5
Elasticity
Percentage Change
Demand increases from 80 to 100.
% increase =
100 - 80
80
= 0.25 = 25%
Demand decreases from 100 to 80.
% decrease =
100 - 80
100
= 0.20 = 20%
Price per pound ($)
Price Elasticity of Demand
1.2
% decrease in quantity
1.0
0.8
0.6
0.4
0.2
% increase in price
5 10 15 20 25 30 35
Pounds of Coffee (M)
Price elasticity =
of demand
% change in quantity demanded
% change in price
“a measure of responsiveness”
Elastic (elasticity>1.0)
very responsive
Inelastic (elasticity<1.0)
not very responsive
Perfectly inelastic
Price per pound ($)
price has no effect
1.2
1.0
0.8
Perfectly elastic
0.6
only one price will do
0.4
0.2
5 10 15 20 25 30 35
Pounds of Coffee (M)
Determinants of Price Elasticity
Using the Price Elasticity of Demand
Price elasticity =
of demand
% change in
=
quantity
% change in quantity demanded
% change in price
Price elasticity
X % change in price
of demand
What impact increasing egg prices from $1.20 to $1.35?
=
X
Changes in Total Revenue
If 50,000 dozen eggs are sold at $1.20, what impact
on revenue of increasing price to $1.35?
Decrease in eggs sold = 50,000 x 1.25% = 625
Old revenue = 50,000 x $1.20 = $60,000
New revenue = 49,375 x $1.35 = $66,656
Elastic
price increase will decrease revenue
Inelastic
price increase will increase revenue
Other Elasticities of Demand
Income elasticity = % change in quantity demanded
of demand
% change in income
Cross elasticity
of demand
=
% change in X demanded
% change in price of Y
Substitutes
cross elasticity is positive
Complements
price elasticity is negative
Price Elasticity of Supply
Price elasticity =
of supply
% change in quantity supplied
% change in price
Determinants of Price Elasticity of Supply
The Incidence of an Excise Tax
Price
Who Bears the Burden?
40
35
30
25$10
When a tax is
imposed on suppliers,
consumers pay more.
20
15
10
And suppliers
receive less.
5
100
200
300
400
500
Quantity
Price
Inelastic demand
(quantity not affected
much by price.)
40
35
30
25
Most of the tax is
born by consumers…
$10
20
15
10
and only a small
portion by producers.
5
100
200
300
400
500
Quantity
Price
Elastic demand
(quantity highly
affected by price.)
40
35
30
25
20
15
10
Tax results in a small
price increase…
$10
… and a large
portion paid by
suppliers.
5
100
200
300
400
500
Quantity
Price
Perfectly Elastic Supply
(horizontal supply curve)
Price increases as
much as the tax.
40
35
30
25
20
15
10
$10
5
100
200
300
400
500
Quantity