Lecture 3, Part 2

Elasticity: The Responsiveness of

Demand and Supply

Readings: All of Chapter 4

 Price elasticity of demand
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 Price elasticity of demand
o Elasticity: A measure of how much one economic
variable, such as the quantity demanded of a product,
responds to changes in another economic variable, such
as the product’s price.

o Price elasticity of demand: The responsiveness of the

quantity demanded of a good to a change in its price.
 Price elasticity of demand
o Divide the percentage change in the quantity
demanded of a product by the percentage change in its
price.

o Note: The price elasticity of demand is not the same as

the slope of a demand curve.
 Price elasticity of demand
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 Price elasticity of demand
o Elastic demand: Demand is elastic when the percentage change
in quantity demanded is greater than the percentage change in
price.

o The price elasticity is greater than one in absolute value.

 Price elasticity of demand
o Inelastic demand: Demand is inelastic when the percentage
change in quantity demanded is less than the percentage
change in price.

o The price elasticity is less than one in absolute value.

 Price elasticity of demand
o Unit-elastic demand: Demand is unit-elastic when the
percentage change in quantity demanded is equal to the
percentage change in price.

o The price elasticity is equal to one in absolute value.

 Price elasticity of demand
If demand is elastic, then
the absolute value of the
price elasticity is greater
than 1.

If demand is inelastic,
then the absolute value
of the price elasticity is
less than 1.
 Price elasticity of demand

If demand is unit elastic,

then the absolute value
of the price elasticity is
equal to 1.

If demand is perfectly
elastic, then the absolute
value of the price
elasticity is equal to
infinity.
 Price elasticity of demand

If demand is perfectly
inelastic, then the
absolute value of the
price elasticity is equal
to 0.
 Price elasticity of demand
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 Price elasticity of demand
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 The mid-point formula
§This formula is used to ensure that the value of the price elasticity of
demand between the same two points is the same whether the price increases
or decreases.

Price elasticity of demand =

(Q2 – Q1) (P2 –P1)
(Q1 + Q2) ÷ (P1 + P2)
2 2
 Price elasticity of demand
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The determinants of the price elasticity of demand

1.Availability of close substitutes

2.The length of time involved

3.Luxuries versus necessities

4.Definition of the market

5.Share of expenditure on the good in the consumer’s budget

Application: demand for housing
o Suppose University is planning to increase the supply
of housing near the campus

o If you are a student who wants to live near the

campus, would you be hoping that the demand for
housing in this are is elastic or inelastic?

o Hint: if the supply curve shifts to the right, what is

happening to the equilibrium price? How does the magnitude
of this change depend on the elasticity of demand?
 Price elasticity of demand

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inelastic demand elastic demand
 Price elasticity of demand
o Total revenue: The total amount of funds received by a seller
of a good or service.

o Total revenue is found by multiplying price per unit by the

number of units sold.

P Q
TR
 Price elasticity of demand
o When demand is price inelastic:
o A decrease in price leads to a decrease in total revenue.
o An increase in price leads to an increase in total revenue.
o When demand is price elastic:
o A decrease in price leads to an increase in total revenue.
o An increase in price leads to a decrease in total revenue.
Price elasticity of demand
Price elasticity of demand
Price elasticity of demand
 Cross-price elasticity of demand
§ Cross-price elasticity of demand: The percentage change in the
quantity demanded of one good divided by the percentage
change in the price of another good.
 Cross-price elasticity of demand
§ Cross-price elasticity will be positive when the two goods are
substitutes in consumption.

§ Cross-price elasticity will be negative when the two goods are

complements in consumption.

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 Cross-price elasticity of demand
If the products are Then the cross-price Example
… elasticity of demand
will be …

substitutes positive Two brands of tablet

computers

complements negative Tablet computers and

applications
downloaded from
online stores
unrelated zero Tablet computers and
peanut butter
 Income elasticity of demand
§ Income elasticity of demand: A measure of the responsiveness
of quantity demanded to a change in income.

§ It is measured by the percentage change in quantity

demanded divided by the percentage change in income
(disposable income).
 Income elasticity of demand
If the income elasticity of Then the good is … Example
demand is …

positive, but less than 1 normal and a necessity milk

positive and greater than 1 normal and a luxury restaurant

meals

negative inferior high-fat mince

meat
 Price elasticity of supply
§ Price elasticity of supply: The responsiveness of the quantity
supplied to a change in price.

§ It is measured by dividing the percentage change in the

quantity supplied of a product by the percentage change in the
product’s price.
 Price elasticity of supply
§ The elasticity of supply will always be positive, as price and
quantity supplied move in the same direction.

§ The primary determinant of the price elasticity of supply is

the amount by which production costs rise as output levels
rise.
– Other key determinants are largely based upon this.
 Price elasticity of supply

If supply is elastic, then the

value of the price elasticity
is greater than 1.

If supply is inelastic, then

the value of the price
elasticity is less than 1.
 Price elasticity of supply

If supply is unit-elastic,
then the value of the
price elasticity is equal
to 1.
 Price elasticity of supply
If supply is perfectly
elastic, then the value of
the price elasticity is
equal to infinity.

If supply is perfectly
inelastic, then the value
of the price elasticity is
equal to 0.
Key determinants of the elasticity of supply
1. Length of time involved in production

2.Type of industry

3. Availability of inputs

4. Existing capacity

5. Inventories held