ECO10004-Economic Principles
Elasticity
Professor Abbas Valadkhani
Week 3
Learning objectives
4.1 Define price elasticity of demand and understand how
to measure it.
4.2 Understand the determinants of the price elasticity of
demand.
4.3 Explain the relationship between the price elasticity of
demand and total revenue.
4.4 Define cross-price elasticity of demand and income
elasticity of demand, and understand their determinants
and how they are measured.
4.5 Define price elasticity of supply, and understand its
main determinants and how it is measured.
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Price elasticity of demand
and its measurement
 Elasticity: A measure of how much one economic
variable, such as the quantity demanded of a
product, responds to changes in another economic
variable, such as the product’s price.
 Price elasticity of demand: The responsiveness of
the quantity demanded of a good to a change in its
price.
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Elastic demand and inelastic
demand (1 of 3)
 Elastic demand: Demand is elastic when the percentage
change in quantity demanded is greater than the
percentage change in price.
 The price elasticity is greater than one in absolute value.
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Elastic demand and inelastic
demand (2 of 3)
 Inelastic demand: Demand is inelastic when the
percentage change in quantity demanded is less than the
percentage change in price.
 The price elasticity is less than one in absolute value.
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Elastic demand and inelastic
demand (3 of 3)
 Unit-elastic demand: Demand is unit-elastic when the
percentage change in quantity demanded is equal to the
percentage change in price.
 The price elasticity is equal to one in absolute value.
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Elastic and inelastic demand curves:
Figure 4.1
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The midpoint formula (1 of 2)
 This formula is used to ensure that the value of the
price elasticity of demand between the same two
points is the same whether the price increases or
decreases.
Price elasticity of demand =
(Q2 – Q1)
(Q1 + Q2)
2
(P1 –P2)
÷ (P1 + P2)
2
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The midpoint formula (2 of 2)
A cinema reduced the price of movie tickets from
$20 to $15, and average daily sales then increased
from 5 000 tickets to 7 000 tickets. Calculate the
price elasticity of demand using the midpoint
formula.
2 000/6 000
−5/17.5
= −1.17
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Polar cases of elasticity
 Perfectly inelastic demand: Demand is perfectly
inelastic when a change in price results in no
change in quantity demanded.
 Perfectly elastic demand: Demand is perfectly
elastic when a change in price results in an infinite
change in quantity demanded.
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Solved Problem 1: Calculating the
price elasticity of demand for wheat
using the midpoint formula (1 of 3)
• % change in P=(340-300)/320=0.125
• % change in Q=(22000-24000)/23000=-0.08696
• Elasticity= -0.6956. Rounded to -0.70.
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9781488616983/Hubbard/Essentials of Economics/4e
Summary of the price elasticities of
demand: Table 4.1 (1 of 3)
If demand is elastic, then
the absolute value of the
price elasticity is greater
than 1.
If demand is inelastic,
then the absolute value of
the price elasticity is less
than 1.
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9781488616983/Hubbard/Essentials of Economics/4e
Summary of the price elasticities of
demand: Table 4.1 (2 of 3)
If demand is unit elastic,
then the absolute value of
the price elasticity is
equal to 1.
If demand is perfectly
elastic, then the absolute
value of the price
elasticity is equal to
infinity.
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9781488616983/Hubbard/Essentials of Economics/4e
Summary of the price elasticities of
demand: Table 4.1 (3 of 3)
If demand is perfectly
inelastic, then the
absolute value of the
price elasticity is equal to
0.
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The determinants of the price
elasticity of demand
1.
Availability of close substitutes
2.
The length of time involved
3.
Luxuries versus necessities
4.
Definition of the market
5.
Share of expenditure on the good in the
consumer’s budget
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The relationship between price
elasticity and total revenue (1 of 2)
 Total revenue: The total amount of funds received by a
seller of a good or service.
 Total revenue is found by multiplying price per unit by the
number of units sold.
 TR=P*Q
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The relationship between price
elasticity and total revenue (2 of 2)
 When demand is price inelastic:
–
An increase in price leads to an increase in total revenue.
–
 When demand is price elastic:
–
An increase in price leads to a decrease in total revenue.
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The relationship between price
elasticity and total revenue: Table
4.2
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Elasticity is not constant along a
linear demand curve: Figure 4.3
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Cross-price elasticity of demand (1
of 2)
 Cross-price elasticity of demand: The
percentage change in the quantity demanded of
one good divided by the percentage change in the
price of another good.
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Cross-price elasticity of demand (2
of 2)
 Cross-price elasticity will be positive when the two goods
are substitutes in consumption.
 Cross-price elasticity will be negative when the two goods
are complements in consumption.
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Summary of cross-price elasticity of
demand: Table 4.3
If the products are
…
Then the cross-price
Example
elasticity of demand will
be …
substitutes
positive
Two brands of tablet
computers
complements
negative
Tablet computers and
applications
downloaded from
online stores
unrelated
zero
Tablet computers and
peanut butter
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Income elasticity of demand
 Income elasticity of demand: A measure of the
responsiveness of quantity demanded to a change in
income.
 It is measured by the percentage change in quantity
demanded divided by the percentage change in
income (disposable income).
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Summary of income elasticity of
demand: Table 4.4
If the income elasticity of
demand is …
Then the good is …
Example
positive, but less than 1
normal and a necessity
milk
positive and greater than
1
normal and a luxury
restaurant
meals
negative
inferior
high-fat mince
meat
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The price elasticity of supply
and its measurement (1 of 2)
 Price elasticity of supply: The responsiveness of the
quantity supplied to a change in price.
 It is measured by dividing the percentage change in the
quantity supplied of a product by the percentage change in
the product’s price.
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The price elasticity of supply
and its measurement (2 of 2)
 The elasticity of supply will always be positive, as
price and quantity supplied move in the same
direction.
 The primary determinant of the price elasticity of
supply is the amount by which production costs rise
as output levels rise.
– Other key determinants are largely based upon
this.
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9781488616983/Hubbard/Essentials of Economics/4e
Key determinants of the price
elasticity of supply
1. Length of time involved in production
2.Type of industry
3. Availability of inputs
4. Existing capacity
5. Inventories held
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Polar cases of perfectly elastic and
perfectly inelastic supply
 The perfectly elastic supply curve is a horizontal
line.
 The perfectly inelastic supply curve is a vertical line.
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Summary of the price elasticities of
supply: Table 4.5 (1 of 3)
If supply is elastic, then the
value of the price elasticity is
greater than 1.
If supply is inelastic, then
the value of the price
elasticity is less than 1.
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Summary of the price elasticities of
supply: Table 4.5 (2 of 3)
If supply is unit-elastic,
then the value of the price
elasticity is equal to 1.
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9781488616983/Hubbard/Essentials of Economics/4e
Summary of the price elasticities of
supply: Table 4.5 (3 of 3)
If supply is perfectly
elastic, then the value of
the price elasticity is
equal to infinity.
If supply is perfectly
inelastic, then the value of
the price elasticity is
equal to 0.
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Using price elasticity of supply to
predict changes in price
 When demand changes, the change in price
depends on the price elasticity of supply.
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Changes in price depend on the
price elasticity of supply: Figure 4.4
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Check your knowledge
Q1. If you know the value of the price elasticity of demand,
then which of the following can you calculate?
a. The effect of a price change on the quantity demanded.
b. The responsiveness of the quantity supplied of a good
to a change in its price.
c. The price elasticity of supply.
d. All of the above.
Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) –
9781488616983/Hubbard/Essentials of Economics/4e
Check your knowledge
Q1. If you know the value of the price elasticity of demand,
then which of the following can you calculate?
a. The effect of a price change on the quantity demanded.
b. The responsiveness of the quantity supplied of a good
to a change in its price.
c. The price elasticity of supply.
d. All of the above.
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9781488616983/Hubbard/Essentials of Economics/4e
Check your knowledge
Q2. How do economists avoid confusion over different
units of measurement in the calculation of elasticities?
a. By using aggregate values rather than single values
b. By using whole numbers rather than fractions
c. By using percentage changes
d. By using computer software packages
Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) –
9781488616983/Hubbard/Essentials of Economics/4e
Check your knowledge
Q2. How do economists avoid confusion over different
units of measurement in the calculation of elasticities?
a. By using aggregate values rather than single values
b. By using whole numbers rather than fractions
c. By using percentage changes
d. By using computer software packages
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9781488616983/Hubbard/Essentials of Economics/4e
Check your knowledge
Q3. When demand is price inelastic, what is the
relationship between price and total revenue?
a. They move in the same direction.
b. They move in opposite directions.
c. When price changes, total revenue remains the same.
d. They are unrelated.
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9781488616983/Hubbard/Essentials of Economics/4e
Check your knowledge
Q3. When demand is price inelastic, what is the
relationship between price and total revenue?
a. They move in the same direction.
b. They move in opposite directions.
c. When price changes, total revenue remains the same.
d. They are unrelated.
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9781488616983/Hubbard/Essentials of Economics/4e
Check your knowledge
Q4. Fill in the blanks: If an increase in the price of a
substitute leads to ________ in quantity demanded, the
cross-price elasticity of demand is ________ .
a. an increase; positive
b. an increase; negative
c. a decrease; positive
d. a decrease; negative
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9781488616983/Hubbard/Essentials of Economics/4e
Check your knowledge
Q4. Fill in the blanks: If an increase in the price of a
substitute leads to ________ in quantity demanded, the
cross-price elasticity of demand is ________ .
a. an increase; positive
b. an increase; negative
c. a decrease; positive
d. a decrease; negative
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9781488616983/Hubbard/Essentials of Economics/4e
Check your knowledge
Q5. Which of the following is likely to be most price
inelastic in supply in the short run?
a. A baker
b. A cattle farm
c. A pizza shop
d. A clothing retailer
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9781488616983/Hubbard/Essentials of Economics/4e
Check your knowledge
Q5. Which of the following is likely to be most price
inelastic in supply in the short run?
a. A baker
b. A cattle farm
c. A pizza shop
d. A clothing retailer
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9781488616983/Hubbard/Essentials of Economics/4e