Elasticity
Chapter 4
Economics 3ed: Global and Southern African Perspectives © 2020 1
Main ideas
After studying this chapter, you will be able to:
• Define, calculate, and explain the factors that influence the price elasticity
of demand
• Define, calculate, and explain the factors that influence the cross elasticity
of demand and the income elasticity of demand
• Define, calculate, and explain the factors that influence the elasticity of
supply
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Price Elasticity of Demand
• When supply increases, the equilibrium price falls and the equilibrium quantity
increases
• But does the price fall by a large amount and the quantity increase by a little? Or,
does the price barely fall and the quantity increase by a large amount?
• The answer depends on the responsiveness of the quantity demanded to a change
in price (this is the price elasticity of demand)
• Figure 4.1 illustrates the principle
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Price Elasticity of Demand
Calculating Price Elasticity of Demand
Price elasticity of demand
=
Percentage change in
quantity demanded
÷
Percentage change in price
• To calculate the price elasticity of
demand, we express the change in price
as a percentage of the average price and
the change in the quantity demanded as a
percentage of the average quantity
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Price Elasticity of Demand
Average Price and Quantity
• We use the average price and average quantity because it gives the most precise
measurement of elasticity.
• Instead of using the price and quantity at a point we focus on the average such
that the change is the same regardless of whether one is moving up or down by
the same magnitude.
Percentages and Proportions
• Elasticity is the ratio of two percentage changes, so when we divide one
percentage change by another, the 100s cancel
A Units-Free Measure
• Elasticity is a units-free measure because the percentage change in each variable
is independent of the units in which the variable is measured
Minus Sign and Elasticity
• Due to the law of demand, changes in prices will bring an inverse change in
quantity, i.e., negative relationship; thus the price elasticity of demand is a
negative number
• We use the magnitude of the elasticity and ignore the minus sign
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Price Elasticity of Demand
Inelastic and Elastic Demand
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Price Elasticity of Demand
Elasticity Along a Linear Demand Curve
• Elasticity and slope are not the same. A linear demand curve has a constant slope
but a varying elasticity
• On a linear demand curve, demand is unit elastic at the midpoint (elasticity is 1),
elastic above the midpoint, and inelastic below the midpoint
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Price Elasticity of Demand: Example
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Price Elasticity of Demand
Total Revenue and Elasticity
• The total revenue from the sale of a good equals the price of the good multiplied
by the quantity sold
• When a price changes, total revenue also changes
Your Expenditure and Your Elasticity
• Your Expenditure and Your Elasticity
The Factors That Influence the Elasticity of Demand
• The closeness of substitutes
‒ The closer the substitutes for a good or service, the more elastic is the
demand for it
• The proportion of income spent on the good
‒ The greater the proportion of income spent on a good, the more elastic (or
less inelastic) is the demand for it
• The time elapsed since the price change
‒ The longer the time that has elapsed since a price change, the more elastic is
demand
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More Elasticities of Demand
Cross Elasticity of Demand
Cross elasticity of demand
=
Percentage change in
quantity demanded
÷
Percentage change in price of
a substitute or complement
Cross elasticity of demand can
be negative (complements),
positive (substitutes) and zero
if they are unrelated.
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Cross Elasticity of Demand: Example
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More Elasticities of Demand
Income Elasticity of Demand
Income elasticity of demand
=
Percentage change in quantity demanded
÷
Percentage change in income
•
Income elasticity of demand can be positive or negative and falls into three ranges:
‒ Greater than 1 (normal good, income elastic)
‒ Positive and less than 1 (normal good, income inelastic)
‒ Negative (inferior good)
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Income Elasticity of Demand: Example
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Elasticity of Supply
Calculating the Elasticity of Supply
Elasticity of supply = % change in quantity demanded/% change in price
The Factors That Influence the Elasticity of Supply
• Resource substitution possibilities
• Time frame for the supply decision
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Elasticity of Supply
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Elasticity of Supply
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Elasticity of Supply
•
•
•
•
•
Each supply curve illustrated on Figure 4.8 has a constant elasticity
The supply curve in part (a) illustrates the supply of a good that has a zero
elasticity of supply.
The supply curve in part (b) illustrates the supply of a good with a unit elasticity of
supply
All linear supply curves that pass through the origin illustrate supplies that are unit
elastic
The supply curve in part (c) illustrates the supply of a good with an infinite
elasticity of supply
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