Micro Chapter 7
Consumer Choice and Elasticity
This chapter is an extension of the
first part of Chapter 3 on demand
and consumer theory
Refer back to your Chapter 3 notes and
mentally combine them with Chapter 7
notes
6 Learning Goals
1) List the key factors influencing consumer
behavior (repeat from Chapter 3)
2) Apply the concept of marginal utility to determine
how a demand curve is derived (repeat from
Chapter 3)
3) Define, calculate, and graph elasticity of demand
4) Relate demand elasticity to total revenue
5) Define and calculate income elasticity
6) Define and graph elasticity of supply
Elasticity of Demand
Law of demand states that if price
rises (falls), quantity demanded
falls (rises)
Elasticity gives us more information about
the consumer
Price elasticity seeks to quantify how
much quantity demanded falls (rises)
Class Activity: Draw two demand curves
side by side. Increase price by the same
amount in each graph. Draw the first
demand curve illustrating a small reduction
in quantity demanded. Draw the second
demand curve illustrating a large reduction
in quantity demanded.
Graphs:
Watch content video: Inelastic-Elastic
demand curves
Other questions to consider:
By how much does price need to rise to
decrease quantity demanded by X%?
By how much does price need to fall to
increase quantity demanded by Y%?
Price elasticity of demand= percentage
change in quantity demanded /
percentage change in price
d
Elasticity = % Δ Q
%ΔP
Values of price elasticity
If ε > 1, then elastic
Consumers change their behavior a lot
If ε < 1, then inelastic
Consumers change their behavior a little
If ε = 1, then unitary elastic
Consumers don’t change their behavior
Key point:
Price elasticity is NOT the slope of the
demand curve
– A straight-line demand curve will have
constant slope but a different elasticity at
every point
I often do a survey of my students to see if their demand for
places at the university responds to prices. The price of
places at the university is the tuition charged. I offer
students the possibility of zero tuition increase for next year,
a 5 percent increase for next year, and a 10 percent
increase. Each student is then asked whether he or she will
return next year. I recently got the following results: For a 5
percent tuition increase, the number of students returning
would decrease by 2.2 percent, implying a price elasticity of
demand equaling -0.44. For a 10 percent tuition increase,
however, the number returning would fall by 11.8 percent,
implying an elasticity of -1.18. The demand curve is surely
downward sloping. Not only does the number of places
demanded decline when tuition rises more; the
responsiveness of demand- the price elasticity of demandis greater in percentage terms when the university tries to
raise tuition by higher amounts. That’s not surprising:
Substitutes that suddenly become slightly cheaper don’t
affect behavior proportionately as much as substitutes that
suddenly become relatively a lot cheaper.
Q: Who is likely to be more inelastic, freshmen or juniors?
Why?
Q7.1 If a large percentage increase in the
price of a good results in a small percentage
reduction in the quantity demanded of the
good, demand is said to be
1.
2.
3.
4.
unitary elastic.
relatively inelastic.
relatively elastic.
perfectly elastic.
Q7.2 When economists say the demand for a
good is highly inelastic, they mean that
1.
2.
3.
4.
even if the price rose substantially, suppliers would be
unwilling to offer much more of the good.
the facilities utilized by producers of the good are inflexible;
producers cannot easily expand their facilities, even in the
long run.
consumers will respond to a change in the price of the
good by purchasing substantially more of it.
a large (percentage) change in the price of a good will
result in only a small (percentage) change in the quantity
demanded.
What determines elasticity?
(1) Availability of substitutes
– More substitutes, more elastic (more
responsive)
(2) Share of budget
– Greater share, more elastic
(3) Time
– More time, more elastic
Q7.3 Members of Alpha fraternity have developed a strong
liking for Coca-Cola. Beta fraternity members buy the same
amount of Coke but believe Pepsi is just about as good. From
this, we can infer that
1.
2.
3.
4.
Alpha members will not care what the price of Coke is.
compared to Alpha members, Betas will have a smaller
price elasticity of demand for Coke.
compared to Alpha members, Betas will have a larger
price elasticity of demand for Coke.
Alpha members will increase their purchases by a larger
amount of Pepsi than Beta members in response to a "50
cents off" sale on a case of Pepsi.
How Demand Elasticity and
Price Changes Affect Total
Expenditures (or Revenues)
on a Product
Price elasticity
of demand
Elasticity
coefficient
(in absolute value)
Elastic
1 to 
Unitary Elastic
1
Inelastic
0 to 1
Impact of higher price
on total consumer
expenditures or a
firm’s total revenue
decrease
-- unchanged-increase
Impact of lower price
on total consumer
expenditures or a
firm’s total revenue
increase
-- unchanged-decrease
Don’t memorize this chart!
Use it as a tool
Think about what elasticity tells us and
then apply it to total revenue
Total Revenue (TR) to the firm is Total
Expenditure (TE) by the consumer.
TR = TE = P x Q
If elastic and price falls: ↓ P x
↑Q = ↑TR
– Lower price and lots more is bought, Q dominates equation
↓Q = ↓TR
If elastic and price rises: ↑ P x
– Raise price and lots less is bought, Q dominates equation
↓P x
If inelastic and price falls:
↑Q
= ↓TR
– Lower price and a little more is bought, P dominates equation
If inelastic and price rises:
↑Px
↓Q
= ↑TR
– Raise price and a little less is bought, P dominates equation
A different way to look at this:
4 graphs
Watch content video: Elasticity and TR
The local airport in Austin, Texas, opened in 1999 with onsite parking, priced from $18 per day for garage parking to
$6 per day for distant uncovered parking. The lots were so
crowded that soon the Airport Authority built an additional lot.
By 2002, off-site parking places had opened up, offering
covered parking for $8 per day, and some offering threeminute shuttle service to the terminal. Not surprisingly, this
entry of new competitors into the parking market has left
many on-site places empty, and the airport’s parking
revenues this year have fallen from $22 million to $18
million. If the Airport Authority is smart, it would think about
what its demand elasticity is, lower prices if it believes
demand is elastic, not lower them, and maybe even raise
them (especially on garage parking) if it believes demand is
inelastic. The evidence suggests management believes that
the demand is elastic for the garage parking, because in
2004 they lowered the price for garage parking to $15 per
day.
Q: For which part of the airport parking areas is the demand
likely to be more or less elastic, the garage parking or the
uncovered distant parking? In light of your beliefs about this
question, how would you alter prices?
Q7.4 Suppose ε = 0.52 and the firm raises price.
What happens to TR?
1. TR rises
2. TR falls
3. TR remains constant
Q7.5 Suppose the firm wants to raise TR and it
knows demand is elastic. What should the firm
do?
1. Raise price
2. Lower price
3. Keep price the same
Q7.6 (MA) In which of the following cases
will the total spending on a good decrease?
1.
2.
3.
4.
Demand is elastic, and price decreases.
Demand is elastic, and price increases.
Demand is inelastic, and price increases.
Demand is inelastic, and price decreases.
Income Elasticity
Price elasticity measures the change in
consumer purchases when price changes
Income elasticity measures the change in
consumer purchases when income
changes
d
Income Elasticity = % Δ Q
%ΔI
Values of income elasticity
If positive, consumers buy more when
income rises
Normal good - a good that consumers will
buy more of when income rises
If negative, consumers buy less when
income rises
Inferior good - a good that consumers will
buy less of when income rises
Price Elasticity of Supply
Price elasticity of supply measures the
responsiveness of quantity supplied to
price changes
How much does quantity supplied
increase (or decrease) when price rises
(or falls)?
Graphs:
Watch content video: Inelastic-Elastic
supply curves
Question Answers:
Q7.1 = 2
Q7.2 = 4
Q7.3 = 3
Q7.4 = 1
Q7.5 = 2
Q7.6 = 2 & 4