CHAPTER
5
Elasticity: A Measure
of Responsiveness
Prepared by: Fernando and Yvonn Quijano
© 2006 Prentice Hall Business Publishing
Economics: Principles and Tools, 4/e
O’Sullivan/ Sheffrin
C H A P T E R 5: Elasticity: A Measure of responsiveness
The Price Elasticity of Demand
• The price elasticity of demand
(Ed) measures the responsiveness
of consumers to changes in price.
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C H A P T E R 5: Elasticity: A Measure of responsiveness
The Price Elasticity of Demand
• We compute the price elasticity of demand
as follows:
• For example, if the price of milk increases
by 10% (from $2 to $2.20) and the quantity
demanded decreases by 15% (from 100 to
85), the price elasticity of demand is:
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C H A P T E R 5: Elasticity: A Measure of responsiveness
Price Elasticity and
the Demand Curve
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C H A P T E R 5: Elasticity: A Measure of responsiveness
Price Elasticity and
the Demand Curve
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C H A P T E R 5: Elasticity: A Measure of responsiveness
Price Elasticity and
the Demand Curve
• When demand is perfectly
inelastic, the quantity
demanded is the same at every
price, so the price elasticity of
demand is zero.
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• When demand is perfectly
elastic, the quantity demanded
is infinitely responsive to
changes in price, so the price
elasticity of demand is infinite.
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C H A P T E R 5: Elasticity: A Measure of responsiveness
What Determines the
Price Elasticity of Demand?
• The price elasticity of demand for a
particular product depends on the
availability of substitutes.
• Products with relatively inelastic
demand have few good substitutes.
• The demand for a specific brand of
a product is typically elastic.
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C H A P T E R 5: Elasticity: A Measure of responsiveness
What Determines the
Price Elasticity of Demand?
• The short-run price elasticity of
demand is typically smaller than the
long-run elasticity.
• Elasticity is larger for goods that
take a relatively large part of a
consumer’s budget.
• The price elasticity of demand for
some products varies with the age
of the consumer.
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C H A P T E R 5: Elasticity: A Measure of responsiveness
Computing Price Elasticity:
Initial Value versus Midpoint
Table 5.1: Computing Percentage Changes and Elasticity
Price
Quantity
Old
New
Initial Value Method
Midpoint value
method
$2.00
$2.20
Percent change: 10% = $0.20 / $2.00
Percent change: 9.52% = 0.20 / 2.10
100
85
Percent change: 15% = 15 / 100
Percent change: 16.22% = 15 / 92.5
Elasticity: 1.5 = 15% / 10%
Elasticity: 1.70 = 16.22% / 9.52%
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The midpoint method measures
the percentage changes more
precisely, so we get a more precise
measure of price elasticity.
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C H A P T E R 5: Elasticity: A Measure of responsiveness
Elasticity Along a
Linear Demand Curve
Percentage
decrease in price
•
The price elasticity of
demand decreases as we
move downward along a
linear demand curve.
•
Demand is elastic on the
upper half of the demand
curve and inelastic on the
lower half.
Percentage
increase in quantity
Elasticity
Point r to point s
4 / 80 = 5%
2 / 10 = 20%
20% / 5% = 4.0
Point t to point u
4 / 50 = 8%
2 / 25 = 8%
8% / 8% = 1.0
Point v to point w
4 / 20 = 20%
2 / 40 = 5%
5% / 20% = 0.25
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C H A P T E R 5: Elasticity: A Measure of responsiveness
Using the Price Elasticity
of Demand to Make Predictions
• Predicting changes in quantity demanded:
• We can rearrange the elasticity formula to
predict changes in quantity demanded as a
result of price changes.
• For example:
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C H A P T E R 5: Elasticity: A Measure of responsiveness
Predicting Changes in Total Revenue
Table 5.2 Price and Total Revenue with Elastic Demand
Price
Quantity of Tickets Sold
Total Revenue
4.00
100
$400
4.40
80
$352
• An increase in the ticket price brings
good news and bad news:
• Good news. You get more money for
each ticket sold.
• Bad news. You sell fewer tickets.
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C H A P T E R 5: Elasticity: A Measure of responsiveness
Predicting Changes in Total Revenue
Table 5.3 Elasticity and Total Revenue
Value of Price
Type
Elasticity
of Demand of Demand
Change in
Quantity Versus
Change in Price
Effect of Higher Effect of Lower
Price on Total
Price on Total
Revenue
Revenue
Elastic
Greater than 1.0 Larger percentage
change in quantity
Decreases
Increases
Inelastic
Less than 1.0
Smaller percentage
change in quantity
Increases
Decreases
Unitary
elastic
1.0
Same percentage
changes in quantity
and price
Does not change Does not change
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C H A P T E R 5: Elasticity: A Measure of responsiveness
Predicting Changes in Total Revenue
•
Total revenue reaches its
maximum at the midpoint of
the demand curve, where
demand is unitary elastic.
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•
Demand is elastic along
the upper half of a linear
demand curve, so an
increase in quantity
increases total revenue.
•
Demand is inelastic along
the lower half of a linear
demand curve, so a
decrease in price
decreases total revenue.
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C H A P T E R 5: Elasticity: A Measure of responsiveness
Other Elasticities of Demand
• The income elasticity of demand
measures of the responsiveness of
demand to changes in income, indicating
how much more or less of a particular
product is purchased as income changes.
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C H A P T E R 5: Elasticity: A Measure of responsiveness
Other Elasticities of Demand
• The cross elasticity of demand measures
the responsiveness of demand to changes
in the price of other goods.
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C H A P T E R 5: Elasticity: A Measure of responsiveness
The Price Elasticity of Supply
• The price elasticity of supply
measures the responsiveness of
producers to changes in price.
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C H A P T E R 5: Elasticity: A Measure of responsiveness
The Price Elasticity of Supply
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• A 10% increase in the
price of milk (from $2 to
$2.20) increases the
quantity supplied by 20%
(from 100 million gallons to
120 million), so the price
elasticity of supply is 2.0 =
20%/10%.
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C H A P T E R 5: Elasticity: A Measure of responsiveness
Predicting Changes
in Quantity Supplied
• Predicting changes in quantity supplied:
• We can rearrange the elasticity formula to
predict changes in quantity supplied as a
result of price changes.
• For example:
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C H A P T E R 5: Elasticity: A Measure of responsiveness
Extreme Cases: Perfectly Inelastic
Supply and Perfectly Elastic Supply
• When supply is perfectly
• When supply is perfectly
inelastic, the quantity supplied
elastic, the quantity supplied is
is the same at every price, so
infinitely responsive to changes
the price elasticity of supply is
in price, so the price elasticity of
zero.
supply is infinite.
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C H A P T E R 5: Elasticity: A Measure of responsiveness
Predicting Changes in Price
Using Supply and Demand Elasticities
• The price-change formula shows the
percentage change in equilibrium price
resulting from a change in demand or
supply, given values for the price elasticity
of supply and price elasticity of demand.
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C H A P T E R 5: Elasticity: A Measure of responsiveness
Predicting Changes in Price
Using Supply and Demand Elasticities
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• In this example, an
increase in demand shifts
the demand curve to the
right, increasing the
equilibrium price. In this
case, a 35% increase in
demand increases the
price by 10%.
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C H A P T E R 5: Elasticity: A Measure of responsiveness
The Price Effects of
a Change in Supply
• A slight variation of the price-change
formula is used to predict the change in
price resulting from a change in supply.
• For example, when the price elasticities of
demand and supply are 0.6 and 1.4
respectively, an increase in the supply of
milk by 10% will decrease equilibrium price
by 5%.
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