AN INTRODUCTION TO
MICROECONOMICS
Dr. Mohammed Migdad
Elasticity
and Its Applications
CHAPTER 3
Chapter 3 content:
Chapter three is about 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.
3.1 Introduction
Elasticity
Is a general concept that can
be used to quantify the
response in one variable when
another variable changes.
3.2 Price Elasticity of Demand
Change in quantity demanded
Change in price
÷
Elasticity =
Quantity demanded
Price
3.2 Price Elasticity of Demand
Qd
÷
Ed=
Qd
P
Qd
Ed=
Qd
Qd
Ed=
p
P
*
P
Qd
*
P
P
Example 1
Consider the market for sales of ice
cream 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 1.75.
• 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.
3.3 Arc Elasticity
Arc Elasticity
Supposing we want to measure the elasticity
between point A and point B appearing on the
same curve in figure (3.1),
we assume that:
• P1 = 4, Qd1 = 12
• P2 = 5, Qd2 = 9
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 =
Qd
P
9-12
Ed =
5-4
Ed =
X
P
Q
X
4
12
-3
4 =X
+1
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:
12-9
5
X
4-6
9
Ed =
Ed =
+3
-1
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
3.4 Point Elasticity and Types of Demand
Elasticity
Point Elasticity >>> ….
3.4 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
3.4.2 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.
3.11.1 Types of "Price Elasticity of
Supply"
1) Perfectly Inelastic Supply (Zero Elastic
Supply)
2) Infinity Elastic Supply
3) Unitary Elastic Supply
4) Elastic Supply
5) Inelastic Demand
1. Perfectly Inelastic Supply (Zero Elastic Supply)
S
P
Inelastic Supply Curve
P1
P
Q
Qs
2. Infinity Elastic Supply
P
Infinity Elastic Supply Curve
S
P
Q1
Q2
Qs
3. Unitary Elastic Supply
P
S
Unitary Elastic Supply Curve
Qs
4. Elastic Supply
S
P
Elastic Supply Curve
Qs
5. Inelastic Demand
P
S
Elastic Supply Curve
Qs
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