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PART I INTRODUCTION TO ECONOMICS
Elasticity
5
PART I INTRODUCTION TO ECONOMICS
5
Elasticity
CHAPTER OUTLINE
Price Elasticity of Demand
Slope and Elasticity
Types of Elasticity
Calculating Elasticities
Calculating Percentage Changes
Elasticity Is a Ratio of Percentages
The Midpoint Formula
Elasticity Changes Along a Straight-Line
Demand Curve
Elasticity and Total Revenue
The Determinants of Demand Elasticity
Availability of Substitutes
The Importance of Being Unimportant
The Time Dimension
Other Important Elasticities
Income Elasticity of Demand
Cross-Price Elasticity of Demand
Elasticity of Supply
Looking Ahead
Appendix: Point Elasticity
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Elasticity
elasticity A general concept used to quantify the
response in one variable when another variable
changes.
elasticity of A with respect to B 
%A
%B
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Price Elasticity of Demand
Slope and Elasticity
 FIGURE 5.1 Slope Is Not a Useful Measure of Responsiveness
Changing the unit of measure from pounds to ounces changes the numerical value of the
demand slope dramatically, but the behavior of buyers in the two diagrams is identical.
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Price Elasticity of Demand
Slope and Elasticity
price elasticity of demand The ratio of the
percentage of change in quantity demanded to
the percentage of change in price; measures
the responsiveness of quantity demanded to
changes in price.
price elasticity of demand 
% change in quantity demanded
% change in price
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Price Elasticity of Demand
Types of Elasticity
TABLE 5.1 Hypothetical Demand Elasticities for Four Products
% Change In
Price
(% P)
% Change
In Quantity
Demanded
(% QD)
Insulin
+10%
0%
.0
Perfectly inelastic
Basic telephone service
+10%
-1%
-.1
Inelastic
Beef
+10%
-10%
-1.0
Unitarily elastic
Bananas
+10%
-30%
-3.0
Elastic
Product
Elasticity
(% QD ÷ %P)
perfectly inelastic demand Demand in which
quantity demanded does not respond at all to a
change in price.
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Price Elasticity of Demand
Types of Elasticity
 FIGURE 5.2 Perfectly Inelastic and Perfectly Elastic Demand Curves
Figure 5.2(a) shows a perfectly inelastic demand curve for insulin. Price elasticity of demand
is zero. Quantity demanded is fixed; it does not change at all when price changes.
Figure 5.2(b) shows a perfectly elastic demand curve facing a wheat farmer. A tiny price
increase drives the quantity demanded to zero. In essence, perfectly elastic demand implies
that individual producers can sell all they want at the going market price but cannot charge a
higher price.
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Price Elasticity of Demand
Types of Elasticity
inelastic demand Demand that responds
somewhat, but not a great deal, to changes in
price. Inelastic demand always has a numerical
value between zero and -1.
A warning: You must be very careful about signs.
Because it is generally understood that demand
elasticities are negative (demand curves have a
negative slope), they are often reported and
discussed without the negative sign.
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Price Elasticity of Demand
Types of Elasticity
unitary elasticity A demand relationship in which
the percentage change in quantity of a product
demanded is the same as the percentage change in
price in absolute value (a demand elasticity of -1).
elastic demand A demand relationship in which the
percentage change in quantity demanded is larger
than the percentage change in price in absolute
value (a demand elasticity with an absolute value
greater than 1).
perfectly elastic demand Demand in which
quantity drops to zero at the slightest increase in
price.
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Price Elasticity of Demand
Types of Elasticity
A good way to remember the difference between
the two “perfect” elasticities is:
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Calculating Elasticities
Calculating Percentage Changes
To calculate percentage change in quantity
demanded using the initial value as the base, the
following formula is used:
% change in quantity demanded 
change in quantity demanded
x 100%
Q
1

Q -Q
x 100%
Q
2
1
1
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Calculating Elasticities
Calculating Percentage Changes
We can calculate the percentage change in price
in a similar way. Once again, let us use the initial
value of P—that is, P1—as the base for calculating
the percentage. By using P1 as the base, the
formula for calculating the percentage of change in
P is
change in price
% change in price 
x 100%
P
1
P -P

x 100%
P
2
1
1
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Calculating Elasticities
Elasticity Is a Ratio of Percentages
Once all the changes in quantity demanded and
price have been converted to percentages,
calculating elasticity is a matter of simple division.
Recall the formal definition of elasticity:
price elasticity of demand 
% change in quantity demanded
% change in price
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Calculating Elasticities
The Midpoint Formula
midpoint formula A more precise way of
calculating percentages using the value halfway
between P1 and P2 for the base in calculating the
percentage change in price, and the value halfway
between Q1 and Q2 as the base for calculating the
percentage change in quantity demanded.
% change in quantity demanded 
change in quantity demanded
x 100%
(Q  Q ) / 2
1

2
Q -Q
x 100%
(Q  Q ) / 2
2
1
1
2
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Calculating Elasticities
The Midpoint Formula
Using the point halfway between P1 and P2 as the
base for calculating the percentage change in
price, we get
% change in price 
change in price
x 100%
(P  P ) / 2
1

2
P -P
x 100%
(P  P ) / 2
2
1
1
2
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Calculating Elasticities
The Midpoint Formula
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Calculating Elasticities
Elasticity Changes Along a Straight-Line Demand Curve
TABLE 5.3 Demand Schedule
for Office Dining
Room Lunches
Price
(per
Lunch)
Quantity
Demanded
(Lunches per Month)
$11
10
9
8
7
6
5
4
3
2
1
0
0
2
4
6
8
10
12
14
16
18
20
22
 FIGURE 5.3 Demand Curve for
Lunch at the Office Dining Room
Between points A and B, demand is quite elastic at -6.4.
Between points C and D, demand is quite inelastic at -.294.
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Calculating Elasticities
Elasticity and Total Revenue
In any market, P x Q is total revenue (TR) received
by producers:
TR = P x Q
total revenue = price x quantity
When price (P) declines, quantity demanded (QD)
increases. The two factors, P and QD move in
opposite directions:
Effects of price changes
on quantity demanded:
P  QD 
and
P  QD 
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Calculating Elasticities
Elasticity and Total Revenue
Because total revenue is the product of P and Q,
whether TR rises or falls in response to a price
increase depends on which is bigger: the
percentage increase in price or the percentage
decrease in quantity demanded.
Effects of price increase on
a product with inelastic demand:
 P x QD   TR 
If the percentage decline in quantity demanded
following a price increase is larger than the
percentage increase in price, total revenue will fall.
Effects of price increase on
a product with inelastic demand:
 P x QD   TR 
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Calculating Elasticities
Elasticity and Total Revenue
The opposite is true for a price cut. When demand
is elastic, a cut in price increases total revenues:
effect of price cut on a product
with elastic demand:
 P x QD   TR 
When demand is inelastic, a cut in price reduces
total revenues:
effect of price cut on a product
with inelastic demand:
 P x QD   TR 
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The Determinants of Demand Elasticity
Availability of Substitutes
Perhaps the most obvious factor affecting demand
elasticity is the availability of substitutes.
The Importance of Being Unimportant
When an item represents a relatively small part of
our total budget, we tend to pay little attention to
its price.
The Time Dimension
The elasticity of demand in the short run may be
very different from the elasticity of demand in the
long run. In the longer run, demand is likely to
become more elastic, or responsive, simply
because households make adjustments over time
and producers develop substitute goods.
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The Determinants of Demand Elasticity
Who Are the Elastic
Smokers?
Bill aims to raise tax on
cigarettes
Seattle Times
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The Determinants of Demand Elasticity
Elasticities at a
Delicatessen in the Short
Run and Long Run
The graph shows the expected
relationship between long-run
and short-run demand for
Frank’s sandwiches. Notice if
you raise prices above the
current level, the expected
quantity change read off the
short-run curve is less than that
from the long-run curve.
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Other Important Elasticities
Income Elasticity of Demand
income elasticity of demand A measure of the
responsiveness of demand to changes in income.
income elasticity of demand 
% change in quantity demanded
% change in income
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Other Important Elasticities
Cross-Price Elasticity Of Demand
cross-price elasticity of demand A measure of
the response of the quantity of one good
demanded to a change in the price of another
good.
% change in quantity of Y demanded
cross - price elasticity of demand 
% change in price of X
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Other Important Elasticities
Elasticity Of Supply
elasticity of supply A measure of the response
of quantity of a good supplied to a change in price
of that good. Likely to be positive in output
markets.
% change in quantity supplied
elasticity of supply 
% change in price
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Other Important Elasticities
Elasticity Of Supply
elasticity of labor supply A measure of the
response of labor supplied to a change in the price
of labor.
elasticity of labor supply 
% change in quantity of labor supplied
% change in the wage rate
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REVIEW TERMS AND CONCEPTS
cross-price elasticity of demand
inelastic demand
elastic demand
midpoint formula
elasticity
perfectly elastic demand
elasticity of labor supply
perfectly inelastic demand
elasticity of supply
price elasticity of demand
income elasticity of demand
unitary elasticity
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APPENDIX
POINT ELASTICITY (OPTIONAL)
 FIGURE 5A.1 Elasticity at a Point
Along a Demand Curve
Consider the straight-line
demand curve in Figure 5A.1.
We can write an expression for
elasticity at point C as follows:
Q
 100
%Q
Q
elasticity 


%P P  100
P
Q
Q1 Q P1


P
P Q1
P1
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APPENDIX
POINT ELASTICITY (OPTIONAL)
∆Q/∆P is the reciprocal of the slope of the curve.
Slope in the diagram is constant along the curve,
and it is negative. To calculate the reciprocal of
the slope to plug into the previous electricity
equation, we take Q1B, or M1, and divide by minus
the length of line segment CQ1. Thus,
Q M 1

P CQ1
Since the length of CQ1 is equal to P1, we can
write:
Q M 1

P P1
By substituting we get:
elasticity 
M 1 P1 M 1 P1
M
 

 1
P1 Q1 P1 M 2 M 2
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APPENDIX
POINT ELASTICITY (OPTIONAL)
 FIGURE 5A.2 Point
Elasticity Changes Along
a Demand Curve
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