (PED)
The following characteristics make a good ELASTIC meaning that Quantity demanded is very
responsive to a change in price or INELASTIC meaning that Quantity demanded is NOT very
responsive to a change in price:
1. Availability of Substitutes:
- If there exists few or no close substitutes then the good is Inelastic. E.g oil and
cigarettes
- If there exists many close substitutes then the good is elastic. E.g. beef
2. % of income (Y):
- If the good takes up a small % of Y then the good is Inelastic e.g. matches
- If the good takes up a large % of Y then the good is elastic e.g. a luxury car
3. Necessity versus Luxury:
- If the good is a Necessity then it is Inelastic.
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LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
- If the good is a Luxury then it is elastic.
4. Urgency of purchase
- If the purchase of the good is Urgent then it’s Inelastic.; e.g. a life saving operation.
- If the purchase of the good is NOT Urgent then it’s elastic; e.g. cosmetic surgery.
5. The width of the category :
- The wider the category of a good; e.g. pants, the more inelastic the demand.
- The narrower the category of a good; e.g. Rock and Republic brand of jeans, the more
elastic the demand.
6. Time
- The longer the period of time, the easier it is to make adjustments in purchases (easier
to find substitutes); hence, the longer the period of time the more elastic the demand.
- The shorter the period of time, the more difficult it is to make adjustments in
purchases (harder to find substitutes); hence, the shorter the period of time the more
inelastic the demand.
Exercise: Summary of characteristics
Elastic
Inelastic
Substitutes e.g. beef
Few Substitutes e.g. oil
Large % of Income e.g.
luxury car
Small % of income
e.g. matches
Luxury
e.g. cosmetic surgery
Necessity
e.g. life saving surgery
Urgent
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LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
Not urgent e.g. cosmetic
surgery
e.g. life saving surgery
Narrow category- e.g. apples
Wider category e.g. fruit
Longer time period
Shorter time period
Exercise: Identify if the following goods are elastic or inelastic and why by using the above
list of characteristics.
GOOD OR SERVICE
Salt
An operation to remove a
ruptured appendix
Lamb
A European vacation
Insulin for Diabetics
Insulin at one of four
pharmacies
Louis Vuitton handbags
Cosmetic surgery
A yacht
alalali tuna
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ELASTIC OR INELASTIC
WHY?
LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
2) Calculating PED
Price elasticity of demand compares the percentage change in quantity demanded with the
percentage change in price that caused it.
PED =
% change in Qd
% change in P
PED =
Change in Qd divided
Sum of Qd’s / 2
by
=
Qd 2 - Qd1
Qd1 + Qd2 / 2 by
Change in P
Sum of P’s / 2
divided P2 - P1
P1 + P2 /2
(Note: PED will always be negative but ignore the negative sign. PED will always be negative
because an increase in price will lead to a decrease in quantity demanded and an decrease in
price will lead to an increase in quantity demanded.)
Interpreting PED coefficients:
INELASTIC
If answer is between 0 and -1: the relationship is inelastic. We take the absolute value,
therefore:
PED
< 1
then the good is INELASTIC
- Hence a 1% change in price will result in a less than 1% change in Qd. We say Qd is NOT
very responsive to a change in price. % change in Price > % change in Qd
- Example: If PED = 0.5, then a 1% change in P will lead to a 0.5% change in Qd.
The Demand curve is drawn more vertical. Draw an inelastic demand curve.
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LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
ELASTIC
If the answer is between -1 and infinity: the relationship is elastic. We take the absolute value,
therefore:
PED > 1 then the good is ELASTIC
- Hence a 1% change in price will result in a greater than 1% change in Qd. We say Qd is VERY
responsive to a change in Price. % change in Price < % change in Qd
- E.g.: If PED = 2, it means that a 1% change in P will cause a 2% change in Qd.
- For an elastic good, the Demand curve is drawn flatter. Draw an elastic demand curve.
For example, look at the following demand schedule:
PRICE OF THE GOOD
$5
$4
QUANTITY DEMANDED PER WEEK
200
220
Assume the price falls from $5 to $4, calculate the PED.
% change in Quantity demanded
% change in Price
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=
Qd 2 - Qd1
Qd1 + Qd2 / 2
=
220 – 200
200 + 220/2
=
.095
=
P2 - P1
P1 + P2 /2
=
$4 - $5
$5 + $4/2
LSSS 231
Prepared by Linda Habibi
PED =
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
=
- .22
% change in Qd
% change in P
=
.095
- .22
PED
=
- 0.43
Ignore the negative sign therefore /– 0.43/ = 0.43. 0.43 is less than 1 so the good is
INELASTIC. A 1% change in price will cause a 0.43% change in quantity demanded.
Exercise: Using the formula
Below is the demand schedule for tins of al alali tuna
Price of tuna per tin
4 Dhs
3 Dhs
Market demand per week
2000
3000
1. Calculate the price elasticity of demand when price falls from 4 Dhs to 3 Dhs.
2. Comment on its value. Is the demand for al alali tuna elastic or inelastic?
3. What will the demand curve for tuna look like? Draw a simple diagram to show
this.
Exercise: Predicting the effect a % change in price will have on quantity demanded
Predict the effect that the following percentage price changes might have on the percentage
change in quantity demanded in each case. Give reasons for your answers. The first one has been
done for you as an example
% change in price
A 20% increase in
Emirates Airlines
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Predicted percentage change in
Reason
quantity demanded
Qd would decrease more than 20% There are
substitutes i.e.
Elastic or
inelastic
Elastic b/c %
change in price
LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
fares
other airlines
 % change in
Qd
A 30% increase in
the price of salt
A 10% increase in
the price of
expensive jewelry
Some Special Demand Curves
Unit elasticity
-
A percentage change in the price of a good will cause an equal percentage change in the
quantity demanded.
-
A 1% change in price will result in exactly a 1% change in Qd.
-
PED = 1
-
The Demand curve is drawn as a rectangular hyperbola . Draw a unit elastic demand
curve.
Unitary Demand Curve
Perfectly Inelastic Demand
What do you think would happen to the quantity demanded if the price of insulin (a drug that
diabetics must have to survive) increases by 100%? _________________ Why?
_______________________________
-
If a rise or fall in the price of a good causes no change in the quantity demanded of that
good, demand is said to be perfectly inelastic.
-
A 1% change in price will result in exactly a 0% change in Qd.
-
Therefore PED = 0
Page 8 of 31
LSSS 231
Prepared by Linda Habibi
-
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
For example: life saving drugs, highly addictive drugs. The demand curve is drawn
perfectly vertical. Draw a perfectly inelastic demand curve.
Perfectly Inelastic Demand Curve
Perfectly elastic demand
-
If a good is only demanded at one particular price, then demand is said to be infinitely
price elastic.
-
That is a small change in price will cause quantity demanded to fall to zero, that is,
quantity demanded will change by an infinite amount.
-
PED = infinity (PED =  )
-
For example, one farmer’s produce e.g. Farmer Jones’ red apples.
-
The demand curve is drawn horizontal. Draw a perfectly elastic demand curve.
Perfectly Elastic Demand Curve
3) Total Revenue Test
A firm calculates its total revenue, that is the amount it receives from selling its goods by
using the following formula:
Price X Quantity = Total Revenue
P
X
Q
= TR
(Note: Total revenue and profit are NOT the same thing!)
Page 9 of 31
LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
A firm would like to know if an increase in price will cause their total revenue to fall or
rise.
The effect of a price change on total revenue depends on by how much quantity
demanded changes – that is it depends on the good’s PED. If quantity demanded
decreases a lot due to a change in price (PED  1), revenue will tend to fall. If quantity
demanded decreases a little due to a change in price (PED  1), revenue will tend to rise.
Exercise: TR test for elasticity
Price
£5
£3
Total Revenue
D
100
140
Quantity Demanded
(000s)
Use the above diagram to answer the following questions.
1. Calculate TR when the price is £5.
2. Calculate TR when the price is £3.
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LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
3. What happens to TR when the price is lowered?
4. Is the good elastic or inelastic?
5. Should the business decrease the price? Why or why not?
Price (£)
Exercise: Calculate TR
10
5
D
5 6
Quantity Demanded
Use the above diagram to answer the following questions.
1. Calculate TR when the price is £10.
2. Calculate TR when the price is £5.
3. What happens to TR when the price is lowered?
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LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
4. Is the good elastic or inelastic?
5. Should the business decrease the price? Why or why not?
Exercise: Calculate TR
Price (£)
10
7
D
5
Quantity Demanded
Use the above diagram to answer the following questions.
1. Calculate TR when the price is £10.
2. Calculate TR when the price is £7.
3. What happens to TR after the price decrease?
4. Is the good elastic or inelastic?
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20
LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
5. Should the business decrease the price? Why or why not?
Exercise: What happens to total revenue?
Below is a demand schedule for bread.
PRICE PER LOAF OF BREAD
2.5 Dhs
2.0 Dhs
QUATITY
DEMANDED PER
MONTH
10,000
10,500
Total revenue
1. Calculate the total revenue for a loaf of bread by filling in the third column in the table
above.
2. When price decreased from 2.5 Dhs to 2.0 Dhs per loaf, what happened to Total
Revenue?
3. Would you advise bread producers to cut the price of bread? Why or why not?
4. Using the information above, we can conclude that if demand is INELASTIC, total
revenue will ________ (decrease/increase/stay the same) when price is decreased and
total revenue will __________________ (decrease/increase/stay the same) when price is
increased.
Page 13 of 31
LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
Fill in the following table to summarize the relationship between Total Revenue and
Elasticity
From the information you learned in exercises 1, 2, and 3, fill in the following table by deciding
if



TR increases
or
TR decreases
or
TR doesn’t change
when the good is Elastic, Inelastic or Unit Elastic and price increases or decreases. Elastic has
been completed for you.
Elastic
Inelastic
Unit Elastic
Price Increase
TR Decreases
Price Decrease
TR Increases
Can you make a general statement about TR and Price based on the above table:
1) If the good is ELASTIC, Price and total revenue move in ____________ (the same
direction, opposite directions or there is no change in TR).
2)
If the good is INELASTIC, Price and total revenue move in ____________ (the same
direction, opposite directions or there is no change in TR).
3) If the good is UNIT ELASTIC, Price and total revenue move in ____________ (the
same direction, opposite directions or there is no change in TR).
Page 14 of 31
LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
Summary of the Total Revenue Test
Total Revenue = Price X Quantity
The following table shows the relationship between Elasticity and Total Revenue
_____________________________________________________________
Price
Unitary
Price
Elastic
Elastic
Inelastic
Demand
Demand
Demand
Price
Increase

Price
Decrease

P X Q  = TR
 P X Q  TR
 P X Q = TR
(no change in TR)
P X Q = TR
 P X Q = TR
P X

Q = TR
( no change in TR)
P and TR move
No change in TR
P and TR move
In OPPOSITE
b/c
in SAME
Directions b/c
%P = %Qd
direction b/c
%P  %Qd
%P  %Qd
_____________________________________________________________
(Note: The size of the arrows indicates how large or small the change in price
compared to change in quantity demanded.)
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
LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
Exercise Calculating Total Revenue and determining inelastic, elastic or unit elasticity
Directions: For each problem, complete the math and circle the correct answer. Then write
whether the product has an elastic, inelastic or unit elastic demand between the two prices. The
first problem is completed for you:
1. Price rises from $5 to $6. Quantity demanded decreases from 15 to 10.
Old Price
$5
X
X
Quantity demanded = old total revenue
15
= $75
New Price
$6
X
X
Quantity demanded =
10
=
new total revenue
$60
Price increased and Total Revenue decreased therefore the good is elastic.
2. Price falls from $8 to $10. Quantity demanded decreases from 10 to 8.
Old Price
X
X
Quantity demanded = old total revenue
=
_______
New Price
X
X
Quantity demanded =
new total revenue
=
___________
Price ________ and Total Revenue ________ therefore the good is ______.
3. Price falls from $6.50 to $6.00. Quantity demanded decreases from 100 to 200.
Old Price
X
X
Quantity demanded = old total revenue
=
_______
New Price
X
X
Quantity demanded =
new total revenue
=
__________
Price ________ and Total Revenue ________ therefore the good is ______.
Page 16 of 31
LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
Elasticity and A Downward Sloping Linear Demand Curve
Let’s look at elasticity in the following table. Given the following table, determine over which
price range demand is elastic, inelastic or unit elastic.
Elasticity and a downward sloping demand curve
TABLE 3.2
ELASTICITY & A LINEAR DEMAND CURVE
ELASTICITY
PRICE QUANTITY TOTAL (PED coefficient)
USD DEMANDED REVENUE
(000)
USD
33
0
0
21.00
30
4
120
6.33
27
8
216
3.40
_(1)___________
24
12
288
2.14
21
16
336
1.44
18
20
360
1.00
(2)_____________
15
24
360
0.69
12
28
336
0.47
9
32
288
_(3)______________
0.29
6
36
216
0.16
Page 17 of 31
LSSS 231
Prepared by Linda Habibi
3
40
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
120
1. Over the price range $30 to $21, Price ___________ (decreased/increased) and Total
Revenue _______ (decreased/increased/stayed the same), hence over this price range
PED is_________ (elastic/inelastic/unit elastic). Also the PED coefficient is _______
(greater than/equal to/ less than) one.
2. Over the price range $18 to $15, price __________ (decreased/increased) and Total
Revenue ______________ (decreased/increased/stayed the same), hence over this price
range PED is ________ (elastic/inelastic/unit elastic). Also the PED coefficient is
_______ (greater than/equal to/ less than) one
3. Over the price range $12 to $6, Price _________ (decreased/increased)
And Total Revenue ________ (decreased/increased/stayed the same); hence over this
price range PED is ________________ elastic/inelastic/unit elastic). Also the PED
coefficient is _______ (greater than/equal to/ less than) one
4. Therefore we can conclude that the price elasticity of demand (PED) ____________
(increases/decreases/stays the same) as we move down a linear demand curve.
Page 18 of 31
LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
5. A Total Revenue diagram and a linear Demand curve diagram are drawn below and show
the changes in elasticity. Note the x-axis in both diagrams are labeled quantity and use
the same scale. In the top diagram, graph a demand curve. Lined up under the a total
revenue curve is the demand curve.
Study the diagrams and answer the following questions:
a. When TR is at maximum, PED _______ , and it is the _______ on the demand curve.
Page 19 of 31
LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
b. At prices above the mid-point of the demand curve, PED is ___ 1, and Demand is
_____________.
c. At prices below the mid-point of the demand curve, PED is ___ 1, and Demand is
_____________.
d. A downward sloping linear demand curve has elasticity that ______ (increases, stays the
same, decreases) as we move down along the demand curve.
Exercise: Applying Elasticity to Real World Situations
Instructions: Each of the following stories contains an assumption about elasticity of demand.
For each story:
i. State whether the assumption made about the elasticity of demand is
correct or is wrong.
ii. Justify your answer.
1. The Ministry of Health is proposing a large increase in the tax on cigarettes.
They say, “We are not proposing these taxes to raise revenue for the
government but to discourage the filthy habit of smoking. If the prices of
cigarettes go up, most people will quit using them. After all, no one needs to
smoke.”
iii. _____________________________________
iv. ______________________________________
_______________________________________________________________
2. The government in Jordan opposed a price increase for water during a recent
drought. The government claimed that there is no substitute for water, and
that the demand for water is perfectly inelastic so that an increase in the price
of water would result in exactly the same quantity of water being used as
before the price went up.
i. _____________________________________
ii. ______________________________________
_______________________________________________________________
3. Mr. Transit, a world traveler, says if the airlines want to attract more
passengers, they should lower fares for business travelers as well as for
economy class (vacationers). Both groups should respond equally to a price
decrease.
i. _____________________________________
ii. ______________________________________
Page 20 of 31
LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
Some other measures of elasticity of demand:
INCOME ELASTICITY OF DEMAND (YED)
We mentioned earlier that changes in people’s incomes would affect demand. By how much a
change in income causes the quantity demanded of a good or service to change is known as
income elasticity of demand.
Income Elasticity of Demand measures how responsive Quantity demanded is to a change in
Income.
Formula:
% change in Qd
% change in Y
= YED
NORMAL GOODS (POSITIVE YED)
-
Most goods and services are called normal goods because quantity demanded rises as
income rises and vice versa.
% change in Qd  = + YED
% change Y 
-
If YED is POSITIVE then the good is a NORMAL GOOD.
-
Examples of normal goods include most goods; i.e., cars, DVD players, etc.
INFERIOR GOODS (NEGATIVE YED)
-
In the case of a few goods, called inferior goods, quantity demanded falls as income
rises and vice versa.
Page 21 of 31
LSSS 231
Prepared by Linda Habibi
-
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
If YED is NEGATIVE then the good is an INFERIOR GOOD.
% change in Qd
% change Y 
-
 = - YED
Examples of inferior goods include public transport and second hand clothing.
Exercise: Income elasticity of demand (YED)
1. If people’s income increases what will happen to the demand for public
transport? ____. Since public transport is a(n) _____ good, YED will be ___.
2. If people’s income decreases what will happen to the demand for cinemas? ____.
Since cinemas are a _____ good, YED will be _______.
3. The income of a consumer rises from $100 to $120 while demand for the product
falls by 40%. The good has ________ (positive/negative) income elasticity and is
therefore a (n) ___________ (normal/inferior) good.
4. The income of consumers rises by 4% and the quantity demanded of Good Z
increases by 2%. Is this good an inferior or a normal good?
CROSS ELASTICITY OF DEMAND (XED)
Another important factor that affects the demand for one good is the prices of other related
goods. E.g. If the price of butter increases what do you think will happen to the quantity
demanded of margarine? _____________
Cross Elasticity of Demand measures how responsive Quantity demanded of one good is to
a Price change of another related good (substitute or complement).
Formula:
% change in Qd of good t
% change in P of good y
= XED
SUBSTITUTES (POSITIVE XED)
-
If the two goods are SUBSTITUTES, for example, butter and margarine, a rise in the
piece of one will cause a rise in the quantity demanded for the other.
Page 22 of 31
LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
% change in Qd of margarine 
= + XED
% change in P of butter
-
If producers of butter increase the Price of butter then Qd for margarine will increase.
-
A positive into a positive yields + XED (and vice versa).
-
Therefore XED for substitutes will be POSITIVE.
COMPLEMENTS (NEGATIVE XED)
If the price of petrol increases what do you think will happen to the quantity demanded of cars?
_____________
-
If the two goods are COMPLEMENTS, for example, cars and petrol, a rise in the price
of one will cause a fall in the price of its complement.
% change in Qd of cars
% change in P of petrol
-

=
- XED
If the price of petrol increases then the Qd for cars will decrease. A positive into a
negative yields - XED (and vice versa)
-
Therefore XED for complements will be NEGATIVE.
Exercise: Cross elasticity of demand (XED)
1. If the price of hot dogs increases what will happen to the quantity demanded of hot
dog buns? ______. Since these two goods are _______, XED will be _______.
2. If the price of good X increases 2%, the quantity demanded of good Y decreases by
1.5%. Are Good X and Good Y complements or substitutes?
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LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
3. If the price of Coke increases what will happen to the quantity demanded of Pepsi?
____. Since these two goods are _____, XED will be _______.
4. The cross elasticity of demand for a product is –5; therefore, the goods are
____________. A 1% increase in the price of one good will cause a _____ % _____
(increase/decrease/no change) in the quantity demanded of the other good.
PRICE ELASTICITY OF SUPPLY (PES)
Price elasticity of supply (PES) is a measure of how responsive QUANTITY SUPPLIED is
to a change in Price.
1) Inelastic PES:
 If the % change in quantity supplied is less than the % change in price, we say
that supply is inelastic.
 Quantity supplied is NOT very responsive to a change in price.
 PES < 1and the good is inelastic.
2) Elastic PES
 If the % change in quantity supplied is more than the % change in price, we say
that supply is elastic.
 Quantity supplied is very responsive to a change in price.
 PES > 1and the good is elastic.
Exercise: Draw two diagrams showing:
a) % change in quantity supplied is more than the % change in price? Label the diagram
elastic.
b) % change in quantity supplied is less than % change in price? Label the diagram
inelastic
a) ____________
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b) _____________
LSSS 231
Prepared by Linda Habibi
LO3: ELASTICIES
Teachers: Ms. Linda/Mr. Mahmoud
What factors affect Price Elasticity of Supply (PES)?
The most important factor that determines elasticity of supply is TIME.
The Momentary Run
How do you think a shop selling bicycles would respond if there is an increase in demand
for bicycles causing an increase in price; however, the shop must supply them
immediately? _________
We can use the example of bicycles to show how price elasticity of supply can vary over time.
Supply of most goods and services, including bikes, will be fixed at any one moment in time. For
example, a shop will only have a certain amount of bikes at any particular time. In this special
case, the supply curve is a vertical line showing that whatever the price the quantity supplied will
be the same.
In the Momentary run, Supply tends to be perfectly inelastic because suppliers have NO time
to adjust to changes in price. A 1% change in price will cause a 0% change in quantity supplied.
Draw a perfectly inelastic supply curve below.
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Teachers: Ms. Linda/Mr. Mahmoud
The Short Run
How do you think a shop selling bikes would respond if there is an increase in demand for
bikes causing an increase in price, and the shop has a short time to supply them – for
example a couple of weeks? _________
In the short run, firms can produce more goods for sale, but only by using more labor, that is, by
either working overtime or employing more workers. More bikes can be produced in existing
factories and sent to the market. However supply can only rise a little because the amount of
factories needed to make bikes are fixed in the short run.
In the Short run, Supply tends to be inelastic because it will be difficult for suppliers to react
swiftly to changes in price.
Draw a diagram showing inelastic supply below.
The Long Run
How do you think a shop selling bikes would respond if there is an increase in demand for
bikes causing an increase in price, and the shop has a long time to supply them – say even
as long as a year? _________
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Teachers: Ms. Linda/Mr. Mahmoud
In the long run, firms can hire more labor, land and capital and they can even build new factories
to increase production, so in the long run, supply becomes more elastic.
In the Long run, Supply tends to be elastic because suppliers have a lot of time to adjust to
changes in price.
Elastic supply shows that quantity supplied is very responsive to a change in price. Draw an
elastic supply curve below.
The following table summarizes PES according to time periods.
Time Period
PES
PES coefficient
Long run
Elastic
PES > 1
Short Run
Inelastic
PES < 1
Momentary Run
Perfectly Inelastic
PES = 0
Importance of Elasticity

Relationship between changes in price and total revenue: It is important for
businesses to have some idea of what the PED is for the goods it sells because if the price
is decreased, more will probably be sold, but the firm will NOT necessarily increase its
total revenue. If TR will increase or decrease with a change in price depends on the
good’s elasticity.

Importance in determining what goods to tax (tax revenue)

Importance in analyzing time lags in production

Influences the behavior of firms
Elasticities
We have looked at 4 basic types of elasticity:
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Price elasticity of demand
Price elasticity of supply
Income elasticity of demand
Cross elasticity
Exercises: Elasticities
1. The demand schedule below relates to the price of candy bars.
PRICE
PER
CANDY
BAR
(Dhs)
20
15
10
5
1
Original
Quantity
demanded
per month
(000s)
10
25
40
55
70
Total
Revenue
a. Calculate total revenue and fill in the column for total revenue.
b. Look at your table. As Price decreased from20 dhs to 15 dhs , total revenue
______ therefore the good is ________.
c. Calculate the price elasticity of demand for candy bars when the price rises from 5
Dhs to 10 Dhs. Comment on its value (elastic or inelastic).
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Teachers: Ms. Linda/Mr. Mahmoud
2. The cross elasticity of demand between Good A and Good B is + 2. What types of
goods are they? __________ (What is the relationship between the two goods?)
3. The cross elasticity of demand between Good X and Good Y is – 1.5. What types of
goods are they? __________ (What is the relationship between the two goods?)
4. A 10% rise in income has caused the demand for candy bars to rise. Are candy bars a
normal or inferior good? ___________ How do you know? ________
Exercise: Applying your Knowledge and Understanding
Read the following article and apply the concepts you have learned.
Article: Elasticity Over Time
Reference:http://images.google.com/imgres?imgurl=http://spot.colorado.edu/~kaplan/econ2010/section4/gifs/fig42.gif&imgrefurl=http://spot.col
orado.edu/~kaplan/econ2010/section4/section4main.html&usg=__7amfJ3RCBbMYXY4qlCNihPP1NwM=&h=280&w=280&sz=7&hl=en&start=49&um=1&tbnid=60uyofVT_UNQM:&tbnh=114&tbnw=114&prev=/images%3Fq%3Dtotal%2Brevenue%2Band%2Binelastic%2Bdemand%26ndsp%3D18%26hl%3Den%26rls%
3Dgm%26sourceid%3Dgmail%26sa%3DN%26start%3D36%26um%3D1
“OPEC was established during the 1950s by oil producing nations located throughout the world.
Until the 1970s, oil prices remained fairly steady at around $3 to $4 a barrel. As a result of the oil
embargo (restriction of oil) of 1973 and 1979, oil prices increased to over $35 a barrel, and were
soon expected to increase above $60 a barrel. Instead, by the mid-1980s, prices per barrel had
fallen to well below $20. It was during the 1970s when the combination of an inelastic good (oil
or gasoline) along with soaring prices had the most dramatic economic effects.
Gasoline is typical of a good that is inelastic in the short-run. When an automobile and energy
dependent country such as the United States was hit by soaring gasoline prices during the 1970s,
consumers had little choice in the short-run but to pay higher prices for gas, they needed to run
their mostly gas-guzzling cars.
The OPEC nations were not the only countries to benefit from very high and rising oil prices.
U.S. oil producers in Texas, Louisiana, Alaska and other states as well as gasoline and petroleum
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distributors also enjoyed soaring profits. In fact, due to rising gas prices, major U.S. gasoline
retail firms were required to pay a windfall profits tax.
However, over time the price elasticity of demand for gasoline increased (became less inelastic)
and consumption (quantity demanded) for oil became more responsive to increases in prices.
Substitutes developed such as more fuel-efficient cars and improved public transportation.
Along with reducing gasoline consumption, conservation and alternative fuels and sources of
petroleum helped to decrease the dependency on OPEC’s oil. Natural gas, coal, solar and other
alternative fuels were increasingly substituted for oil by consumers, industry and electric utilities.
The Iran-Iraq war lead to widespread cheating by OPEC members who went over their
predetermined quotas. Eventually, gasoline prices fell as oil production increased during the
1980s. Although the major gasoline companies were not enthusiastic about lowering the prices of
an inelastic good such as gasoline, an increase in market supplies of oil led to this outcome in the
United States.
The conclusion we can draw from the 1970s, characterized by quickly rising oil prices, is that
over time, elasticity increases (PED becomes less inelastic). Even for goods that are very price
inelastic such as gasoline, substitutes and alternatives in consumption develop when prices
increase.
There may be little opportunity for consumer response in the short-run, but in the long- run he or
she will often find it easier to reduce consumption of a good when its price increases by a large
amount.
As OPEC has learned, while rapidly rising prices of oil can lead to very high short-term profits,
such behavior can result in a long-run problems. For this reason, OPEC, looking at the long run
effects, have a market incentive not to increase the price of oil unreasonably high, because if
prices are too high consumers will start looking for alternative sources of oil in the long run.
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The text above is typical of the sort of article available in newspapers and magazines such as
'The Economist', 'Newsweek' and so on. You will gain a great deal from reading all manner of
relevant articles in your studies - but the secret is to read it like an economist!!
Exercise: When reading the text
1. Look up any new vocabulary words.
2. Some of the concepts you should apply include:
a. Supply and Demand
b. Elasticity
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