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ELASTICITIES OF DEMAND AND
SUPPLY
ECO 2023
Principles of Microeconomics
Dr. McCaleb
Elasticities of Demand and Supply
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TOPIC OUTLINE
I.
Price Elasticity of Demand
II. Application: Elasticity and the Demand for
Smoking
III. Price Elasticity of Supply
IV. Cross Price Elasticity and Income Elasticity
Elasticities of Demand and Supply
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Price Elasticity of Demand
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
 What Is the Price Elasticity of Demand?
The price elasticity of demand is the ratio of the percentage change in
the quantity demanded to the percentage change in price.
Price elasticity of
=
demand
Percent change in quantity demanded
Percent change in price
 What Is the Price Elasticity of Demand Used
For?
It measures the size of the change in quantity demanded when the
price of a good changes.
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
 How Is the Price Elasticity of Demand
Calculated?
Mid-point method
Calculate the change in quantity demanded as a percent of the
average of the two quantities and multiply by 100 to convert to
percent
Percent change
in quantity =
New quantity ΠInitial quantity
(New quantity + Initial quantity)Φ 2
Elasticities of Demand and Supply
x 100
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PRICE ELASTICITY OF DEMAND
 How Is the Price Elasticity of Demand
Calculated?
Calculate the change in price as a percent of the average of the two
prices and multiply by 100 to convert to percent
New price ΠInitial price
Percent change in price
=
x 100
(New Price + Initial Price) Φ 2
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
 Why Do Economists Use Elasticity to Measure
the Size of the Change?
Because elasticity is a ratio of two percentages, the percentages
“cancel out” so that elasticity is a pure number, a number with no
units of measurement attached to it.
That allows us to compare the demands for different goods even
though they are measured in different units or to compare goods at
different points in time or even to compare goods in different
countries that use different currencies.
Elasticities of Demand and Supply
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The quantity demanded of lattes at a Starbucks
decreases from 15 cups per hour to 5 cups per hour
when the price increases from $3.00 to $5.00. Using
the mid-point method, what is the percent change in
quantity demanded? (Hint: Make sure the answer is
in percent. Include the negative sign if it is negative,
but do not include the percent sign.)
Elasticities of Demand and Supply
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The quantity demanded of lattes at a Starbucks
decreases from 15 cups per hour to 5 cups per hour
when the price increases from $3.00 to $5.00. Using
the mid-point method, what is the percent change in
price? (Hint: Make sure the answer is in percent.
Include the negative sign if it is negative, but do not
include the percent sign.)
Elasticities of Demand and Supply
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The quantity demanded of lattes at a Starbucks
decreases from 15 cups per hour to 5 cups per hour
when the price increases from $3.00 to $5.00. What
is the elasticity of demand? (Hint: No decimal
numbers. If the answer is negative, include the
negative sign.)
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
 What Does the Elasticity Number or Coefficient
Mean?
The absolute value of the elasticity coefficient shows whether the
quantity change is bigger than the price change, the same size as the
price change, or smaller than the price change.
The bigger the absolute value, the more sensitive or responsive
consumers are to a price change.
The smaller the absolute value, the less sensitive or responsive they
are to a price change.
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
 What Does an Elasticity Coefficient Greater
than 1 in Absolute Value Mean?
Demand is elastic.
The percent change in quantity demanded is greater than the
percent change in price
Consumers are relatively sensitive or responsive to price changes.
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
 What Does an Elasticity Coefficient Smaller
than 1 in Absolute Value Mean?
Demand is inelastic.
The percent change in quantity demanded is smaller than the
percent change in price
Consumers are relatively insensitive or not very responsive to price
changes.
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
 What Does an Elasticity Coefficient Equal to 1
in Absolute Value Mean?
Demand is unit elastic.
The percent change in quantity demanded equals the percent
change in price
Consumers are neither very sensitive or responsive to price
changes nor are they very insensitive or unresponsive.
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
 What Does It Mean When the Elasticity
Coefficient Is Equal to 0?
Demand is perfectly inelastic.
The percentage change in quantity demanded is zero when the
price changes.
Consumers are completely insensitive or unresponsive to the price
change. They want the same quantity no matter what the price is.
A perfectly inelastic demand curve is vertical.
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
Special Case: Perfectly
Inelastic Demand
When the price rises, . . .
the quantity demanded does not
change.
There is no change in the quantity
demanded when price changes.
Therefore, demand is perfectly
inelastic.
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
 What Does It Mean If the Elasticity Coefficient
Is Infinite?
Demand is perfectly elastic.
Even an infinitesimally small percentage price change will cause a
very (“infinitely”) large percentage change in quantity demanded.
The numerator (the percent change in quantity demanded) is so
large and the denominator (the percent change in price) is so small
that the coefficient of elasticity approaches infinity in the limit.
The demand curve is horizontal are almost so.
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
Special Case: Perfectly
Elastic Demand
For even a very small change in the
price of spring water, . . .
the quantity demanded of spring
water changes by a very large
amount.
The change in the quantity
demanded is much (infinitely)
larger than the change in price.
Therefore, the demand for spring
water is perfectly elastic.
Elasticities of Demand and Supply
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If the price elasticity of demand for furniture is 1.26, the
demand for furniture is
1.
Perfectly elastic
2.
Elastic but not perfectly elastic
3.
Unit elastic
4.
Inelastic but not perfectly inelastic
5.
Perfectly inelastic
Elasticities of Demand and Supply
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If the price elasticity of demand for furniture is 1.26, the
percent change in quantity demanded is _____ the percent
change in price and buyers are _____ sensitive to price
changes.
1.
Greater than; very
2. Greater than; not very
3.
Less than; very
4. Less than; not very
Elasticities of Demand and Supply
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If the price elasticity of demand for tobacco is 0.61, the
demand for tobacco is
1.
Perfectly elastic
2.
Elastic but not perfectly elastic
3.
Unit elastic
4.
Inelastic but not perfectly inelastic
5.
Perfectly inelastic
Elasticities of Demand and Supply
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If the price elasticity of demand for tobacco is 0.61, the
percent change in quantity demanded is _____ the percent
change in price and buyers are _____ sensitive to price
changes.
1.
Greater than; very
2.
Greater than; not very
3.
Less than; very
4.
Less than; not very
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
 What Causes the Demand for Some Goods To
Be More Elastic or More Inelastic than Others?
• Substitution effects
• Income effects
• Time
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
Substitution effects
If it is easy to find a substitute for a good, then, ceteris paribus, the
demand for the good tends to be more elastic or less inelastic.
More or better substitutes  Higher elasticity
If it is harder to find a substitute for a good, then, ceteris paribus, the
demand for the good tends to be more inelastic or less elastic.
Few or poorer substitutes  Lower elasticity
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
Substitution effects: Examples
• Ceteris paribus, the demand for Toyota Camrys is likely to be more
elastic (or less inelastic) than the demand for automobiles which in
turn is more elastic (or less inelastic) than the demand for motor
vehicles.
• The demand for a college textbook is likely to be more inelastic (or
less elastic), ceteris paribus, than the demand for a popular novel.
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
Income Effects
If consumers spend a relatively larger percent of their income on a
good, then, ceteris paribus, the demand for the good tends to be more
elastic or less inelastic.
Larger share of income  Higher elasticity
If consumers spend a relatively smaller percent of their income on a
good, then, ceteris paribus, the demand for the good tends to be less
elastic or more inelastic.
Smaller share of income  Lower elasticity
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
Income Effects: Examples
• Purchases of automobiles require a larger proportion of income than
purchases of gasoline so, ceteris paribus, the demand for
automobiles is likely to be more elastic (or less inelastic) than the
demand for gasoline.
• Households spend more of their income on steak than on the salt to
put on the steak. Ceteris paribus, the demand salt is likely to be more
inelastic (or less elastic) than the demand for steak.
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
Time
The longer the time period over which elasticity is measured, the
larger, ceteris paribus, it is likely to be because consumers have more
time to find good substitutes and adjust their consumption.
Longer time  Higher elasticity
Shorter time  Lower elasticity
Example: The elasticity of demand for gasoline is very low one day or
one week after a change in the price, but the elasticity is higher
(although still inelastic) one year after the price change. In fact, the
demand for gasoline becomes elastic after several years have passed.
Elasticities of Demand and Supply
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Universal to cut price of CD's to raise sales
Amy Harmon New York Times
Friday, September 5, 2003
Universal Music Group's plan to cut prices on compact discs
by as much as 30 percent represents a big gamble in its
aggressive bid to lure consumers back into record stores.
The deep price cut, announced on Wednesday, is the only one
to apply to new CD's since the format was introduced in the
early 1980's.
Universal, owned by Vivendi Universal, is betting that
consumers will buy more CD's once the price dips below $13.
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
 Total Revenue and Price Elasticity of Demand
Relationship between price elasticity of demand and
total revenue
There is a unique relationship between the price elasticity of demand,
a change in the price of the good, and sellers’ total revenue from (or
buyers’ total expenditure on) the good.
This relationship is valid for the price elasticity of demand only. It is
not valid for any other elasticity (that is, income elasticity of demand,
price elasticity of supply, or cross-elasticities).
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
 Total Revenue and Price Elasticity of Demand
Elastic demand
• If demand is elastic, a price change results in a change in total
revenue (or total expenditure) in the opposite direction.
P increase  TR decrease
P decrease  TR increase
• According to the law of demand, a price change causes a change
in quantity demanded in the opposite direction. Because demand is
elastic, the quantity change is bigger than the price change. So the
quantity change determines what happens to total revenue.
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
 Total Revenue and Price Elasticity of Demand
Inelastic demand
• If demand is inelastic, a price change results in a change in total
revenue (or total expenditure) in the same direction.
P increase  TR increase
P decrease  TR decrease
• According to the law of demand, a price change causes a change
in quantity demanded in the opposite direction. Because demand is
inelastic, the price change is bigger than the quantity change. So
the price change determines what happens to total revenue.
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
 Total Revenue and Price Elasticity of Demand
Unit elastic demand
• If demand is unit elastic, a price change results in no change in
total revenue (or total expenditure).
P increase  TR unchanged
P decrease  TR unchanged
• According to the law of demand, a price change causes a change
in quantity demanded in the opposite direction. Because demand is
unit elastic, the quantity change equals the price change. So the
quantity change and the price change offset each other and total
revenue doesn’t change.
Elasticities of Demand and Supply
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The price elasticity of demand for automobiles is 1.35. If
Toyota wants to increase its revenues, it should
1.
Raise price
2.
Leave price unchanged
3.
Lower price
Elasticities of Demand and Supply
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President Weatherell wants to raise tuition (price) by a
significant amount to increase the University's budget (total
revenue). Therefore, he must be assuming that your demand
for an FSU education is
1. elastic
2.
unit elastic
3.
inelastic
Elasticities of Demand and Supply
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The demand for most agricultural commodities is inelastic.
Therefore, when a freeze reduces the size of the orange crop,
total revenue of all orange growers increases even though the
incomes of growers who lose a large part of their crop falls.
Elasticities of Demand and Supply
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Application: Elasticity and the Demand for
Smoking
Elasticities of Demand and Supply
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ELASTICITY AND THE DEMAND FOR
SMOKING
In November 1996, residents of
Oregon approved a ballot measure
increasing the excise tax on sellers
of cigarettes by $0.30 per pack.
The average price per pack
increased from $1.75 to $2.05.
Annual per capita consumption
decreased from 92 packs to 86
packs.
Price per pack
Example: Oregon’s AntiSmoking Campaign
$6.50
$6.50
$6.00
$6.00
$5.50
$5.50
$5.00
$5.00
$4.50
$4.50
$4.00
$4.00
$3.50
$3.50
$3.00
$3.00
$2.50
$2.50
$2.00
$2.00
$1.50
$1.50
$1.00
$1.00
$0.50
$0.50
$0.00
$0.00
S+tax
S+tax
SS
D
0
Elasticities of Demand and Supply
20 40
40 60
60 80
20
80 100
100 120
120
Annual Packs
Annual
Packsper
perCapita
Capita
38
ELASTICITY AND THE DEMAND FOR
SMOKING
10% of the additional tax revenue
was allocated to the Oregon Health
Division (OHD) to develop and
implement a tobacco-use prevention
program.
Because of the fall in demand,
annual per capita consumption
decreased by an additional 4
packs, from 86 to 82.
Price per pack
Example: Oregon’s AntiSmoking Campaign
$6.50
$6.50
$6.00
$6.00
$5.50
$5.50
$5.00
$5.00
$4.50
$4.50
$4.00
$4.00
$3.50
$3.50
$3.00
$3.00
$2.50
$2.50
$2.00
$2.00
$1.50
$1.50
$1.00
$1.00
$0.50
$0.50
$0.00
$0.00
S+tax
S+tax
S
D
D'
D'
0
Elasticities of Demand and Supply
20 40
40 60
60 80
20
80 100
100 120
120
Annual Packs
Annual
Packsper
perCapita
Capita
39
ELASTICITY AND THE DEMAND FOR
SMOKING
 Addiction and Elasticity
Nonusers
Nonusers’ demand for addictive substances is elastic. For example,
the estimated elasticity of demand for cigarettes among teenage
nonusers is 1.2.
Therefore, a moderately higher price leads to a substantially smaller
number of people trying a drug.
Elasticities of Demand and Supply
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ELASTICITY AND THE DEMAND FOR
SMOKING
 Addiction and Elasticity
Users
Existing users’ demand for addictive substances is inelastic. For
example, the estimated elasticity of demand for cigarettes among
adult smokers is 0.4.
Therefore, a substantial price rise brings only a modest decrease in
the quantity demanded. Even addicted users, however, may reduce
their consumption at the margin so demand is not perfectly inelastic.
Elasticities of Demand and Supply
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Price Elasticity of Supply
Elasticities of Demand and Supply
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PRICE ELASTICITY OF SUPPLY
 What Is the Price Elasticity of Supply?
The price elasticity of supply is the ratio of the percent change in the
quantity supplied to the percent change in price.
Price elasticity of
=
supply
Percentage change in quantity supplied
Percentage change in price
The price elasticity of supply is interpreted in the same way as the
price elasticity of demand.
Elasticities of Demand and Supply
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PRICE ELASTICITY OF SUPPLY
• What Causes the Supply of Some Goods To Be
More Elastic or More Inelastic than Others?
• Substitution effects
• Time: Same effect as elasticity of demand
Elasticities of Demand and Supply
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PRICE ELASTICITY OF SUPPLY
Substitution effects
If it is easy for sellers to switch production and sales to another good,
if they have good alternative uses for their productive inputs, then,
ceteris paribus, the supply of the good tends to be more elastic or less
inelastic.
More or better substitutes  Higher elasticity
If it is harder for sellers to switch to production and sales of alternative
goods, if inputs tend to be more specialized, then, ceteris paribus, the
supply of the good tends to be more inelastic or less elastic.
Few or poorer substitutes  Lower elasticity
Elasticities of Demand and Supply
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PRICE ELASTICITY OF DEMAND
Substitution effects: Examples
• Ceteris paribus, the supply of physicians is likely to be more elastic
(or less inelastic) than the supply of surgeons which in turn is more
elastic (or less inelastic) than the supply of neurosurgeons. The more
specialized the resources required to produce a good, the less elastic
its supply is likely to be.
• Storage provides sellers with a way of substituting between current
sales and future sales. Ceteris paribus, the lower the cost of storing a
good, frozen fish for example, the more elastic is its supply. On the
other hand, the supply of a non-storable good like fresh fish is highly
inelastic.
Elasticities of Demand and Supply
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Cross Price Elasticity and Income Elasticity of
Demand
Elasticities of Demand and Supply
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CROSS PRICE ELASTICITY AND INCOME
ELASTICITY OF DEMAND
 What Is the Cross Price Elasticity of Demand?
The ratio of the percent change in quantity demanded of a good to the
percent change in the price of a substitute or a complement.
Cross elasticity
=
of demand
Percent change in quantity demanded of a
good
Percent change in the price of one of its
substitutes or complements
Elasticities of Demand and Supply
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CROSS ELASTICITY AND INCOME
ELASTICITY OF DEMAND
Substitutes
Suppose that when the price of a burger falls by 10 percent, the
quantity of pizza demanded decreases by 5 percent.
Cross elasticity of
demand for pizza
Π 5 percent
=
Π10 percent
=
0.5
The cross price elasticity of demand between substitutes is positive.
Elasticities of Demand and Supply
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CROSS ELASTICITY AND INCOME
ELASTICITY OF DEMAND
Complements
Suppose that when the price of a burger falls by 10 percent, the
quantity of pizza demanded decreases by 5 percent.
Cross elasticity of
demand for pizza
2 percent
=
– 10 percent
=
-0.2
The cross price elasticity of demand between complements is negative.
Elasticities of Demand and Supply
50
CROSS ELASTICITY AND INCOME
ELASTICITY OF DEMAND
 What Is the Income Elasticity of Demand?
The ratio of the percent change in quantity demanded to the percent
change in buyers’ incomes.
Percentage change in quantity demanded
Income elasticity
of demand
=
Percentage change in income
Positive income elasticity  normal good
Negative income elasticity  inferior good
Elasticities of Demand and Supply
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If the cross price elasticity of demand between two goods is
positive, the two goods are
1. Normal
2. Inferior
3. Substitutes
4. Complements
5. Elastic
6. inelastic
Elasticities of Demand and Supply
52
If the cross price elasticity of demand between two goods is
negative, the two goods are
1. Normal
2. Inferior
3. Substitutes
4. Complements
5. Elastic
6. inelastic
Elasticities of Demand and Supply
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True or false: If the income elasticity of demand for a
good is positive and less than 1 in absolute value, the
good is a normal good and the demand for the good is
inelastic.
Elasticities of Demand and Supply
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True or false: If the income elasticity of demand for a
good is negative and greater than 1 in absolute value,
the good is an inferior good and the demand for the
good is elastic.
Elasticities of Demand and Supply
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