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Ch. 4: Elasticity.
• Define, calculate, and explain the factors
that influence




the price elasticity of demand
the cross elasticity of demand
the income elasticity of demand
the elasticity of supply
Price Elasticity of Demand
• The slope of the demand curve affects
how much equilibrium price and quantity
change for a given change in supply.
• If supply increases,
– the decrease in price is greater if demand is
steeper
– The increase in quantity is smaller if demand
is steeper
Price Elasticity of Demand
• Price elasticity of demand
– units-free measure of the responsiveness
of the quantity demanded of a good to a
change in its price, ceteris paribus.
% quantity demanded
e
% price
Price Elasticity of Demand
%Q = Q/Qavg
= 2/10
= .2
%P = P/Pavg
= -$1/$20
= -.05
e = .2/.05 =4
Price Elasticity of Demand
 By using the average price and average
quantity, we get the same elasticity value
regardless of whether the price rises or falls.
 Measuring as % changes leaves the elasticity
value the same (“units free”).
 Although the formula yields a negative value
for elasticity because price and quantity move
in opposite directions, we report the absolute
value.
Suppose that quantity demanded rises from 100
to 120 when the price drops from $10 to $9.
What is the elasticity of demand (round to the
nearest tenth (e.g. 4.2).
0%
30
Price Elasticity of Demand
• Inelastic and Elastic Demand
• if e>1: elastic
• if e=1: unit elastic
• if e<1: inelastic
• Shape of
• Perfectly inelastic demand curve (e=0)
• Perfectly elastic demand curve (e= infinite)
Price Elasticity of Demand
At prices above the
mid-point of the
demand curve,
demand is elastic.
At prices below the
mid-point of the
demand curve,
demand is inelastic.
Price Elasticity of Demand
• Total Revenue and Elasticity
TR=P*QD
When P changes, TR could rise or fall
because QD moves in opposite direction.
But a higher price doesn’t always increase
total revenue.
Price Elasticity of Demand
% TR = %  P + %  Q
= %  P - %  P(e)
= %  P(1-e)
If demand is elastic (e>1),
P increase  TR decreases
P decrease  TR increases
If demand is inelastic (e<1),
P increase  TR increases
P decrease  TR decreases
If demand is unitary elastic,
P increase or decrease  TR unchanged.
Price Elasticity of Demand
• As P falls from $25 to
$12.50, D is elastic,
and TR rises.
• At $12.50, D is unit
elastic and TR stops
increasing.
• As P falls from $12.50
to 0, D is inelastic, and
TR decreases.
Price Elasticity of Demand
Suppose that when the price of football tickets rises
from $20 to $30, the number of football tickets sold
drops from 50,000 to 45,000. Based on this, we can
conclude that demand is _____ because total
revenue _____ when the price rises.
25%
In
el
as
tic
;
fa
l
r is
...
tic
;
In
el
as
fa
l
st
ic ;
Ela
25%
...
25%
ls.
..
r is
es
. ..
st
ic ;
0%
Elastic; rises.
Elastic; falls.
Inelastic; rises.
Inelastic; falls.
Ela
a)
b)
c)
d)
25%
30
If demand is elastic and a firm cuts its price,
total revenue will rise.
se
50%
Fa
l
0%
50%
Tr
ue
a) True
b) False
30
If the price elasticity of demand for gasoline is 0.1,
a 10% increase in the price of gasoline will cause
the amount of gasoline sold to fall by _____ an d
the total revenue from gasoline sales to _____.
25% 25% 25% 25%
l1
0%
;f
al
10
%
ch
an
10
%
;n
ot
fa
l
1%
1%
;r
is e
0%
g.
..
l9
%
1%; rise 9%
1% fall 9%
10%; not change
10%; fall 10%
9%
a)
b)
c)
d)
30
Based on the diagram below, if the price of gasoline
rises from $5 to $6, total revenue would ____ because
demand is _____.
$10
D for gasoline
el
in
st
i..
30
in
el
a
l;
Fa
l
as
t ic
.
el
l;
25%
.
25%
se
;
Ri
se
;
el
as
t ic
0%
Ri
Rise; elastic.
Fall; elastic.
Rise; inelastic.
Fall; inelastic.
25%
as
ti.
..
25%
.
a)
b)
c)
d)
Q in millions of gallons per day
Fa
l
50
Price Elasticity of Demand
• The elasticity of demand for a good
depends on:
 The number & closeness of substitutes
 The proportion of income spent on the good
 The time elapsed since a price change
XM and Sirius are both satellite radio
providers. If Sirius goes out of business, the
demand for XM radio will become more
inelastic.
50%
50%
se
Fa
l
0%
Tr
ue
a) True
b) False
30
The average income of smokers is lower in
Mexico than in the U.S. This should cause
the demand for cigarattes to be more
inelastic in the U.S. than in Mexico.
se
50%
Fa
l
0%
50%
Tr
ue
a) True
b) False
30
More Elasticities of Demand
• Cross Elasticity of Demand
– measures responsiveness of demand for a
good to a change in the price of another
good.
exy= % quantity demanded for x
% change in price of y
 exy > 0  substitutes
 exy <0  complements
More Elasticities of Demand
• Income Elasticity of Demand
– measures how the quantity demanded of a
good responds to a change in income, ceteris
paribus.
eI =
% in quantity demanded
%  in income
 eI >0  normal good
 eI >1 luxury good
 eI <0 inferior good
Oranges and apples are likely to have
...
el
cr
o
om
in
c
ga
t
ne
A
e
ive
ec
iv
po
sit
A
0%
33%
as
. ..
33%
ro
.. .
33%
An
a) A positive cross
elasticity of demand
b) A negative cross
elasticity of demand
c) An income elasticity
of demand greater
than one.
30
Which of the following is most likely to have
a negative income elasticity of demand?
a) Plasma TVs
b) Second hand
clothing.
c) Housing
d) Medication for
high blood
pressure.
fo
r. .
.
g
M
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ic a
tio
n
Ho
us
in
nd
ha
on
d
Se
c
0%
Pl
a
sm
a
cl.
.
.
TV
s
25% 25% 25% 25%
30
Price Elasticity of Supply
A change in demand causes
• A larger change in equilibrium price if supply
is supply is steeper,
• A smaller change in equilibrium quantity if
supply is steeper.
Elasticity of Supply
Elasticity of supply
– measures the responsiveness of the quantity
supplied to a change in the price of a good when all
other influences on selling plans remain the same.
% quantity supplied
es 
% price
Elasticity of Supply
Elasticity of Supply
• Factors That Influence the Elasticity of
Supply
– Elasticity of supply for inputs
– Substitution possibilities for inputs
– The time frame for supply decisions
– Storage costs
Suppose that the City of Oxford imposes a
ban on any new construction of rental
housing. This would cause the supply of
housing to be more elastic.
se
.
50%
Fa
l
0%
50%
Tr
ue
a) True
b) False.
30
Suppose that the City of Oxford imposes a
ban on any new construction of rental
housing. This would cause rental prices to
rise more for any given increase in the
demand for housing.
se
.
50%
Fa
l
0%
Tr
ue
a) True
b) False.
50%
30
Suppose that a new technology reduces the
cost of storing tomatoes. This should cause
the price of tomatoes to fluctuate ____ in
response to changes in the demand for
tomatoes because tomato supply will
25% 25% 25% 25%
become more ____.
st
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.
ne
la
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ss
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s;
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or
e
M
Le
s
las
ti.
..
st
ic
;e
la
or
e
M
0%
tic
.
More; elastic.
More; inelastic.
Less; elastic.
Less; inelastic.
.
a)
b)
c)
d)
30