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Micro Chapter 7
Consumer Choice and Elasticity
This chapter is an extension of the
first part of Chapter 3 on demand
and consumer theory
Refer back to your Chapter 3 notes and
mentally combine them with Chapter 7
notes
6 Learning Goals
1) List the key factors influencing consumer
behavior (repeat from Chapter 3 and on your
own)
2) Apply the concept of marginal utility to determine
how a demand curve is derived (repeat from
Chapter 3 and on your own)
3) Define, calculate, and graph elasticity of demand
4) Relate demand elasticity to total revenue
5) Define and calculate income elasticity
6) Define and graph elasticity of supply
Elasticity of Demand
Law of demand states that if price
rises (falls), quantity demanded
falls (rises)
Elasticity gives us more information about
the consumer
Price elasticity seeks to quantify how
much quantity demanded falls (rises)
Other questions to consider:
By how much does price need to rise to
decrease quantity demanded by X%?
By how much does price need to fall to
increase quantity demanded by Y%?
Price elasticity of demand= percentage
change in quantity demanded /
percentage change in price
Elasticity =
Values of price elasticity
If ε > 1, then elastic
Consumers change their behavior a lot
If ε < 1, then inelastic
Consumers change their behavior a little
If ε = 1, then unitary elastic
Consumers don’t change their behavior
Key point:
Price elasticity is NOT the slope of the
demand curve
– A straight-line demand curve will have
constant slope but a different elasticity at
every point
What determines elasticity?
(1) Availability of substitutes
– More substitutes, more elastic (more
responsive)
(2) Share of budget
– Greater share, more elastic
(3) Time
– More time, more elastic
How Demand Elasticity and
Price Changes Affect Total
Expenditures (or Revenues)
on a Product
Price elasticity
of demand
Elasticity
coefficient
(in absolute value)
Elastic
1 to 
Unitary Elastic
1
Inelastic
0 to 1
Impact of higher price
on total consumer
expenditures or a
firm’s total revenue
decrease
-- unchanged-increase
Impact of lower price
on total consumer
expenditures or a
firm’s total revenue
increase
-- unchanged-decrease
Don’t memorize this chart!
Use it as a tool
Think about what elasticity tells us and
then apply it to total revenue
Total Revenue (TR) to the firm is Total
Expenditure (TE) by the consumer.
TR = TE = P x Q
If elastic and price falls: ↓ P x
↑Q = ↑TR
– Lower price and lots more is bought, Q dominates equation
↓Q = ↓TR
If elastic and price rises: ↑ P x
– Raise price and lots less is bought, Q dominates equation
↓P x
If inelastic and price falls:
↑Q
= ↓TR
– Lower price and a little more is bought, P dominates equation
If inelastic and price rises:
↑Px
↓Q
= ↑TR
– Raise price and a little less is bought, P dominates equation
A different way to look at this:
4 graphs
Income Elasticity
Price elasticity measures the change in
consumer purchases when price changes
Income elasticity measures the change in
consumer purchases when income
changes
Income elasticity =
Values of income elasticity
If positive, consumers buy more when
income rises
Normal good - a good that consumers will
buy more of when income rises
If negative, consumers buy less when
income rises
Inferior good - a good that consumers will
buy less of when income rises
Price Elasticity of Supply
Price elasticity of supply measures the
responsiveness of quantity supplied to
price changes
How much does quantity supplied
increase (or decrease) when price rises
(or falls)?
Graphs: