Chapter 6
Elasticity
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Price Elasticity of Demand
• Measures buyers’ responsiveness to price
changes
• Elastic demand
• Sensitive to price changes
• Large change in quantity
• Inelastic demand
• Insensitive to price changes
• Small change in quantity
LO2
6-2
Price Elasticity of Demand
Formula
• Formula for price elasticity of demand
Ed =
LO2
percentage change in quantity
demanded of product X
percentage change in price
of product X
6-3
Price Elasticity of Demand
Formula
• Use the midpoint formula
• Ensures consistent results
Ed =
LO2
Change in quantity
Sum of quantities/2
÷
Change in price
Sum of prices/2
6-4
Price Elasticity of Demand
Formula
• Use percentages
• Unit free measure
• Compare elasticities across products
• Eliminate the minus sign
• Easier to compare elasticities
LO2
6-5
Interpretation of Elasticity of Demand
• Ed > 1 demand is elastic
• Ed = 1 demand is unit elastic
• Ed < 1 demand is inelastic
• Extreme cases
• Ed = 0 demand is perfectly inelastic
• Ed= ∞ demand is perfectly elastic
LO2
6-6
Extreme Cases
P
D1
Perfectly
inelastic
demand
(Ed = 0)
0
Perfectly inelastic demand
LO2
6-7
Extreme Cases
P
D2
Perfectly elastic
demand
(Ed = ∞)
0
Perfectly elastic demand
LO2
6-8
Total Revenue Test
• Total Revenue = Price X Quantity
• Total Revenue Test
• Inelastic demand
• P and TR move in the same direction
• Elastic demand
• P and TR move in opposite directions
LO2
6-9
Total Revenue Test
• Lower price and elastic demand
• Blue gain exceeds orange loss
P
$3
a
2
b
1
D1
0
LO2
10
20
30
40
Q
6-10
Total Revenue Test
• Lower price and inelastic demand
• Orange loss exceeds blue gain
P
$4
c
3
2
d
1
D2
LO2
0
10
20
Q
6-11
Total Revenue Test
• Lower price and unit elastic demand
• Blue gain equals orange loss
P
e
$3
2
f
1
D3
0
LO2
10
20
30
Q
6-12
Total Revenue Test
Price Elasticity of Demand for Movie Tickets as Measured by the Elasticity Coefficient and the Total Revenue Test
(1)
Total Quantity of
Tickets Demanded
per Week, Thousands
1
2
3
4
5
6
7
8
LO2
(3)
Elasticity
Coefficient (Ed)
(2)
Price per Ticket
$8
7
6
5
4
3
2
1
]
]
]
]
]
]
]
5.00
2.60
1.57
1.00
0.64
0.38
0.20
(4)
Total Revenue
(1) X (2)
$ 8,000
14,000
18,000
20,000
20,000
18,000
14,000
8,000
(5)
Total-Revenue
Test
]
]
]
]
]
]
]
Elastic
Elastic
Elastic
Unit-elastic
Inelastic
Inelastic
Inelastic
6-13
Price
Elasticity and Total Revenue
Elastic
Ed > 1
Unit elastic
Ed = 1
Inelastic
Ed < 1
$8
7 a
b
6
c
5
d
4
e
3
f
2
g
1
h
0 1 2 3 4 5 6 7 8
D
Total revenue
(Thousands of dollars)
Quantity demanded
LO2
$20
18
16
14
12
10
8
6
4
2
TR
0 1 2 3 4 5 6 7 8
Quantity demanded
6-14
Summary of Price Elasticity of
Demand
Price Elasticity of Demand: A Summary
Absolute Value
of Elasticity
Coefficient
Impact on Total Revenue of a:
Demand Is:
Description
Price Increase
Price Decrease
Greater than 1
(Ed > 1)
Elastic or
relatively
elastic
Qd changes by a
larger percentage
than does price
Total Revenue
decreases
Total Revenue
increases
Equal to 1
(Ed = 1)
Unit or unitary
elastic
Qd changes by the
same percentage
as does price
Total revenue is
unchanged
Total revenue
is unchanged
Less than 1
(Ed < 1)
Inelastic or
relatively
inelastic
Qd changes by a
smaller
percentage than
does price
Total revenue
increases
Total revenue
decreases
6-15
Determinants of Price Elasticity
of Demand
• Substitutability
• More substitutes, demand is more elastic
• Proportion of income
• Higher proportion of income, demand is
more elastic
LO3
6-16
Determinants of Price Elasticity
of Demand
• Luxuries versus necessities
• Luxury goods, demand is more elastic
• Time
• More time available, demand is more
elastic
LO3
6-17
Price Elasticity of Demand
Selected Price Elasticities of Demand
Product or Service
Price Elasticity of
Demand (Ed)
Product or Service
Price Elasticity of
Demand (Ed)
Newspapers
.10
Milk
.63
Electricity (household)
.13
Household appliances
.63
Bread
.15
Liquor
.70
MLB Tickets
.23
Movies
.87
Telephone Service
.26
Beer
.90
Cigarettes
.25
Shoes
.91
Sugar
.30
Motor vehicles
1.14
Medical Care
.31
Beef
1.27
Eggs
.32
China, glassware
1.54
Legal Services
.37
Residential land
1.60
Automobile repair
.40
Restaurant meals
2.27
Clothing
.49
Lamb and mutton
2.65
Gasoline
.60
Fresh peas
2.83
6-18
Applications of Price Elasticity of
Demand
• Large crop yields
• Inelastic demand, lower total revenue
• Excise taxes
• Inelastic demand, more total revenue
• Decriminalization of illegal drugs
• Inelastic demand, more total revenue
LO3
6-19
Price Elasticity of Supply
• Measures sellers’ responsiveness to price
changes
• Elastic supply, producers are responsive to
price changes
• Inelastic supply, producers are not as
responsive to price changes
LO4
6-20
Price Elasticity of Supply
• Formula for price elasticity of supply
Es =
LO4
percentage change in quantity
supplied of Product X
percentage change in price
of product X
6-21
Price Elasticity of Supply
• Es > 1 supply is elastic
• Es = 1 supply is unit elastic
• Es < 1 supply is inelastic
• Additionally,
• Es = 0 supply is perfectly inelastic
LO4
6-22
Price Elasticity of Supply
• Time is primary determinant of elasticity of
supply
• Time periods considered
• Immediate market period
• Short run
• Long run
LO4
6-23
Es: The Immediate Market Period
• Perfectly inelastic supply
Sm
Pm
P0
D2
D1
Q0
LO4
6-24
The Short Run
• Short run supply is more elastic than in the
immediate market period
Ss
Ps
P0
D2
D1
LO4
Q0 Qs
6-25
The Long Run
• Long run supply is even more elastic than in
the short run
SL
Pl
P0
D2
D1
LO4
Q0
Ql
6-26
Applications of Elasticity of
Supply
• Antiques
• Inelastic supply
• Reproductions
• More elastic supply
• Volatile gold prices
• Inelastic supply
LO4
6-27
Cross Elasticity of Demand
• Formula for cross elasticity of demand
Ex,y =
LO5
percentage change in quantity
demanded of product X
percentage change in price
of product Y
6-28
Cross Elasticity of Demand
• Measures responsiveness of purchases of one
good to change in the price of another good
• Substitute goods if elasticity is positive
• Complement goods if elasticity is negative
• Independent goods if elasticity is 0
LO5
6-29
Cross Elasticity of Demand
• Applications of cross elasticity of demand
• Should a company change a price?
• Should the government allow a merger?
LO5
6-30
Income Elasticity of Demand
• Formula for income elasticity of demand
Ei =
LO5
percentage change in quantity demanded
percentage change in income
6-31
Income Elasticity of Demand
• Measures responsiveness of buyers to
changes in their income
• Normal goods if elasticity is positive
• Inferior goods if elasticity is negative
LO5
6-32
Income Elasticity Insights
• High income elasticities
• Most affected by a recession
• Low or negative income elasticity
• Not affected that much by a recession
LO5
6-33
Cross and Income Elasticities
Cross and Income Elasticities of Demand
Value of Coefficient
Cross elasticity:
Positive (Ewz > 0)
Description
Type of Good(s)
Quantity demanded of W changes in same
direction as change in price of Z
Substitutes
Quantity demanded of X changes in opposite
direction from change in price of Y
Complements
Income elasticity:
Positive (Ei >0)
Quantity demanded of the product changes in
same direction as change in income
Normal or superior
Negative (Ei<0)
Quantity demanded of the product changes in
opposite direction from change in income
Inferior
Negative (Exy < 0)
LO5
6-34
Elasticity and Pricing Power
• Charge different prices to different buyers
based on price elasticities
• Business air travelers
• Children discounts
• College tuition
6-35