Chapter 4
ELASTICITY
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Gottheil — Principles of Economics, 7e
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Economic Principles
Demand sensitivity
Determinants of demand sensitivity to price
changes
Price elasticity of demand
Cross elasticity
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Economic Principles
Substitute and complementary goods
Normal and inferior goods
Supply elasticity
Relationship between price elasticity of
supply and tax revenues
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EXHIBIT 1A DEMAND RESPONSE TO PRICE CHANGE
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EXHIBIT 1B DEMAND RESPONSE TO PRICE CHANGE
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EXHIBIT 1C DEMAND RESPONSE TO PRICE CHANGE
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Exhibit 1: Demand Response to
Price Change
1. The demand curve in panel a can
be described as:
• Vertical
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Exhibit 1: Demand Response to
Price Change
The demand curve is vertical
in panel a because:
• The demand for penicillin doesn’t change
regardless of what price is charged.
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Exhibit 1: Demand Response to
Price Change
The demand curve in panel b can be
described as:
• Fairly steep
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Exhibit 1: Demand Response to
Price Change
The demand curve in panel b
compares to the demand curve in
panel c:
• The demand curve in panel b is steeper than
in panel c.
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Exhibit 1: Demand Response to
Price Change
This tells us that the demand
response for spark plugs versus
Coca-Cola:
• When price is cut, the demand response for
Coca-Cola is greater than the demand
response for spark plugs.
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Demand Sensitivity
Demand Sensitivity
• Demand sensitivity describes how consumer demand
reacts to changes in price.
• High sensitivity: a given change in price will result in a
large change in quantity demanded.
• Low sensitivity, or insensitivity: a given change
in price will result in little or no change in
quantity demanded.
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EXHIBIT 2
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MARKET DEMAND FOR COCA-COLA AND
SPARK PLUGS
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Exhibit 2: Market Demand for
Coca-Cola and Spark Plugs
In Exhibit 2, which demand curve,
Panel a or b, has a steeper slope?
• Panel a, the demand for Coca-Cola, has a
steeper slope.
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Exhibit 2: Market Demand for
Coca-Cola and Spark Plugs
Which panel depicts high demand
sensitivity?
• Panel a depicts high demand sensitivity.
• A decrease in the price of Coca-Cola results in a
large increase in quantity demanded.
• The slope of the demand curve is steep.
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What Factors Influence
Demand Sensitivity?
All else equal, the demand for lowpriced goods is less elastic than
high-priced goods.
• When something is inexpensive people are
less price sensitive.
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What Factors Influence
Demand Sensitivity?
The elasticity of demand for poor
people is larger than for rich people.
• Poor people are more sensitive to price
changes than rich people.
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What Factors Influence
Demand Sensitivity?
The price elasticity of demand for
basic goods (necessities) is not larger
than for less essential goods.
• There are fewer substitutes for basic goods
(such as bread, electricity, or gasoline) than for
less essential goods (such as slices of
pizza or specific brands of running shoes).
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What Factors Influence
Demand Sensitivity?
A product used as a compliment
with an essential good will have the
elasticity characteristics of the
essential good.
• If something is used in conjunction with an
essential good, then consumption will not
decline very much if price rises.
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What Factors Influence
Demand Sensitivity?
In which of the following situations will
the price elasticity of demand be
largest:
• When people have a brief period of time to
adjust.
• When people have a long time period to
adjust.
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What Factors Influence
Demand Sensitivity?
In which of the following situations will
the price elasticity of demand be
largest:
• When people have a brief period of time to
adjust.
• When people have a long time period to
adjust.
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From Sensitivity to Elasticity
The price elasticity of demand is not
the same thing as the slope of the
demand curve.
• The slope of the demand curve will differ
based on the units used to measure price
and quantity.
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From Sensitivity to Elasticity
The price elasticity of demand is not
the same thing as the slope of the
demand curve.
• We want a measure of sensitivity that will
be the same regardless of the units used
to measure price and quantity.
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From Sensitivity to Elasticity
The price elasticity of demand is not
the same thing as the slope of the
demand curve.
• Price elasticity of demand is the percent
change in quantity demanded divided
by the percentage change in price.
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From Sensitivity to Elasticity
Formula for computing the price
elasticity of demand:
• ed = (Q2 – Q1)/[(Q2 + Q1)/2] divided by
(P2 – P1)/[(P2 + P1)/2]
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EXHIBIT 3A
PRICE
ELASTICITIES
OF DEMAND
FOR
FOOTBALL
TICKETS
AND MILK
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EXHIBIT 3B
PRICE
ELASTICITIES
OF DEMAND
FOR
FOOTBALL
TICKETS
AND MILK
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Exhibit 3: Price Elasticities of
Demand for Football Tickets and Milk
In Exhibit 3, elasticity of demand for
football tickets within the $4 to $3
price range is 3.5. This means:
• A price elasticity of 3.5 means that a 1 percent
change in price generates a 3.5 percent change
in quantity demanded.
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Exhibit 3: Price Elasticities of
Demand for Football Tickets and Milk
In Exhibit 3, elasticity of demand for
football tickets within the $4 to $3
price range is 3.5. This means:
• Elasticities greater than 1.0 are price elastic.
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Exhibit 3: Price Elasticities of
Demand for Football Tickets and Milk
In the $2 to $1 price range, elasticity
of demand for football tickets falls to
0.5. This means:
• A 0.5 price elasticity means that a 1 percent
change in price generates a 0.5 percent
change in quantity demanded.
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Exhibit 3: Price Elasticities of
Demand for Football Tickets and Milk
In the $2 to $1 price range, elasticity of
demand for football tickets falls to 0.5.
This means:
• Elasticities less than 1.0 are price inelastic.
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Exhibit 3: Price Elasticities of
Demand for Football Tickets and Milk
When the price of football tickets
rises from $1 to $2, quantity
demanded falls from 700 to 500. The
price elasticity of demand is:
• (Q2 – Q1)/[(Q2 + Q1)/2]
= (700 – 500)/[(700 + 500)/2] = 1/3
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Exhibit 3: Price Elasticities of
Demand for Football Tickets and Milk
When the price of football tickets
rises from $1 to $2, quantity
demanded falls from 700 to 500. The
price elasticity of demand is:
• (P2 – P1)/[(P2 + P1)/2] = (2 – 1)/[(2 + 1)/2] = 2/3
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Exhibit 3: Price Elasticities of
Demand for Football Tickets and Milk
When the price of football tickets
rises from $1 to $2, quantity
demanded falls from 700 to 500. The
price elasticity of demand is:
• ed = (1/3)/(2/3) = 1/2
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EXHIBIT 4
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ELASTICITIES, PRICE, AND REVENUE
CHANGES
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Exhibit 4: Elasticities, Price,
and Revenue Changes
If demand is price inelastic and price
goes down, total revenue decreases.
• When demand is price inelastic, the increase in
quantity is less than proportionate to the
decrease in price.
• Price falls more than quantity increases and
total revenue decreases.
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Elasticity and the relevant price
range
• The price elasticity of demand for a good
changes from highly elastic to increasingly
inelastic as its price continuously falls.
• The price elasticity of demand for a good is
described as elastic or inelastic depending
on the elasticity within a price range that is
relevant to our experience.
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Cross Elasticity
Cross elasticity of demand
• It is the ratio of a percentage change in quantity
demand of one good to a percentage change in
the price of another good.
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EXHIBIT 5
PRICE ELASTICITIES OF DEMAND FOR
SELECTED GOODS
Source: Edward Mansfield, Microeconomics (New York: W. W. Norton, 1997); Robert Hall and Mark Lieberman, Economics (Cincinnati: SouthWestern College Publishing, 1998); Gary Brester and Michael Wohlgenant, “Estimating Interrelated Demands for Meat Using New Measures for
Ground and Table Cut Beef,” American Journal of Agricultural Economics (November 1991); and Heinz Kohler, Intermediate Economics: Theory and
Applications (new York: Scott, Foresman, 1986).
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Exhibit 5: Price Elasticities of
Demand for Selected Goods
Which of the following has the largest
price elasticity of demand?
• Corn
• Cigarettes
• Movies
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Exhibit 5: Price Elasticities of
Demand for Selected Goods
Which of the following has the largest
price elasticity of demand?
• Corn
• Cigarettes
• Movies
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EXHIBIT 6
PRICE ELASTICITIES OF DEMAND IN THE
SHORT RUN AND LONG RUN
Source: H. S. Houthakker and Lester Taylor, Consumer Demand in the United States, 1929–1970 (Cambridge, Mass.:
Harvard University Press, 1970); Richard Voith, “The Long-Run Elasticity of Demand for Commuter Rail Transportation,”
Journal of Urban Economics (November 1991); and James Griffen and Henry Steele, Energy Economics and Policy (New
York: Academic Press, 1980).
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Exhibit 6: Price Elasticities of
Demand in the Short Run and
Long Run
Which of the following has the
smallest price elasticity of demand in
the long run?
• Gasoline
• Jewelry and watches
• Hospital care
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Exhibit 6: Price Elasticities of
Demand in the Short Run and
Long Run
Which of the following has the
smallest price elasticity of demand in
the long run?
• Gasoline
• Jewelry and watches
• Hospital care
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EXHIBIT 7
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CROSS ELASTICITIES BETWEEN
SUBSTITUTES
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Exhibit 7: Cross Elasticities
Between Substitutes
In Exhibit 7, the demand for Tums
increase when the price of Rolaids
increased because:
• Tums and Rolaids are substitute goods— goods
that can replace each other.
• When the price of Rolaids increases, some
consumers are willing to switch to a cheaper
substitute—Tums.
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Exhibit 7: Cross Elasticities
Between Substitutes
In Exhibit 7, the demand for Tums
increase when the price of Rolaids
increased because:
• Cross elasticities for substitute goods are positive.
• A decrease (or increase) in the price of one good
generates a corresponding decrease (or a
corresponding increase) in the quantity
demanded of the other.
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EXHIBIT 8
CROSS ELASTICITIES OF DEMAND FOR
SUBSTITUTE GOODS
Source: Edwin Mansfield, Microeconomics (New York: W. W. Norton, 1997); F. Gasmi, J. J. Laffont, and Q. Vuong, “Econometric Analysis of
Collusive Behavior in a Soft Drink Market,” Journal of Economics and Management Strategy (Summer 1992); and Gary Brester and Michael
Wohlgenant, “Estimating Interrelated Demands for Meats Using New Measures for Ground and Table Cut Beef,” American Journal of Agricultural
Economics (November 1991).
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Exhibit 8: Cross Elasticities of
Demand for Substitute Goods
Which of the following are the
closest substitutes, according to
Exhibit 8:
• Butter and margarine
• Poultry and ground beef
• Natural gas and electricity
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Exhibit 8: Cross Elasticities of
Demand for Substitute Goods
Which of the following are the
closest substitutes, according to
Exhibit 8:
• Butter and margarine
• Poultry and ground beef
• Natural gas and electricity
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Exhibit 8: Cross Elasticities of
Demand for Substitute Goods
Butter and margarine the closest
substitutes because:
• They have the largest cross elasticity of
demand.
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EXHIBIT 9A CROSS ELASTICITIES BETWEEN
COMPLEMENTS
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EXHIBIT 9B CROSS ELASTICITIES BETWEEN
COMPLEMENTS
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Exhibit 9: Cross Elasticities
Between Complements
When the price of flights decreases,
the demand for hotel rooms:
• The demand for hotel rooms will increase,
because people fly more and need more hotel
rooms.
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Income Elasticity
Income elasticity
• It is the ratio of the percentage change in
quantity demanded to the percentage
change in income.
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Income Elasticity
Income elasticity
• A good is considered income elastic when a
1 percent change in income generates a
greater than 1 percent change in quantity
demanded.
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Income Elasticity
Income elasticity
• A good is considered income inelastic when
a 1 percent change in income generates a
less than 1 percent change in quantity
demanded.
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EXHIBIT 10 AIR TRAVEL
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Exhibit 10: Air Travel
The demand curve in Exhibit 10 shift
from Dy to D′y even though price
remains constant because:
• In Exhibit 10, the demand for air travel is
income elastic. As income increases, the
demand for flights increases, even though
the price of flights remains unchanged.
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EXHIBIT 11
INCOME ELASTICITIES OF DEMAND
Source: Edwin Mansfield, Microeconomics (New York: W. W. Norton, 1997); and F. Chalemaker, “Rational Addictive Behavior and Cigarette
Smoking,” Journal of Political Economy (August 1991).
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Exhibit 11: Income Elasticities
of Demand
The income elasticity of demand for
electricity so much lower than for
furniture because:
• Electricity is a necessity, while furniture is
a luxury.
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EXHIBIT 12 COMPARISON OF INCOME ELASTICITIES
OF DEMAND FOR FOOD, BY COUNTRY
Source: Ching-Fun and James Peale Jr., “Income and Price Elasticities,” in Advances in Econometrics Supplement, ed. Henri Thell (Greenwich,
Conn.: JAI Press, 1989); and Y. Wu, E. Li, and S. N. Samuel, “Food Consumption in Urban China: An Empirical Analysis,” Applied Economics (June
1995).
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Exhibit 12: Comparison of
Income Elasticities of Demand
for Food, by Country
The type of countries which tend to
have the lowest income elasticity for
food are:
• Industrialized countries.
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EXHIBIT 13A ELASTICITIES OF SUPPLY
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EXHIBIT 13B ELASTICITIES OF SUPPLY
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EXHIBIT 13C ELASTICITIES OF SUPPLY
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Exhibit 13: Elasticities of
Supply
In Exhibit 13, the different supply
curves have different price elasticities
because:
• Panel a depicts the market-day supply curve.
• At any price suppliers are unable to
adjust supply.
• The price elasticity of supply is 0.
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Exhibit 13: Elasticities of Supply
In Exhibit 13, the different supply
curves have different price elasticities
because:
• Panel b depicts the short-run supply curve.
• Suppliers are willing, but not able, to meet all
the demand.
• Suppliers can only increase production
with existing capacity.
• Price elasticity is 0.47.
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Exhibit 13: Elasticities of Supply
In Exhibit 13, the different supply
curves have different price elasticities
because:
• Panel c depicts the long-run supply curve.
• Suppliers encounter no obstacles in
adjusting quantity supplied to price.
• The price elasticity is 1.64.
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EXHIBIT 14A WHAT GETS TAXED?
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EXHIBIT 14B WHAT GETS TAXED?
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Exhibit 14: What Gets Taxed
If government imposes a per unit tax,
the type of demand (elastic or inelastic)
which will generate the most revenue?
• Inelastic.
• Quantity will not decline very much
when the tax raises the price of the
product.
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