SUPPLY AND DEMAND (3.6.2)
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Table of Contents
Access Prior
Knowledge
Set Goals
New
Information
Activity
Conclusion
Elasticity Survey
“Elasticity of Demand”
Learning Targets
The Price
Elasticity of Demand
Determining Elasticity
“Elasticity of Demand”
Learning Targets
The Midpoint Method
Coefficient of
Elasticity
Total Revenue Test
Determinants of
Elasticity
Cross-Price
Elasticity of Demand
Income
Elasticity of Demand
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“Elasticity of Demand” Targets
Knowledge
Understand the difference between elastic and inelastic demand.
Reasoning
Determine whether items are elastic or inelastic using the determinants of
elasticity.
Skill
Use formulas to calculate the price elasticity of demand, the cross-price
elasticity of demand, and the income elasticity of demand.
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The Price Elasticity of Demand
The elasticity of demand measures how much the quantity demanded will
change when other factors change.
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The Price Elasticity of Demand
The elasticity of demand measures how much the quantity demanded will
change when other factors change.
1) Price elasticity of demand
measures how sensitive consumers
are to a change in price.
In the opening activity, we measured how sensitive
you were to changes in price.
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The Price Elasticity of Demand
The elasticity of demand measures how much the quantity demanded will
change when other factors change.
1) Price elasticity of demand
measures how sensitive consumers
are to a change in price.
2) Elastic demand means consumers
are sensitive to a change in price.
Consumers are highly sensitive to a change in price
for a meal at a sit-down restaurant. They will
consume much less even if the price rises just a little.
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The Price Elasticity of Demand
The elasticity of demand measures how much the quantity demanded will
change when other factors change.
1) Price elasticity of demand
measures how sensitive consumers
are to a change in price.
2) Elastic demand means consumers
are sensitive to a change in price.
3)
Inelastic
demand
means
consumers are not sensitive to a
change in price.
Consumers are not sensitive to a change in price for
gasoline. They will consume only a little less even if
the price rises a lot.
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The Price Elasticity of Demand
The elasticity of demand measures how much the quantity demanded will
change when other factors change.
1) Price elasticity of demand
measures how sensitive consumers
are to a change in price.
2) Elastic demand means consumers
are sensitive to a change in price.
3)
Inelastic
demand
means
consumers are not sensitive to a
change in price.
Price elasticity
of demand
% change in quantity
% change in price
4) Elasticity equals the percent
change in quantity demanded divided
by the percent change in price.
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The Midpoint Method
When measuring percent changes, you will get a different result depending on
which number you start with. The midpoint method eliminates this problem.
We will use this formula to calculate the price elasticity
of demand. The midpoint method tells us how to
calculate each “% change” properly.
Price elasticity
of demand
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% change in quantity
% change in price
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The Midpoint Method
When measuring percent changes, you will get a different result depending on
which number you start with. The midpoint method eliminates this problem.
1) Formula to find the numerator:
% change in
quantity
Change in quantity
Average quantity
Price elasticity
of demand
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% change in quantity
% change in price
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The Midpoint Method
When measuring percent changes, you will get a different result depending on
which number you start with. The midpoint method eliminates this problem.
1) Formula to find the numerator:
% change in
quantity
Change in quantity
Average quantity
2) Numerator formula rewritten:
% change in
quantity
Example
Price (P)
Quantity Demanded (Q)
Situation 1
$3
12
Situation 2
$5
8
Q2 - Q1
(Q1 + Q2) / 2
Calculate
% change in quantity
Price elasticity
of demand
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% change in quantity
% change in price
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The Midpoint Method
When measuring percent changes, you will get a different result depending on
which number you start with. The midpoint method eliminates this problem.
1) Formula to find the numerator:
% change in
quantity
Change in quantity
Average quantity
2) Numerator formula rewritten:
% change in
quantity
Example
Price (P)
Quantity Demanded (Q)
Situation 1
$3
12
Situation 2
$5
8
Q2 - Q1
(Q1 + Q2) / 2
8 - 12
(12 + 8) / 2
Price elasticity
of demand
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-4
10
- 0.4
% change in quantity
% change in price
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The Midpoint Method
When measuring percent changes, you will get a different result depending on
which number you start with. The midpoint method eliminates this problem.
1) Formula to find the numerator:
% change in
quantity
Example
Change in quantity
Average quantity
2) Numerator formula rewritten:
% change in
quantity
Price (P)
Quantity Demanded (Q)
Situation 1
$3
12
Situation 2
$5
8
Q2 - Q1
(Q1 + Q2) / 2
8 - 12
(12 + 8) / 2
-4
10
- 0.4
3) Denominator has a similar formula:
% change in
price
P2 - P1
(P1 + P2) / 2
Calculate
% change in price
Price elasticity
of demand
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% change in quantity
% change in price
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The Midpoint Method
When measuring percent changes, you will get a different result depending on
which number you start with. The midpoint method eliminates this problem.
1) Formula to find the numerator:
% change in
quantity
Example
Change in quantity
Average quantity
2) Numerator formula rewritten:
% change in
quantity
Price (P)
Quantity Demanded (Q)
Situation 1
$3
12
Situation 2
$5
8
Q2 - Q1
(Q1 + Q2) / 2
8 - 12
(12 + 8) / 2
-4
10
- 0.4
$5 - $3
($3 + $5) / 2
$2
$4
0.5
3) Denominator has a similar formula:
% change in
price
P2 - P1
(P1 + P2) / 2
Price elasticity
of demand
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% change in quantity
% change in price
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The Midpoint Method
When measuring percent changes, you will get a different result depending on
which number you start with. The midpoint method eliminates this problem.
1) Formula to find the numerator:
% change in
quantity
Example
Change in quantity
Average quantity
2) Numerator formula rewritten:
% change in
quantity
Price (P)
Quantity Demanded (Q)
Situation 1
$3
12
Situation 2
$5
8
Q2 - Q1
(Q1 + Q2) / 2
8 - 12
(12 + 8) / 2
-4
10
- 0.4
$5 - $3
($3 + $5) / 2
$2
$4
0.5
3) Denominator has a similar formula:
% change in
price
P2 - P1
(P1 + P2) / 2
4) This is the complete formula:
PED
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Q2 - Q1
(Q1 + Q2) / 2
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÷
P2 - P1
Complete the Final Step
(P1 + P2) / 2
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The Midpoint Method
When measuring percent changes, you will get a different result depending on
which number you start with. The midpoint method eliminates this problem.
1) Formula to find the numerator:
% change in
quantity
Example
Change in quantity
Average quantity
2) Numerator formula rewritten:
% change in
quantity
Price (P)
Quantity Demanded (Q)
Situation 1
$3
12
Situation 2
$5
8
Q2 - Q1
(Q1 + Q2) / 2
8 - 12
(12 + 8) / 2
-4
10
- 0.4
$5 - $3
($3 + $5) / 2
$2
$4
0.5
3) Denominator has a similar formula:
% change in
price
P2 - P1
(P1 + P2) / 2
4) This is the complete formula:
PED
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Q2 - Q1
(Q1 + Q2) / 2
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÷
P2 - P1
(P1 + P2) / 2
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PED
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- 0.4 ÷ 0.5
- 0.8
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Coefficient of Elasticity
The values we get when we calculate the price elasticity of demand are called
coefficients of elasticity. They tell us the relative elasticity of an item.
All price elasticities of demand are negative by
definition (or zero). Economists usually drop the
negative signs, however, for simplicity.
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Coefficient of Elasticity
The values we get when we calculate the price elasticity of demand are called
coefficients of elasticity. They tell us the relative elasticity of an item.
1) Coefficient Is Zero
Perfectly inelastic demand:
Consumers pay no attention to price.
D
When demand is perfectly inelastic, its graph is a
vertical line. Any change in price has no effect on
quantity.
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Coefficient of Elasticity
The values we get when we calculate the price elasticity of demand are called
coefficients of elasticity. They tell us the relative elasticity of an item.
1) Coefficient Is Zero
Perfectly inelastic demand:
Consumers pay no attention to price.
2) Coefficient Is Between 0 and 1
Inelastic demand:
Consumers are not sensitive to price.
D
D
Inelastic demand is relatively steep. Notice how even
a large change in price has had only a minimal effect
on quantity.
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Coefficient of Elasticity
The values we get when we calculate the price elasticity of demand are called
coefficients of elasticity. They tell us the relative elasticity of an item.
1) Coefficient Is Zero
Perfectly inelastic demand:
Consumers pay no attention to price.
2) Coefficient Is Between 0 and 1
Inelastic demand:
Consumers are not sensitive to price.
3) Coefficient Is 1
Unit elastic demand:
Demand is not elastic or inelastic.
D
D
Unit elastic demand shows an equal change in price
and quantity. Using the midpoint method, price has
changed by 40% and quantity has changed by 40%.
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Coefficient of Elasticity
The values we get when we calculate the price elasticity of demand are called
coefficients of elasticity. They tell us the relative elasticity of an item.
1) Coefficient Is Zero
Perfectly inelastic demand:
Consumers pay no attention to price.
2) Coefficient Is Between 0 and 1
Inelastic demand:
Consumers are not sensitive to price.
3) Coefficient Is 1
D
Unit elastic demand:
Demand is not elastic or inelastic.
D
4) Coefficient Is Greater Than 1
Elastic demand:
Consumers are sensitive to price.
Elastic demand is relatively flat. Notice how only a
small change in price has had a large effect on
quantity.
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Coefficient of Elasticity
The values we get when we calculate the price elasticity of demand are called
coefficients of elasticity. They tell us the relative elasticity of an item.
1) Coefficient Is Zero
Perfectly inelastic demand:
Consumers pay no attention to price.
2) Coefficient Is Between 0 and 1
Inelastic demand:
Consumers are not sensitive to price.
D
3) Coefficient Is 1
D
Unit elastic demand:
Demand is not elastic or inelastic.
4) Coefficient Is Greater Than 1
Elastic demand:
Consumers are sensitive to price.
5) Coefficient Is Infinite
Perfectly elastic demand:
Price changes infinitely affect quantity.
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Perfectly elastic demand is a horizontal line. Any rise
in price will eliminate all demand. The coefficient is
infinite since you must divide by zero in the formula.
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Total Revenue Test
Each section of a demand curve has a different
elasticity. The Total Revenue Test, which also
calculates elasticity, shows how this works.
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Total Revenue Test
Each section of a demand curve has a different
elasticity. The Total Revenue Test, which also
calculates elasticity, shows how this works.
1) Calculations
A) Total Revenue = Price x Quantity
The top graph is a regular demand curve. The
bottom graph shows total revenue for each of the
corresponding quantities from the top graph.
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Total Revenue Test
Each section of a demand curve has a different
elasticity. The Total Revenue Test, which also
calculates elasticity, shows how this works.
1) Calculations
A) Total Revenue = Price x Quantity
B) Calculate total revenue for the
original price and quantity.
For example, suppose the firm in this market has a
price of $1 and a quantity of 9. The total revenue in
this situation is $9.
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Total Revenue Test
Each section of a demand curve has a different
elasticity. The Total Revenue Test, which also
calculates elasticity, shows how this works.
1) Calculations
A) Total Revenue = Price x Quantity
B) Calculate total revenue for the
original price and quantity.
C) Calculate total revenue for the new
price and quantity.
Now, suppose the price increases to $2 and the
quantity drops to 8. Total revenue is now $16. This
firm has increased its revenue by increasing price.
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Total Revenue Test
Each section of a demand curve has a different
elasticity. The Total Revenue Test, which also
calculates elasticity, shows how this works.
Inelastic
1) Calculations
A) Total Revenue = Price x Quantity
B) Calculate total revenue for the
original price and quantity.
C) Calculate total revenue for the new
price and quantity.
2) Results
A) INELASTIC: total revenue moved
in the same direction as price.
Notice that this firm will increase its revenue as long
as it keeps increasing its price up to $5. Price and
revenue are moving in the same direction.
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Total Revenue Test
Each section of a demand curve has a different
elasticity. The Total Revenue Test, which also
calculates elasticity, shows how this works.
Elastic
Inelastic
1) Calculations
A) Total Revenue = Price x Quantity
B) Calculate total revenue for the
original price and quantity.
C) Calculate total revenue for the new
price and quantity.
2) Results
A) INELASTIC: total revenue moved
in the same direction as price.
B) ELASTIC: total revenue moved in
the opposite direction as price.
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Notice that as price increases beyond $5, total
revenue gets smaller. Price and revenue are moving
in opposite directions.
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Total Revenue Test
Each section of a demand curve has a different
elasticity. The Total Revenue Test, which also
calculates elasticity, shows how this works.
Elastic
Unit Elastic
Inelastic
1) Calculations
A) Total Revenue = Price x Quantity
B) Calculate total revenue for the
original price and quantity.
C) Calculate total revenue for the new
price and quantity.
2) Results
A) INELASTIC: total revenue moved
in the same direction as price.
B) ELASTIC: total revenue moved in
the opposite direction as price.
C) UNIT ELASTIC: total revenue did
not change.
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When total revenue reaches its maximum, the
demand is unit elastic. Notice that moving from $4 to
$6, for example, does not change total revenue.
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Determinants of Elasticity
Several factors help determine whether an item is relatively elastic or inelastic.
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Determinants of Elasticity
Several factors help determine whether an item is relatively elastic or inelastic.
1) Items Are Elastic If…
A) Substitutes exist and are readily
available.
Pizza restaurants have many competitors and, thus,
many substitutes. If one chain raises their prices,
consumers can easily find a substitute.
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Determinants of Elasticity
Several factors help determine whether an item is relatively elastic or inelastic.
1) Items Are Elastic If…
A) Substitutes exist and are readily
available.
B) The item represents a large portion
of a person’s income.
For most people, airline travel is extremely costly.
Although flying has few substitutes, many people will
simply choose not to travel if prices are too high.
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Determinants of Elasticity
Several factors help determine whether an item is relatively elastic or inelastic.
1) Items Are Elastic If…
A) Substitutes exist and are readily
available.
B) The item represents a large portion
of a person’s income.
C) The item is a luxury.
Food in general is a very inelastic item. When
discussing the market for restaurant food, however,
the good is considered a luxury and is thus elastic.
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Determinants of Elasticity
Several factors help determine whether an item is relatively elastic or inelastic.
1) Items Are Elastic If…
A) Substitutes exist and are readily
available.
B) The item represents a large portion
of a person’s income.
C) The item is a luxury.
D) Consumers have a lot of time to
adjust to a change in price.
Gasoline is inelastic in the short run but is elastic in
the long run. This is because consumers will find
alternative fuels and adjust their habits if given time.
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Determinants of Elasticity
Several factors help determine whether an item is relatively elastic or inelastic.
1) Items Are Elastic If…
A) Substitutes exist and are readily
available.
B) The item represents a large portion
of a person’s income.
C) The item is a luxury.
D) Consumers have a lot of time to
adjust to a change in price.
2) Items Are Inelastic If…
A) Substitutes are hard to find or may
not exist.
Electricity is a necessary good for most people. If the
price of electricity increases, we may complain about
it, but we will certainly pay it.
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Determinants of Elasticity
Several factors help determine whether an item is relatively elastic or inelastic.
1) Items Are Elastic If…
A) Substitutes exist and are readily
available.
B) The item represents a large portion
of a person’s income.
C) The item is a luxury.
D) Consumers have a lot of time to
adjust to a change in price.
2) Items Are Inelastic If…
A) Substitutes are hard to find or may
not exist.
B) The item is a small portion of a
person’s income.
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A cup of coffee generally costs very little. Thus, even
large percentage increases in price may go largely
unnoticed by the consumer.
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Determinants of Elasticity
Several factors help determine whether an item is relatively elastic or inelastic.
1) Items Are Elastic If…
A) Substitutes exist and are readily
available.
B) The item represents a large portion
of a person’s income.
C) The item is a luxury.
D) Consumers have a lot of time to
adjust to a change in price.
2) Items Are Inelastic If…
A) Substitutes are hard to find or may
not exist.
B) The item is a small portion of a
person’s income.
C) The item is a necessity.
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Consumers often have little choice about whether or
not to take a prescription medication. They will pay
almost any price if it means feeling healthy.
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Determinants of Elasticity
Several factors help determine whether an item is relatively elastic or inelastic.
1) Items Are Elastic If…
A) Substitutes exist and are readily
available.
B) The item represents a large portion
of a person’s income.
C) The item is a luxury.
D) Consumers have a lot of time to
adjust to a change in price.
2) Items Are Inelastic If…
A) Substitutes are hard to find or may
not exist.
B) The item is a small portion of a
person’s income.
C) The item is a necessity.
Consumers may be able to find alternative fuels and
adjust their habits in the long run, but they are not
sensitive to increases in gas prices in the short run.
D) Consumers have little time to
adjust to a change in price.
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Cross-Price Elasticity of Demand
Another type of elasticity is the cross-price elasticity of demand, which
measures how strongly two substitutes or two complements are related.
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Cross-Price Elasticity of Demand
Another type of elasticity is the cross-price elasticity of demand, which
measures how strongly two substitutes or two complements are related.
1) We use a slightly different formula:
Cross elasticity
of demand
Title Page
Example
Item A
P
Q
Item B
P
Q
Situation 1
$12
14
Situation 1
$19
34
Situation 2
$10
18
Situation 2
$21
30
% change in quantity of A
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% change in price of B
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Cross-Price Elasticity of Demand
Another type of elasticity is the cross-price elasticity of demand, which
measures how strongly two substitutes or two complements are related.
1) We use a slightly different formula:
Cross elasticity
of demand
Example
Item A
P
Q
Item B
P
Q
Situation 1
$12
14
Situation 1
$19
34
Situation 2
$10
18
Situation 2
$21
30
% change in quantity of A
% change in price of B
2) Still use the midpoint method for
calculating each percent change.
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Calculate
% change in quantity of A
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Cross-Price Elasticity of Demand
Another type of elasticity is the cross-price elasticity of demand, which
measures how strongly two substitutes or two complements are related.
1) We use a slightly different formula:
Cross elasticity
of demand
Example
Item A
P
Q
Item B
P
Q
Situation 1
$12
14
Situation 1
$19
34
Situation 2
$10
18
Situation 2
$21
30
% change in quantity of A
% change in price of B
2) Still use the midpoint method for
calculating each percent change.
Calculate the value of the numerator
4
18 - 14
0.25
16
(14 + 18) / 2
Calculate
% change in price of B
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Cross-Price Elasticity of Demand
Another type of elasticity is the cross-price elasticity of demand, which
measures how strongly two substitutes or two complements are related.
1) We use a slightly different formula:
Cross elasticity
of demand
Example
Item A
P
Q
Item B
P
Q
Situation 1
$12
14
Situation 1
$19
34
Situation 2
$10
18
Situation 2
$21
30
% change in quantity of A
% change in price of B
2) Still use the midpoint method for
calculating each percent change.
Calculate the value of the numerator
4
18 - 14
0.25
16
(14 + 18) / 2
Calculate the value of the denominator
$2
$21 - $19
0.1
$20
($19 + $21) / 2
Complete the Final Step
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Cross-Price Elasticity of Demand
Another type of elasticity is the cross-price elasticity of demand, which
measures how strongly two substitutes or two complements are related.
1) We use a slightly different formula:
Cross elasticity
of demand
Example
Item A
P
Q
Item B
P
Q
Situation 1
$12
14
Situation 1
$19
34
Situation 2
$10
18
Situation 2
$21
30
% change in quantity of A
% change in price of B
2) Still use the midpoint method for
calculating each percent change.
Calculate the value of the numerator
4
18 - 14
0.25
16
(14 + 18) / 2
Calculate the value of the denominator
$2
$21 - $19
0.1
$20
($19 + $21) / 2
Divide numerator by denominator
CED
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0.25 ÷ 0.1
2.5
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Cross-Price Elasticity of Demand
Another type of elasticity is the cross-price elasticity of demand, which
measures how strongly two substitutes or two complements are related.
1) We use a slightly different formula:
Cross elasticity
of demand
Example
Item A
P
Q
Item B
P
Q
Situation 1
$12
14
Situation 1
$19
34
Situation 2
$10
18
Situation 2
$21
30
% change in quantity of A
% change in price of B
2) Still use the midpoint method for
calculating each percent change.
3) Goods with positive cross-price
elasticities are substitutes.
Calculate the value of the numerator
4
18 - 14
0.25
16
(14 + 18) / 2
Calculate the value of the denominator
$2
$21 - $19
0.1
$20
($19 + $21) / 2
Divide numerator by denominator
CED
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Cross-Price Elasticity of Demand
Another type of elasticity is the cross-price elasticity of demand, which
measures how strongly two substitutes or two complements are related.
1) We use a slightly different formula:
Cross elasticity
of demand
Example
Item A
P
Q
Item B
P
Q
Situation 1
$12
14
Situation 1
$19
34
Situation 2
$10
18
Situation 2
$21
30
% change in quantity of A
% change in price of B
2) Still use the midpoint method for
calculating each percent change.
3) Goods with positive cross-price
elasticities are substitutes.
4) Goods with negative cross-price
elasticities are complements.
Calculate the value of the numerator
4
18 - 14
0.25
16
(14 + 18) / 2
Calculate the value of the denominator
$2
$21 - $19
0.1
$20
($19 + $21) / 2
Divide numerator by denominator
CED
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Cross-Price Elasticity of Demand
Another type of elasticity is the cross-price elasticity of demand, which
measures how strongly two substitutes or two complements are related.
1) We use a slightly different formula:
Cross elasticity
of demand
Example
Item A
P
Q
Item B
P
Q
Situation 1
$12
14
Situation 1
$19
34
Situation 2
$10
18
Situation 2
$21
30
% change in quantity of A
% change in price of B
2) Still use the midpoint method for
calculating each percent change.
3) Goods with positive cross-price
elasticities are substitutes.
4) Goods with negative cross-price
elasticities are complements.
5) Cross-price elasticities near zero
mean the goods are unrelated.
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Calculate the value of the numerator
4
18 - 14
0.25
16
(14 + 18) / 2
Calculate the value of the denominator
$2
$21 - $19
0.1
$20
($19 + $21) / 2
Divide numerator by denominator
CED
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Income Elasticity of Demand
Another type of elasticity is the income elasticity of demand, which measures
how much quantity changes when consumer income changes.
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Income Elasticity of Demand
Another type of elasticity is the income elasticity of demand, which measures
how much quantity changes when consumer income changes.
1) We use a slightly different formula:
Income elasticity
of demand
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Example
P
Q
Situation 1
$25
45
Situation 1
$700
Situation 2
$21
55
Situation 2
$900
% change in quantity
% change in income
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Income
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Income Elasticity of Demand
Another type of elasticity is the income elasticity of demand, which measures
how much quantity changes when consumer income changes.
1) We use a slightly different formula:
Income elasticity
of demand
Example
P
Q
Situation 1
$25
45
Situation 1
$700
Situation 2
$21
55
Situation 2
$900
% change in quantity
% change in income
2) Still use the midpoint method for
calculating each percent change.
Income
Calculate
% change in quantity
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Income Elasticity of Demand
Another type of elasticity is the income elasticity of demand, which measures
how much quantity changes when consumer income changes.
1) We use a slightly different formula:
Income elasticity
of demand
Example
P
Q
Situation 1
$25
45
Situation 1
$700
Situation 2
$21
55
Situation 2
$900
% change in quantity
% change in income
2) Still use the midpoint method for
calculating each percent change.
Income
Calculate the value of the numerator
10
55 - 45
0.2
50
(45 + 55) / 2
Calculate
% change in income
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Income Elasticity of Demand
Another type of elasticity is the income elasticity of demand, which measures
how much quantity changes when consumer income changes.
1) We use a slightly different formula:
Income elasticity
of demand
Example
P
Q
Situation 1
$25
45
Situation 1
$700
Situation 2
$21
55
Situation 2
$900
% change in quantity
% change in income
2) Still use the midpoint method for
calculating each percent change.
Income
Calculate the value of the numerator
10
55 - 45
0.2
50
(45 + 55) / 2
Calculate the value of the denominator
$200
$900 - $700
0.25
$800
($700 + $900) / 2
Complete the Final Step
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Income Elasticity of Demand
Another type of elasticity is the income elasticity of demand, which measures
how much quantity changes when consumer income changes.
1) We use a slightly different formula:
Income elasticity
of demand
Example
P
Q
Situation 1
$25
45
Situation 1
$700
Situation 2
$21
55
Situation 2
$900
% change in quantity
% change in income
2) Still use the midpoint method for
calculating each percent change.
Income
Calculate the value of the numerator
10
55 - 45
0.2
50
(45 + 55) / 2
Calculate the value of the denominator
$200
$900 - $700
0.25
$800
($700 + $900) / 2
Divide numerator by denominator
IED
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0.8
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Income Elasticity of Demand
Another type of elasticity is the income elasticity of demand, which measures
how much quantity changes when consumer income changes.
1) We use a slightly different formula:
Income elasticity
of demand
Example
P
Q
Situation 1
$25
45
Situation 1
$700
Situation 2
$21
55
Situation 2
$900
% change in quantity
% change in income
2) Still use the midpoint method for
calculating each percent change.
3) Normal goods
income elasticities.
have
Income
Calculate the value of the numerator
10
55 - 45
0.2
50
(45 + 55) / 2
positive
Calculate the value of the denominator
$200
$900 - $700
0.25
$800
($700 + $900) / 2
Divide numerator by denominator
IED
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0.8
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Income Elasticity of Demand
Another type of elasticity is the income elasticity of demand, which measures
how much quantity changes when consumer income changes.
1) We use a slightly different formula:
Income elasticity
of demand
Example
P
Q
Situation 1
$25
45
Situation 1
$700
Situation 2
$21
55
Situation 2
$900
% change in quantity
% change in income
2) Still use the midpoint method for
calculating each percent change.
3) Normal goods
income elasticities.
have
Calculate the value of the numerator
10
55 - 45
0.2
50
(45 + 55) / 2
positive
4) If below 1, it is income-inelastic:
demand rises slower than income.
Income
Calculate the value of the denominator
$200
$900 - $700
0.25
$800
($700 + $900) / 2
Divide numerator by denominator
IED
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0.8
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Income Elasticity of Demand
Another type of elasticity is the income elasticity of demand, which measures
how much quantity changes when consumer income changes.
1) We use a slightly different formula:
Income elasticity
of demand
Example
P
Q
Situation 1
$25
45
Situation 1
$700
Situation 2
$21
55
Situation 2
$900
% change in quantity
% change in income
2) Still use the midpoint method for
calculating each percent change.
3) Normal goods
income elasticities.
have
Calculate the value of the numerator
10
55 - 45
0.2
50
(45 + 55) / 2
positive
4) If below 1, it is income-inelastic:
demand rises slower than income.
5) If above 1, it is income-elastic:
demand rises faster than income.
Calculate the value of the denominator
$200
$900 - $700
0.25
$800
($700 + $900) / 2
Divide numerator by denominator
IED
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Income
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0.8
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Income Elasticity of Demand
Another type of elasticity is the income elasticity of demand, which measures
how much quantity changes when consumer income changes.
1) We use a slightly different formula:
Income elasticity
of demand
% change in income
3) Normal goods
income elasticities.
have
Q
Situation 1
$25
45
Situation 1
$700
Situation 2
$21
55
Situation 2
$900
5) If above 1, it is income-elastic:
demand rises faster than income.
6) Inferior goods
income elasticities.
have
negative
Back
Income
Calculate the value of the numerator
10
55 - 45
0.2
50
(45 + 55) / 2
positive
4) If below 1, it is income-inelastic:
demand rises slower than income.
Table of Contents
P
% change in quantity
2) Still use the midpoint method for
calculating each percent change.
Title Page
Example
Calculate the value of the denominator
$200
$900 - $700
0.25
$800
($700 + $900) / 2
Divide numerator by denominator
IED
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Determining Elasticity
DETERMINANTS OF ELASTICITY
The table lists the characteristics of an item that is elastic (first column) and
the characteristics of an item that is inelastic (second column). In the
problems that follow, first identify whether the item is elastic or inelastic.
Then, write down the letter(s) from the table that lists the proper explanation.
THE PRICE ELASTICITY OF DEMAND
Use the formula for the price elasticity of demand to solve these problems.
Remember, coefficients below 1 are inelastic; coefficients equal to 1 are unit
elastic; and coefficients greater than 1 are elastic.
TOTAL REVENUE TEST
Use the Total Revenue Test to solve these problems. Remember, if total
revenue moves in the same direction as price, it is inelastic; if total revenue
stays the same, it is unit elastic; and if total revenue moves in the opposite
direction as price, it is elastic.
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“Elasticity of Demand” Targets
Knowledge
Understand the difference between elastic and inelastic demand.
Reasoning
Determine whether items are elastic or inelastic using the determinants of
elasticity.
Skill
Use formulas to calculate the price elasticity of demand, the cross-price
elasticity of demand, and the income elasticity of demand.
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Images courtesy of www.sxc.hu
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