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CHAPTER 3: ELASTICITY
1. Elasticity of demand
2. Elasticity of supply
3. Applications
1. Elasticity of Demand
1.1. Price elasticity of demand
1.2. Cross elasticity of demand
1.3. Income elasticity of demand
1.1. Price elasticity of demand
• Price elasticity of demand (Edp) measures how much Qd
responds to a change in P.
• The percentage change in quantity demanded resulting
from 1% change in price.
• Loosely speaking, it measures the price-sensitivity of
buyers’ demand.
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Calculating Edp
• Standard method;
• Midpoint method.
Standard method
Edp =
% change in Qd
% change in
Midpoint method
in Qd
Edp = %%change
change in
% change = (end value – start value/midpoint) x 100%
Note: Ed < 0, |Ed|
The Determinants of Price Elasticity
•
•
•
•
The extent to which close substitutes are available
Whether the good is a necessity or a luxury
How broadly or narrowly the good is defined
The time horizon—elasticity is higher in the long run
than the short run
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“Perfectly inelastic demand” (one extreme case)
Price elasticity
=
of demand
% change in Q
% change in P
P
D curve:
vertical
0%
=
10%
=0
D
P1
Consumers’
price sensitivity:
none
P2
P falls
by 10%
Elasticity:
0
Q
Q1
Q changes
by 0%
“Inelastic demand”
Price elasticity
=
of demand
% change in Q
% change in P
< 10%
10%
<1
P
D curve:
relatively steep
P1
Consumers’
price sensitivity:
relatively low
Elasticity:
<1
=
P2
D
P falls
by 10%
Q
Q1 Q2
Q rises less
than 10%
“Unit elastic demand”
Price elasticity
=
of demand
% change in Q
% change in P
10%
10%
=1
P
D curve:
intermediate slope
P1
Consumers’
price sensitivity:
intermediate
Elasticity:
1
=
P2
P falls
by 10%
D
Q1
Q2
Q
Q rises by 10%
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“Elastic demand”
Price elasticity
=
of demand
% change in Q
% change in P
> 10%
10%
>1
P
D curve:
relatively flat
P1
Consumers’
price sensitivity:
relatively high
Elasticity:
>1
=
P2
D
P falls
by 10%
Q1
Q2
Q
Q rises more
than 10%
“Perfectly elastic demand” (the other extreme)
Price elasticity
=
of demand
% change in Q
% change in P
Elasticity:
infinity
any %
0%
= infinity
P
D curve:
horizontal
Consumers’
price sensitivity:
extreme
=
D
P2 = P1
P changes
by 0%
Q2
Q1
Q
Q changes
by any %
The Variety of Demand Curves
• The price elasticity of demand is closely related to the slope of the
demand curve.
• Rule of thumb:
The flatter the curve, the greater the elasticity.
The steeper the curve, the smaller the elasticity.
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The Variety of Demand Curves
5 classifications of D curve:
•
|Ed| = 0: Perfectly Inelastic;
•
|Ed| <1: Inelastic;
•
|Ed| = 1: Unit elastic;
•
|Ed| > 1: Elastic;
•
|Ed| = ∞ : Perfectly elastic.
Edp and Total Revenue
Total revenue - TR: the amount paid by buyers
and received by sellers of a good.
TR = P x Q
Edp and Total Revenue
Ex: P = 4$, Qd = 100 units
TR = 4 x 100 = 400
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Edp and Total Revenue
|Ed| < 1: P rises  TR rises
At
At
Edp and Total Revenue
|Ed| > 1: P falls  TR falls
1.2. Cross elasticity of demand
Cross-price elasticity of demand: measures the response of
demand for one good to changes in the price of another good
Cross-price elast.
=
of demand
% change in Qd for good 1
% change in price of good 2
Ex: Edx,y = 1,5  PY changes by 1%, QdX changes by1,5%
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1.2. Cross elasticity of demand
For substitutes, cross-price elasticity > 0 (e.g., an
increase in price of beef causes an increase in demand for
chicken)
For complements, cross-price elasticity < 0 (e.g., an
increase in price of computers causes decrease in demand
for software)
1.3. Income elasticity of demand
Income elasticity of demand: measures the
response of Qd to a change in consumer income.
Income elasticity
of demand
=
Percent change in Qd
Percent change in income
For normal goods, income elasticity > 0.
For inferior goods, income elasticity < 0.
2. Elasticity of supply
• Price elasticity of supply measures how much
Qs responds to a change in P.
• The percentage change in quantity supplied
resulting from 1% change in price.
• Loosely speaking, it measures sellers’ pricesensitivity.
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Standard method
% change in Q
% change in
Es =
Midpoint method
in Q
Es = %%change
change in
% change = (end value – start value/midpoint) x 100%
Note: Es > 0
The Variety of Supply Curves
Five classifications of S curve:
• Es = 0: Perfectly Inelastic;
• Es <1: Inelastic;
• Es = 1: Unit elastic;
• Es > 1: Elastic;
• Es = ∞ : Perfectly elastic.
“Perfectly inelastic” (one extreme)
Price elasticity
=
of supply
% change in Q
% change in P
P
S curve:
vertical
10%
=0
S
P2
Sellers’
price sensitivity:
none
Elasticity:
0
0%
=
P1
P rises
by 10%
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Q1
Q
Q changes
by 0%
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“Inelastic”
Price elasticity
=
of supply
% change in Q
% change in P
< 10%
10%
P
S curve:
relatively steep
<1
S
P2
Sellers’
price sensitivity:
relatively low
Elasticity:
<1
=
P1
P rises
by 10%
Q
Q1 Q2
Q rises less
than 10%
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product or service or otherwise on a password-protected website for classroom use.
“Unit elastic”
Price elasticity
=
of supply
% change in Q
% change in P
10%
10%
=1
P
S curve:
intermediate slope
S
P2
Sellers’
price sensitivity:
intermediate
Elasticity:
=1
=
P1
P rises
by 10%
Q1
Q
Q2
Q rises
by 10%
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product or service or otherwise on a password-protected website for classroom use.
“Elastic”
Price elasticity
=
of supply
% change in Q
% change in P
> 10%
10%
>1
P
S curve:
relatively flat
S
P2
Sellers’
price sensitivity:
relatively high
Elasticity:
>1
=
P1
P rises
by 10%
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product or service or otherwise on a password-protected website for classroom use.
Q1
Q2
Q
Q rises more
than 10%
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“Perfectly elastic” (the other extreme)
Price elasticity
=
of supply
% change in Q
% change in P
Elasticity:
infinity
any %
0%
= infinity
P
S curve:
horizontal
Sellers’
price sensitivity:
extreme
=
P2 = P1
P changes
by 0%
S
Q1
Q2
Q
Q changes
by any %
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product or service or otherwise on a password-protected website for classroom use.
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The Variety of Supply Curves
 The slope of the supply curve is closely related to price elasticity of
supply.
 Rule of thumb:
The flatter the curve, the greater the elasticity.
The steeper the curve, the smaller the elasticity.
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product or service or otherwise on a password-protected website for classroom use.
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The Determinants of Supply Elasticity
• How easy the sellers can change the quantity they
produce
• The time horizon—elasticity is higher in the long run
than the short run
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product or service or otherwise on a password-protected website for classroom use.
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3. Applications
Elasticity and tax incidence
If the government imposes a tax on the supplier,
which group will bear most of the burden?
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product or service or otherwise on a password-protected website for classroom use.
Elasticity and tax incidence
Who bill bear most of the burden?
Short explanation and Illustrating by graphs (Work in groups)
The buyer’s pricesensitivity is higher then
the seller’s
A
B
The buyer’s price-sensitivity
is lower than the seller’s
C
D
The buyer is perfectly
sensitive with the change
in price
The buyer is not
sensitive with the change
in price
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product or service or otherwise on a password-protected website for classroom use.
Elasticity and tax incidence
A. The buyer’s price-sensitivity is higher then the seller’s
Tax drops on:
Buyer (td) =
Seller (ts) =
 ……………bears the most
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product or service or otherwise on a password-protected website for classroom use.
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Elasticity and tax incidence
B. The buyer’s price-sensitivity is lower than the seller’s
Tax drops on:
Buyer (td)= P2 – P1
Seller (ts) = t – td
 …………….bears the most
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product or service or otherwise on a password-protected website for classroom use.
Elasticity and tax incidence
C. The buyer is perfectly sensitive with the change in price
The equilibrium price…………..
after tax

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product or service or otherwise on a password-protected website for classroom use.
Elasticity and tax incidence
D. The buyer is not sensitive with the change in price
The change in equilibrium price =
…………………………..

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product or service or otherwise on a password-protected website for classroom use.
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