AN INTRODUCTION
TO
MICROECONOMICS
PROF. DR. MOHAMMED MIGDAD
FIRST SEMESTER 2015
ELASTICITY
AND ITS
APPLICATIONS
CHAPTER 3
CHAPTER 3 CONTENT:
Elasticity and its applications, It includes:
Price elasticity of demand,
Point and arc elasticity,
Types of elasticity,
Factors affecting elasticity,
Elasticity and total revenue,
Income elasticity of demand,
Price elasticity of supply,
In addition to elasticity and tax.
Elasticity
 Elasticity
is a general concept
that can be used to quantify the
response in one variable when
another variable changes.
4
How to measure elasticity
% A
elasticity of A with respect to B 
% B
5
Price Elasticity of Demand
A
popular measure of elasticity is
price elasticity of demand
measures how responsive
consumers are to changes in the
price of a product.
6
How to measure P.E.D

7
Price elasticity of demand equals
the percentage change in the quantity
demanded divided by the percentage change
in price of the product.
3.2 Price Elasticity of
Demand
Elasticity =
Change in quantity
demanded
Quantity demanded
Change in price
÷
Price
How to measure P.E.D
% change in quantity demanded
price elasticity of demand 
% change in price
9
The absolute term
• The value of demand
elasticity is always
negative, but it is stated
in absolute terms.
10
The negative sign
 The
negative sign of the
P.E.D show the negative
relation between price and
quantity demanded.
11
Slope and Elasticity
12

The value of the slope of the demand
curve and the value of elasticity are not
the same.

Unlike the value of the slope, the value
of elasticity is a useful measure of
responsiveness.
Example 1
Consider the market for sales of icecream cones at a state fair. The table
below gives the market quantity
demanded with consideration in
giving all the sellers the same price.
Calculate the price elasticity of
demand for the ice-cram.
Ice-Cream Demand Schedule
Price of Ice Cream ($)
0.50
1.00
1.50
2.00
2.50
3.00
Quantity Demanded
(millions)
16
13
10
7
4
1
Continue
You can calculate the market price
elasticity of demand using the
information contained in the table
above.
For instance, suppose you decided to
calculate the price elasticity of
demand at the price $2.00 by
examining a price decrease from
$2.00 to $1.50 per cone.
Continue
In this case, the demand for ice cream
will increase from 7 million cones to
10 million cones. You can use these
figures to calculate the price
elasticity of demand as follows:
Continue
This implies the following:
• The price elasticity of demand for ice-cream
cones at a price of $2.00, according to the
demand schedule provided, is -1.72.
Continue
• The sign here illustrates the negative relation
between price and quantity demanded and
that we deal here with the absolute number.
So the value of the elasticity in this case
equals 1.72.
• This elasticity means that the % change in
quantity is higher than the % change in price,
which indicates that the demand here is an
elastic demand.
Example 2
You are a cement producer. You wish
to plot your firm's demand curve and
to find the price elasticity of demand
at various points along the demand
curve. You decide to calculate
elasticity by examining the effects of
price declines from $50 to $40, $40
to $30, etc.
To calculate the price elasticity of
demand between a price of $50 and
$40 on the demand curve, divide the
percentage change in quantity
demanded by the percentage change
in price.
Continue
Cement Demand Schedule
Price
($ per ton)
Quantity
(thousands of tons)
50
500
40
600
30
700
20
800
10
900
Continue
• Similarly, you can find the elasticity between
prices of $40 and $30, $30 and $20, and $20
and $10.
• To illustrate, here is what you will find when
you calculate elasticity between $40 and $30:
Continue
This is the equation of elasticity
between $30 and $20:
Continue
This is the equation for elasticity
between $20 and $10
Continue
Notice that demand becomes
increasingly less as prices fall.
Intuitively, this makes sense;
consumers can be expected to react
much more dramatically to a change
in price when prices are high than
they are low.
Slope and Elasticity
26
Slope and Elasticity



27
when we calculate slope in the two graphs:
The slope of the first graph equals
change in price / change in quantity
= -1/5 = -20%
The slope of the second graph equals
-1/ 80 = -1.25%
Slope and Elasticity



28
But when we calculate elasticity in the two
graphs:
The elasticity of the first graph =
% change in quantity / % change in price
= q2-q1/q1 divided by p2-p1/p1= 10-5 / 5
divided 2-3/3 = 1/ -0.33 = -3
The elasticity of the second graph =
160-80/80 divided 2-3/3 =1/-0.33 = -3
continue
29

Changing the units of measure yields a
very different value of the slope, yet the
behavior of buyers in both diagrams is
identical.

And as a result the elasticity is the
same, in both graphs and equals -3
Arc Elasticity
Supposing we want to measure the
elasticity between point A and point B
appearing on the same curve in the
figure
we assume that:
• P1 = 4, Qd1 = 12
• P2 = 5, Qd2 = 9
Arc Elasticity
If we intend to calculate the elasticity
between the two points, A and B, starting
from point B and using the elasticity formula
as illustrated above, this is what we get:
Ed =
Ch. Qd
Ch. P
Ed =
Ed =
P
Q
X
9-12
5-4
-3
+1
X
X
4
12
4
12
= -1
If we intend to calculate the elasticity
between the two points, A and B,
starting from point A and using the
elasticity formula as illustrated
above, this is what we get:
Ed =
Ed =
12-9
4-5
+3
-1
5
9
X
X
5
9
= -1.7
We notice some differences in the
results because the starting points
were different. To avoid this
difference in calculating the Arc
Elasticity, calculating from the
middle point between both points, A
and B, could be the best way. This is
known as the Midpoint Law which
gives an average result.
Change in Quantity
Price elasticity of
demand=
Price 1+ price 2
X
Change in price
Qd1 – Qd2
Ed =
Ed =
Ed =
P1 – p2
12 – 9
4–5
Quantity 1+ Quantity 2
p1 + p2
X
Qd1+ Qd2
X
3
9
9
x
= = - 1.3
-3
21
7
4+5
12 + 9
Point Elasticity and Types of Demand Elasticity
Types of Demand Elasticity
P
E
ed =
D
Types of Demand Elasticity
ed > 1
C
ed = 1
B
ed < 1
A ed = 0
Qd
3.4.1 Types of Price Elasticity of Demand
1.
2.
3.
4.
5.
Elastic Demand
Inelastic Demand
Unitary Elastic Demand
Perfectly Elastic Demand
Perfectly Inelastic Demand/The
Zero Elasticity
Elastic Demand
p
Elastic Demand
P2
P1
D
Q2
Q1
Qd
Inelastic Demand
p
Inelastic Demand
P2
P1
D
Q2
Q1
Qd
The Unitary-Elastic Demand
p
Unitary-Elastic Demand
P2
P1
D
Q2
Q1
Qd
Perfectly Elastic Demand
Perfectly Inelastic Demand/The Zero Elasticity
Special Cases for the Negative Demand Elasticity
• Luxury cars, particularly at the higher end, like
the Rolls-Royce Phantom pictured here, are
often said to be desirable due to their price.
As a result, it is argued that luxury cars are
Veblen goods.
• In such cases, if we measure the demand
elasticity, it will be positive with positive
relationship between price and quantity
demanded
3.5 Elasticity and Total Revenue
Example
Product X1 can be sold for $5. The seller
decides to increase the price to $7 in order to
earn more money, but finds that he earns less
money. This is because he is selling fewer of
the products due to the increased price.
His/her total revenue is falling, as a result. The
demand for this product must be elastic. The
producer failed in achieving his/her aim due
to the lack of knowledge about the elasticity
of the good.
3.5.1The Relationship between (TR) and Elasticity,
and (TE) and Elasticity
• If the demand on a product was as follows, the
demand on this product will be elastic
P
6
5
Qd
100
130
TR
600
650
Table: Total Revenue when the Price Decreases in the Elastic Demand
• The demand on this product is elastic; therefore, the
decrease in price causes an increase in total revenue
(TR). The price decreases 20%, the quantity increases
30%, and total revenue increases 8.3%.
130- 100
Ed =
x
5-6
30
Ed =
5 +6
-1
11
x
-230
130 + 100
330
=
-230
= -1.4
If the demand was unitary-elastic, total
revenue remains constant no matter
the price changes.
Total Revenue when the Price Decreases in the
Unitary Elastic Demand
P
Qd
TR
6
100
600
5
120
600
The price decreases 20%, the quantity increases 20%, and
total revenue remains constant.
120- 100
Ed =
x
5-6
20
Ed =
5 +6
-1
11
x
220
120 + 100
220
=
-220
= -1
The Relationship between Elasticity and Total
Revenue
Inelastic demand
Unitary-demand
Elastic demand
Ed <1
Ed = 1
Ed > 1
Price increases
Revenue increases
Revenue constant
Revenue decreases
Price decreases
Revenue decreases
Revenue constant
Revenue increases
Elasticity of demand
Change in price
The Relationship between Price and Total Revenue
Price & revenue
F
M
H
L
G
E
TR
P4
P3
The
Relationship
between Price
and
Total Revenue.
C
P2
P1
A
MR
Qd
3.6 The Relationship between Marginal Revenue,
Price, and Elasticity
Marginal revenue can be defined as "the change
in total revenue caused by selling an
additional new unit".
Change in total revenue
Marginal revenue =
Change in the number of units sold.
3.7 Elasticity and the Slop
The Slope of the Infinity Elastic Demand Curve
P
P
Slope =
D
3
4
Qd
Q
0
=
1
=0
The Slope of the Perfectly Inelastic Demand Curve
P
D
P
3
Slope =
2
4
Qd
1
=
Qd
0
=infinity
The Slope of the Normal Demand Curve
P
8
6
F
ed=
1
Slop
e
P
Q
x
E
P
Q
Slope =
C
4
=1
B
2
A
2
4
6
8
Qd
The Slope of the Unitary-Elastic Demand Curve
P
When the demand curve
slope = 1
Elasticity differs
6
4
45
2
4
Qd
3.7.1 The Determinants of Price Elasticity of Demand
(Factors that Affect Elasticity)
The elasticity differs from one good to another
depending on different factors as following:
1) The Availability of Substitutes
2) Necessity of a Product
3) Amount of Income Spent on the Good
4) Consumer Income (The Wealth of
Consumers)
5) Time
3.8 Practical Applications to Price
Elasticity of Demand
The Effect of Decreasing Supply on Total Revenue
P
S1
S
P1
P
D
Q1
Q
Qd
Monopoly ……
Price
MC
E
TR
P1
D
C
A
Q1
MR
Qd
3.9 Cross Price Elasticity of Demand
(CPED)
• CPED is the extent to which the quantity of
good (y) is affected by the change in the price
of good (x).
Cross elasticity of demand between
product y and x =
Eyx =
% change in quantity demanded of
product (y)
% change in price of product (x)
Qdy %
px %
Continue
Eyx =
Qdy
Qdy
Qdy
Eyx =
Divided by
Px
x
Qdy
px
Px
Qdy
=
px
px
x
px
Qdy
The more precise equation in calculating cross
price elasticity of demand is the mid-point law
Cross elasticity of
demand yandx =
% change in quantity
demanded of (y)
Both prices summed
X
% change in price of (x)
Both quantities
summed
3.10 Income Elasticity of Demand
Income elasticity of demand could be measured
through the following formula:
EI =
Qd %
I%
EI =
EI =
Qd
I
x
I
Qd
Qd
I
x
I
Qd
EI =
Qd2 – Qd1
I2 – I1
I1 + I2
x
Qd1 + Q2
Example
Measure the income elasticity of
demand from the following data, and
then illustrate the level of elasticity
and type of the good. (Income
increases from 100 to $150, as a
result quantity increases from 90 to
110 units).
EI =
EI =
110 -90
150-100
20
50
X
150 + 100
110 + 90
250
x
200
The income elasticity is positive and less than one that
indicates a normal good with an inelastic demand
3.11 Price Elasticity of Supply
Its formula is as follows:
ES =
ES=
QS %
p%
Qs
Qd
÷
p
P
Formula’s also include:
Qs
ES=
P
*
Qd
p
Qs
ES=
P
*
P
Qd
The sign of "price elasticity of supply" is generally positive
because there is a positive relationship between prices and
quantity supplied.
3.12 Supply Elasticity in the Short Run and the
Long Run
Economists usually differentiate between
three time periods due to some conditions:
1) Market Period (Very Short Run)
2) The Short Run
3) The Long Run
The Supply Curve in the Very Short Run
S
P
Supply Easticity
(Market Period)
P1
P
D1
D
Q
Qs
Qd
Supply Curve in the Short Run
S
P
Supply Elasticity
(Short Run)
P1
P
D1
D
Q1 Q2
Qs
Qd
Supply Curve in the Long Run
Supply Elasticity
(Long Run)
P
S
P1
P
D1
D
Q1
Q2
Qs
Qd
3.12 Elasticity and Tax Incidence (Practical Cases)
There are five different cases concerning both
supply and demand elasticity
First: Cases of Price Elasticity of Demand
Second: Cases of Price Elasticity of Supply
First: Cases of Price Elasticity of Demand
1. If the demand for product (x) is perfectly inelastic
and the government imposes ($1) tax on this
product, the consumer bears the full burden of the
imposed tax
P
D
S1
4
3
E1
S
(Perfectly Inelastic Demand)
E Customer bear full burden of
imposed tax
Q
First: Cases of Price Elasticity of Demand
2. If the demand for product (x) is infinity elastic
and the government imposes ($1) tax on this
product, the supplier bears the full burden of
the imposed tax
P (Infinity Elasticity)
Customer bear full burden of
imposed tax.
S1
S
D
3
Q
Q1
Q
First: Cases of Price Elasticity of Demand
3. If the demand on product (x) is unitary elastic and
the government imposes ($1) tax on this product,
the supplier bears half the burden of the imposed tax
and the consumer bears the other half.
P
D
S1
S
N
3. 5
E1
3
E
( Unitary Elastic Demand)
Suppliers bear half of the
burden of imposed tax,
& C ustomer bear half .
Q
First: Cases of Price Elasticity of Demand
4. If the demand on product (x) is inelastic, and the
government imposes ($1) tax on this product, the
customer bears most of the burden of the imposed
tax and the supplier bears the remaining few burden
of tax.
D
P
S1
E1
N
S
3.75
3
E
(Inelastic Demand)
Suppliers bear least
burden of
imposed tax,
&Customer bear most
Q
First: Cases of Price Elasticity of Demand
5. If the demand on product (x) is elastic and the
government imposes ($1) tax on this product, the
supplier bears most of the burden of imposed tax
and the customer bears the remaining few burden of
(Elastic Demand)
tax.
Customer bear least burden of
P
imposed tax, &suppliers bear
most.
N
D
3.25
3
S1
S
E1
E
Q
Second: Cases of Price Elasticity of Supply
1.If the supply of product (x) is perfectly inelastic and
the government imposes ($1) tax on this product,
the supplier bears the full burden of imposed tax.
S
P
3
(Perfectly Inelasticity Supply)
Supplier bear the full burden
of tax.
E
D
Q
Second: Cases of Price Elasticity of Supply
2. If the supply of product (x) is infinity elastic, and the
government imposes ($1) tax on this product, the
consumer bears the full burden of imposed tax. In
this case, the supplier is able to increase the prices to
cover the burden of tax.
(Infinity
Elastic Supply)
Consumers bear the full
burden of tax.
P
4
E1
S1
S
3
E
D
Q
Second: Cases of Price Elasticity of Supply
3. If the supply of product (x) is unitary elastic and the
government imposes ($1) tax on this product, the
consumer bears half the burden of imposed tax and
the supplier bares the remaining burden of tax. In
this case, the suppliers are not able to increase the
prices to cover the full burden of tax.
D
S1
P
S
N
3.5
E1
3
E
(Unitary Elas tic Supply)
Suppliers bear half of the
burden of impos ed tax,
&Cus tomer bear half.
Q
Second: Cases of Price Elasticity of Supply
4. If the supply of product (x) is inelastic and the
government imposes ($1) tax on this product, the
consumer bears less and the supplier bears more of
the burden of imposed tax.
S1
P
S
N
E1
3.25
3
E
D
Q
(Supply Inelastic)
Supplier bear most & consumer bear least of the burden of tax
Second: Cases of Price Elasticity of Supply
5. If the supply of product (x) is elastic and the
government imposes ($1) tax on this product, the
consumer bears more and the supplier bears less of
the burden of imposed tax.
P
S1
3.75
3
E1
N
S
E
D
Q
(Elastic supply)
Consumers bear most and suppliers least of the burden of tax
THE END OF
CHAPTER 3
Types of Elasticity
1.
2.
3.
4.
5.
82
Unitary elasticity = -1
Elastic demand
> -1
Inelastic demand < -1
Perfectly elastic demand = ∞
Perfectly inelastic demand = 0
Types of Elasticity
 Hypothetical
Demand
Elasticity for Four products
83
Hypothetical Demand Elasticities for Four Products
PRODUCT
84
%
% CHANGE IN
CHANGE
QUANTITY
IN PRICE
DEMANDED (%QD)
(%P)
ELASTICITY
(%QD d %P)
Insulin
+10%
0%
0.0
Perfectly
inelastic
Basic telephone
service
+10%
-1%
-0.1
Inelastic
Beef
+10%
-10%
-1.0
Unitarily
elastic
Bananas
+10%
-30%
-3.0
Elastic
Elastic and Inelastic Demand Curves

85
Different graphs that show different types of
elasticity
Perfectly Elastic and
Perfectly Inelastic Demand Curves
86
Perfect inelasticity
 When
demand does not
respond at all to a change in
price, demand is perfectly
inelastic, this is the
horizontal demand curve.
87
Perfect elasticity
 Demand
is perfectly elastic
when quantity demanded
drops to zero at the slightest
increase in price, this is the
vertical demand curve.
88
Calculating Elasticities
 The
elasticity of the first graph =
% change in quantity / % change in
price
 = q2-q1/q1 divided by p2-p1/p1
89
% change in Quantity
Q2  Q1
% change in quantity demanded 
x 100%
Q1
90
Calculating Elasticities
P2  P1
% change in price 
x 100%
P1
91
Calculating Elasticities
92
Elasticity
 Elasticity
is a ratio of
percentages.
 Using the values on the graph
to compute elasticity, using
percentage changes yields the
following result:
93
Price Elasticity
 100%
price elasticity of demand 
  3.0
 33.3%
94
Calculating Elasticities
95
The midpoint formula
A
more accurate way of computing
elasticity than percentage changes
is the midpoint formula:
96
The midpoint formula
Q2  Q1
x 100%
%  Qd
(Q1  Q2 ) / 2

P2  P1
% P
x 100%
( P1  P2 ) / 2
97
The midpoint formula
10  5
x 100%
%  Qd (5  10) / 2


2 3
% P
x 100%
( 3  2) / 2
98
5
x 100% 66.7%
7.5
=
  167
.
-1
-40.0%
x 100%
2.5
Interpret Elasticities
Here is how to interpret two different values of
elasticity:
99
e

When = 0.2, a 10% increase in price leads
to a 2% decrease in quantity demanded.

When = 2.0, a 10% increase in price leads
to a 20% decrease in quantity demanded.
e
Elasticity Changes along a
Straight-Line Demand Curve
10
0
Elasticity along a Straight-Line
 Price
elasticity of demand
decreases as we move
downward along a straight
line demand curve. This is
because quantity is large.
10
1
Elasticity along a Straight-Line
Demand
is elastic in the
upper range and inelastic
in the lower range of the
line, this is because
quantity is small .
10
2
103
Elasticity
 Along
10
4
the elastic range, elasticity
values are greater than one.
 Along the inelastic range, elasticity
values are less than one.
 And in the middle elasticity equals
one
Elasticity and Total Revenue
TR  P  Q
10
5
Value
of Ed
Change in quantity
versus change in
price
Effect of an
increase in
price on total
Effect of a
decrease in
price on total
revenue P↑
revenue P ↓
Type of
demand
Elastic
Greater
than 1.0
Larger percentage
change in quantity
Total revenue
decreases
Total revenue
increases
Inelastic
Less
than 1.0
Smaller percentage
change in quantity
Total revenue
increases
Total revenue
decreases
Unitary
elastic
Equal to
1.0
Same percentage
change in quantity and
price
Total revenue
does not change
Total revenue
does not
change
10
6
Elasticity and Total Revenue
When demand is inelastic,
price and total revenues are
directly & positively related.
Price increases generate
higher revenues.
10
7
continue
When demand is elastic, price
and total revenues are
indirectly & negatively related.
 Price increases generate
lower revenues.
10
8
The Determinants of Demand Elasticity
1.
2.
10
9
Availability of substitutes demand is more elastic when
there are more substitutes for the
product.
Time dimension -- demand
becomes more elastic over time.
continue
3.
11
0
Importance of the item in the budget -demand is more elastic when the item is a
more significant portion of the consumer’s
budget.
Home Exam
1.
2.
3.
11
1
Define economics and it main
branches.
What is elasticity, and what is its
application?
Give example to calculate price
elasticity of demand & explain its
importance.
Exam
4.
5.
11
2
Explain the relation between elasticity
& revenue? How to use the relation in
decision making? Give numerical
examples.
What are factors determines the
elasticity?
Use Graphs and numerical examples
as much as you can in answers.
Other Important Elasticities
elasticity of demand –
measures the responsiveness of
demand to changes in income.
 Income
11
3
The form
% change in quantity demanded
income elasticity of demand 
% change in income
11
4
Other Important Elasticities

11
5
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.
The form
% change in quantity of Y demanded
cross-price elasticity of demand 
% change in price of X
11
6
Other Important Elasticities
 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.
11
7
The form
% change in quantity supplied
elasticity of supply 
% change in price
11
8
Other Important Elasticities
 Elasticity
of labor supply: A
measure of the response of labor
supplied to a change in the price of
labor.
11
9
The form
% change in quantity of labor supplied
elasticity of labor supply 
% change in the wage rate
12
0
Constraints on the Market
A
price ceiling is a maximum price
that sellers may charge for a good,
usually set by government.
12
1
price ceiling
In 1974, the government set a price
ceiling to distribute the available supply
of gasoline.
 At an imposed price of 57 cents per
gallon, the result was excess demand.

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123
Prices and the Allocation of Resources
 Price
changes resulting from shifts
of demand cause profits to rise or
fall.
 Profits attract capital; losses lead
to disinvestment.
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4
price ceiling


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5
Higher wages attract labor and encourage
workers to acquire skills.
At the core of the system, supply, demand,
and prices in input and output markets
determine the allocation of resources and the
ultimate combinations of things produced.
Price Floors
A
price floor is a minimum price
below which exchange is not
permitted.
–
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The most common example of a
price floor is the minimum wage,
which is a floor set under the price of
labor.
Price Floors
 The
result of setting a price floor
will be excess supply, or higher
quantity supplied than quantity
demanded.
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Impact of tax and subsidies on price
and quantity



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Taxes shift supply curve up to the left
And we reach a new equilibrium point
Pe will increase and Qe will decrease
How tax or tariffs on imports affect
foreign trade

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This depend on the elasticity of demand and
supply.
Energy price control

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0
An example for government intervention
comes when the Gov. legislates a maximum
price ceiling.