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CHAPTER 6
Describing Supply and Demand: Elasticities
Eleventh Edition
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Chapter Goals
Use elasticity to describe the responsiveness of quantities to
changes in price and distinguish five elasticity terms.
Explain the importance of substitution in determining
elasticity of supply and demand.
Relate price elasticity of demand to total revenue.
Define and calculate income elasticity and cross-price
elasticity of demand.
Explain how the concept of elasticity makes supply and
demand analysis more useful.
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Price Elasticity of Demand
an increase in supply brings

A large fall in price

A small increase in the
quantity
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demanded
3
Price Elasticity of Demand
an increase in
supply brings
A small fall
in price

A large
increase in the
quantity
demanded

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Price Elasticity of Demand
The contrast between the outcomes price changes,
highlights the need for a measure of the
responsiveness of the quantity demanded to a price
change.
The price elasticity of demand is a units-free
measure of the responsiveness of the quantity
demanded of a good to a change in its price when
all other influences on buying plans remain the
same.
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Price Elasticity: Demand 1
Price elasticity of demand is the percentage change in
quantity demanded divided by the percentage change in
price.
% change in Quantity Demanded
ED =
% change in Price
This tells us exactly how quantity demanded responds to a
change in price.
Elasticity is independent of units.
Price elasticity of demand is always expressed as a positive
number.
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Price Elasticity: Demand 2
Demand is elastic if the percentage change in quantity is
greater than the percentage change in price.
Elastic demand is when ED > 1.
Demand is inelastic if the percentage change in quantity is
less than the percentage change in price.
Inelastic demand is when ED < 1.
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Calculating Elasticities: Price Elasticity of Demand
What is the price
elasticity of demand
between A and B?
Point
Price
Quantity
Demanded
A
$20
14
B
$26
10
Q2  Q1
%Q 1 2 (Q2  Q1 )
ED 

P2  P1
%P
1 2 (P2  P1 )
10  14
1 (10  14)
.33
 2

 1.27
26  20
.26
1 (26  20)
2
Access the text alternative for slide images.
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Price Elasticity of Demand
Rearranging the formula:
%Q / %P = Pavg Q / Qavg P
(P1+P2)/2 x (Q2-Q1)
(Q1+Q2)/2 x (P2-P1)
OR
Q2  Q1
%Q 1 2 (Q2  Q1 )
ED 

P2  P1
%P
1 2 (P2  P1 )
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Elasticity Is Not the Same as Slope
Elasticity is not the same as slope, but, the steeper a curve is at a given
point, the less elastic demand or supply.
This curve is perfectly inelastic,
meaning that Q does not respond at
all to changes in price, ED = 0.
This curve is perfectly elastic, meaning
that Q responds enormously to
changes in price, ED = ∞.
Access the text alternative for slide images.
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Elasticity Changes Along Straight-Line Curves 1
On straight-line
supply and
demand curves,
slope stays
constant, but
elasticity changes.
Elasticity declines
along this straightline demand curve
as we move
towards the Q
axis.
Access the text alternative for slide images.
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Five Terms to Describe Elasticity
Five elasticity terms are:
1. Perfectly elastic (E = ∞).
2. Elastic (E > 1).
3. Unit elastic (E = 1).
4. Inelastic (E < 1).
5. Perfectly inelastic (E = 0).
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Substitution and Elasticity
What makes supply or demand more or less elastic?
Substitution
The most important determinant of price elasticity is the
number of substitutes for the good.
A general rule is: The more substitutes a good has, the more
elastic its supply or demand.
If a good has substitutes, a rise in the price of that good will
cause the consumer to shift consumption to those substitute
goods.
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Substitution and Demand
The number of substitutes a good has is affected by several
factors. Four of the most important factors:
1.The time period being considered.
The more time consumers have to adjust to a price change,
or the longer that a good can be stored without losing its
value, the more elastic is the demand for that good
2.The degree to which a good is a luxury.
Necessities, such as food or housing, generally have
inelastic demand.
Luxuries, such as exotic vacations, generally have elastic
demand.
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Substitution and Demand
3.The market definition.
If the definition of the good is broad, there are few
substitutes and demand is inelastic. When definition
becomes more specific, there are more substitutes and
demand becomes more elastic.
4. The importance of the good in one’s budget.
The greater the proportion of income consumers spend on a
good, the larger is the elasticity of demand for that good
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Elasticity, Total Revenue, and Demand
The elasticity of demand tells suppliers how their total
revenue will change if their price changes.
Total revenue is price multiplied by quantity:
TR = (P)(Q)
• If ED > 1, an increase in price decreases total revenue.
(Price and total revenue move in opposite directions.)
• If ED = 1, an increase in price leaves total revenue
unchanged.
• If ED < 1, an increase in price increases total revenue.(like
price of fuel )
(Price and total revenue move in the same direction.)
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Relationship between elasticity and total revenue
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Example link
https://www.extension.iastate.edu/agdm/wholefarm/html/c5-207.html
https://www.youtube.com/watch?v=Wj8ooMI2iP4
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Application: Unit Elastic Demand
TRE = P × Q = areas A
+ B = $4 × 6 = $24
TRF = P × Q = areas A
+ C = $6 × 4 = $24
If ED = 1, an increase in
price leaves total
revenue unchanged.
Access the text alternative for slide images.
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Application: Inelastic Demand (like fuel )
TRG = P × Q = areas A +
B = $1 × 9 = $9
TRH = P × Q = areas A +
C = $2 × 8 = $16
If ED < 1, an increase in
price increases total
revenue.
Access the text alternative for slide images.
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Application: Elastic Demand( like meat)
TRJ = P × Q = areas A +
B = $8 × 2 = $16
TRK = P × Q = areas A +
C = $9 × 1 = $9
If ED > 1, an increase in
price decreases total
revenue.
Access the text alternative for slide images.
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Relationship Between Elasticity and Total Revenue
Price Rise
Price Decline
Elastic (ED > 1)
TR decreases
TR increases
Unit Elastic (ED = 1)
TR constant
TR constant
Inelastic (ED < 1)
TR increases
TR decreases
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Elasticity Changes Along Straight-Line Curves 2
On straight-line supply
curve, slope stays constant,
but elasticity changes.
If it intersects the vertical
axis (S0), elasticity starts at
infinity and declines, and
eventually approaches 1.
If it intersects the horizontal
axis (S1), it starts at zero
and increases, and
eventually approaches 1.
Access the text alternative for slide images.
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Price Elasticity: Supply 1
Price elasticity of supply is the percentage change in
quantity supplied divided by the percentage change in price.
% change in Quantity Supplied
ES =
% change in Price
This tells us exactly how quantity supplied responds to a
change in price.
Elasticity is independent of units.
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Price Elasticity: Supply 2
Supply is elastic if the percentage change in quantity is
greater than the percentage change in price.
Elastic supply is when ES > 1.
Supply is inelastic if the percentage change in quantity is
less than the percentage change in price.
Inelastic supply is when ES < 1.
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Calculating Elasticities: Price Elasticity of Supply
What is the price elasticity
of supply between A and B?
Point
Price
Quantity
Supplied
A
$4.50
476
B
$5.00
485
Q 2  Q1
%Q 1/ 2  Q 2  Q1 
Es 

P2  P1
%P
1/ 2  P2  P1 
485  476
1/ 2  485  476  0.0187


= 0.18
5  4.50
0.105
1/ 2  5  4.50 
Access the text alternative for slide images.
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Price Elasticity of Supply
Rearranging the formula:
%Q / %P = Pavg Q / Qavg P
(P1+P2)/2 x (Q2-Q1)
(Q1+Q2)/2 x (P2-P1)
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Income and Cross-Price Elasticity 1
Income elasticity of demand measures the responsiveness
of demand to changes in income.
% change in Demand
EIncome =
% change in Income
Normal goods are those whose consumption increases with
an increase in income.
Necessity: 0 < EIncome > 1
Luxury: EIncome > 1
Inferior goods are those whose consumption decreases
with an increase in income, EIncome < 0.
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Income and Cross-Price Elasticity 2
Cross–price elasticity of demand measures the
responsiveness of demand to changes in prices of other
goods.
Ecross-price
% change in Demand

% change in P of related good
E QaPb=
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(P1+P2)/2 x (Q2-Q1)
(Q1+Q2)/2 x (P2-P1)
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Cross Price Elasticity of Demand
Substitutes are goods that can be used in place of another, Ecrossprice > 0.
Complements are goods that are used conjunction with other
goods, Ecross-price < 0.(sugar and coffee)
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Shifting Supply and Elastic Demand
The more elastic the
demand (supply), the
greater the effect of a
supply (demand) shift
on quantity and the
smaller the effect on
price.
Demand is relatively
elastic.
Supply shifts out and
caused a greater
effect on quantity than
on price.
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Shifting Supply and Inelastic Demand
Demand is relatively
inelastic.
Supply shifts out
and caused a
greater effect on
price than on
quantity.
Access the text alternative for slide images.
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Elasticity of Supply
When demand
increases, is the
change in the
quantity supplied
small or large?
In Figure an
increase in
demand brings
A large rise in
price
A small increase in
the quantity
supplied
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Elasticity of Supply
More Elastic
supply:
In Figure an
increase in
demand brings
A small rise
in price

A large
increase in the
quantity

supplied
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Chapter Summary 1
Elasticity is percentage change in quantity divided by
percentage change in some variable that affects demand
(supply). The most common elasticity is price.
Percentage change in quantity demanded
Ed =
Percentage change in price
Percentage change in quantity supplied
Es =
Percentage change in price
Elasticity is a better descriptor than is slope because it is
independent of units of measurement.
To calculate percentage changes in prices and quantities,
use the average of the end values.
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Chapter Summary 2
Five elasticity terms are elastic (E>1); inelastic (E<1); unit
elastic (E=1); perfectly inelastic (E=0) ; and perfectly elastic
(E=∞).
The more substitutes a good has, the greater its elasticity.
Demand becomes less elastic as we move down along a
demand curve.
The most important factor affecting the number of substitutes
in supply is time. The longer the time interval, the more
elastic is supply.
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Chapter Summary 3
Factors affecting the number of substitutes in demand are:
time period, degree to which the good is a luxury, market
definition, importance of the good in one’s budget.
When a supplier raises price, if demand is inelastic, total
revenue increases; if demand is elastic, total revenue
decreases; if demand is unit elastic, total revenue remains
constant.
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Chapter Summary 4
Other important elasticity concepts are income elasticity and
cross-price elasticity of demand.
Income elasticity of demand is the percentage change in
demand/percentage change in income.
Cross-price elasticity of demand is the percentage change in
demand/percentage change in price of a related good.
The more elastic the demand/supply, the greater the effect of
a shift on quantity and the smaller the effect on price.
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