
The price elasticity of demand coefficient E d
is the ratio of the percentage change in quantity demanded to the percentage change in price. The averages of the two prices and two quantities are used as the base references in calculating the percentage changes.

When E d
is greater than 1, demand is elastic; when E d
is less than
1, demand is inelastic; when E d
is equal to 1, demand is of unit elasticity.

When price changes, total revenue will change in the opposite direction if demand is price-elastic, in the same direction if demand is price-inelastic, and not at all if demand is unit-elastic.

Demand is typically elastic in the high-price (low-quantity) range of the demand curve and inelastic in the low-price (high-quantity) range of the curve.

Price elasticity of demand is greater (a) the larger the number of substitutes available; (b) the higher the price of a product relative to one’s budget; (c) the greater the extent to which the product is a luxury; and (d) the longer the time period involved.

Price elasticity of supply measures the sensitivity of suppliers to changes in the price of a product. The price-elasticity-of-supply coefficient E s
is the ratio of the percentage change in quantity supplied to the percentage change in price. The elasticity of supply varies directly with the amount of time producers have to respond to the price change.


The cross-elasticity-of-demand coefficient E xy
is computed as the percentage change in the quantity demanded of product X divided by the percentage change in the price of product Y. If the cross-elasticity coefficient is positive, the two products are substitutes; if negative, they are complements.

The income-elasticity coefficient E i
is computed as the percentage change in quantity demanded divided by the percentage change in income. A positive coefficient indicates a normal or superior good. The coefficient is negative for an inferior good.

Consumer surplus is the difference between the maximum price that a consumer is willing to pay for a product and the lower price actually paid.

Producer surplus is the difference between the minimum price that a producer is willing to accept for a product and the higher price actually received.

At the equilibrium price and quantity in competitive markets, marginal benefit equals marginal cost, maximum willingness to pay equals minimum acceptable price, and the total of consumer surplus and producer surplus is maximized. These individual conditions define allocative efficiency.

Quantities less than or greater than the allocatively efficient level of output create efficiency losses, often called deadweight losses.

1. Price elasticity of demand measures consumer response to price changes. If consumers are relatively sensitive to price changes, demand is elastic. If they are relatively unresponsive to price changes, demand is inelastic.
2. The price-elasticity coefficient E d
measures the degree of elasticity or inelasticity of demand. The coefficient is found by the formula:
𝐄 𝐝
=
𝑷𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐪𝐮𝐚𝐧𝐭𝐢𝐭𝐲 𝐝𝐞𝐦𝐚𝐧𝐝𝐞𝐝 𝐨𝐟 𝐗
𝐏𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐏𝐫𝐢𝐜𝐞 𝐨𝐟 𝐗
Economists use the averages of prices and quantities under consideration as reference points in determining percentage changes in price and quantity. If E d
is greater than 1, demand is elastic. If E d
is less than 1, demand is inelastic. Unit elasticity is the special case in which E d equals 1.
3. Perfectly inelastic demand is graphed as a line parallel to the vertical axis; perfectly elastic demand is shown by a line above and parallel to the horizontal axis.
4. Elasticity varies at different price ranges on a demand curve, tending to be elastic in the upper-left segment and inelastic in the lower-right segment. Elasticity cannot be judged by the steepness or flatness of a demand curve.
5. If total revenue changes in the opposite direction from prices, demand is elastic. If price and total revenue change in the same direction, demand is inelastic. Where demand is of unit elasticity, a change in price leaves total revenue unchanged.
6. The number of available substitutes, the size of an item’s price relative to one’s budget, whether the product is a luxury or a necessity, and length of time to adjust is all determinants of elasticity of demand.

7. The elasticity concept also applies to supply. The coefficient of price elasticity of supply is found by the formula:
𝐄 𝐬
=
𝑷𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐪𝐮𝐚𝐧𝐭𝐢𝐭𝐲 𝐒𝐮𝐩𝐩𝐥𝐢𝐞𝐝 𝐨𝐟 𝐗
𝐏𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐏𝐫𝐢𝐜𝐞 𝐨𝐟 𝐗
The averages of the prices and quantities under consideration are used as reference points for computing percentage changes. Elasticity of supply depends on the ease of shifting resources between alternative uses, which varies directly with the time producers have to adjust to a price change.
8. Cross elasticity of demand indicates how sensitive the purchase of one product is to changes in the price of another product. The coefficient of cross elasticity of demand is found by the formula:
𝐄 𝐱𝐲
=
𝑷𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐪𝐮𝐚𝐧𝐭𝐢𝐭𝐲 𝐝𝐞𝐦𝐚𝐧𝐝𝐞𝐝 𝐨𝐟 𝐗
𝐏𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐏𝐫𝐢𝐜𝐞 𝐨𝐟 𝐘
Positive cross elasticity of demand identifies substitute goods; negative cross elasticity identifies complementary goods.
9. Income elasticity of demand indicates the responsiveness of consumer purchases to a change in income. The coefficient of income elasticity of demand is found by the formula:
𝐄 𝐢
=
𝑷𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐪𝐮𝐚𝐧𝐭𝐢𝐭𝐲 𝐝𝐞𝐦𝐚𝐧𝐝𝐞𝐝 𝐨𝐟 𝐗
𝐏𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐈𝐧𝐜𝐨𝐦𝐞
The coefficient is positive for normal goods and negative for inferior goods.
10. Consumer surplus is the difference between the maximum price that a consumer is willing to pay for a product and the lower price actually paid; producer surplus is the difference between the minimum price that a producer is willing to accept for a product and the higher price actually received. Collectively, consumer surplus is represented by the triangle under the demand curve and above the actual price,

whereas producer surplus is shown by the triangle above the supply curve and below the actual price.
11. Graphically, the combined amount of producer and consumer surplus is represented by the triangle to the left of the intersection of the supply and demand curves that is below the demand curve and above the supply curve. At the equilibrium price and quantity in competitive markets, marginal benefit equals marginal cost; maximum willingness to pay equals minimum acceptable price, and the combined amount of consumer surplus and producer surplus is maximized.
12. Output levels that are either less than or greater than the equilibrium output creates efficiency losses, also called deadweight losses. These losses are reductions in the combined amount of consumer surplus and producer surplus. Underproduction creates efficiency losses because output is not being produced for which maximum willingness to pay exceeds minimum acceptable price.
Overproduction creates efficiency losses because output is being produced for which minimum acceptable price exceeds maximum willingness to pay.

I.
Use the following diagram to answer the next question. Refer to the diagram. Between the prices of $10 and $8, the price elasticity of demand is: o
.5 o
.9 o
1.11 o
2
II.
Use the following diagram to answer the next question. Refer to the diagram. Suppose total revenue at price P
3
is the same as at price
P
2
. Then, over the price range from P
2
to P
3
, demand is: o
Relatively elastic o
Relatively inelastic o
Unit elastic o
Perfectly elastic
III.
Suppose that a 2% increase in income in the economy decreases the quantity of gadgets demanded by 1% at every possible price. This implies that: o
The supply of gadgets is elastic o
Income elasticity is positive and gadgets are a normal good o
Income elasticity is negative and gadgets are a normal good o
Income elasticity is negative and gadgets are an inferior good
IV.
The maker of a particular breakfast cereal found that increasing the price from $3.00 to $3.25 per box had no impact on total revenue,

but increasing the price further to $3.50 reduced total revenue by 2%.
Thus, the demand for the cereal is: o
Inelastic over the range $3.00 to $3.50 o
Elastic over the range $3.00 to $3.25 but not over the range
$3.25 to $3.50 o
Unit elastic over the range $3.00 to $3.25 and elastic over the range $3.25 to $3.50 o
Unit elastic over the range $3.00 to $3.25 and inelastic over the range $3.25 to $3.50
V.
Use the following diagram to answer the next question. Refer to the diagram. In this competitive market, combined consumer and producer surplus is maximized at: o
Price M o
Price B o
Output G o
Output H
VI.
The cross elasticity of demand between two goods is reported to be +0.2. This implies that: o
A 2% increase in the price of one shifts the demand curve for the other to the left by 1% o
The two goods are complements o
The two goods are substitutes o
Both goods are normal goods
VII.
Which of the following is likely to have the most elastic demand? o
Food o
Fruit

o
Bananas o
Dole brand bananas
VIII.
Answer the next question on the basis of the following diagram:
Refer to the diagram. At the equilibrium price and quantity, total consumer surplus in this market is: o
$3 o
$7 o
$150 o
$350
IX.
Suppose legalization—and subsequent regulation—of heroin and cocaine reduces their prices by 50%. Estimates suggest the total quantity of heroin and cocaine demanded would rise by 83% and 42%, respectively. Consequently, legalization would: o
Increase total expenditures on both heroin and cocaine o
Decrease total expenditures on both heroin and cocaine o
Increase total expenditures on heroin and decrease total expenditures on cocaine o
Decrease total expenditures on heroin and increase total expenditures on cocaine
X.
Assume that the price of product Y decreases by 5% and the quantity supplied decreases by 2%. The coefficient of price elasticity of supply for good Y is: o
Negative and therefore Y is an inferior good o
Less than one and therefore supply is inelastic o
More than one and therefore supply is elastic o
Negative and therefore the supply curve is downward sloping

Problem 1:
Suppose a firm sells 20,000 units when the price is $16, but sells 30,000 units when the price falls to $14. a) Calculate the percentage change in the quantity sold over this price range using the midpoint formula. b) Calculate the percentage change in the price using the midpoint formula. c) Find the price elasticity of demand over this range of prices. State whether demand is elastic or inelastic over this range. d) Suppose the firm's elasticity of demand is constant over a large range of prices. If the price were to fall another 4%, what should the firm predict will happen to its sales?
Answers: a) The midpoint formula uses the average of the two quantities as the reference point for computing the percentage change. In this example, the percentage change is:
Change in quantity
→
Sum of Quantities
2
30000 − 20000
→
50000
2
10,000
25,000
→ 0.40 → 40% b) The percentage change is:
Change in Price
→
Sum of Prices
2
16 − 14
→
30
2
2
15
, 0.133 → 13.3% c) The price elasticity of demand is the ratio of the percentage change in quantity to the percentage change in price. In this example,
E d
40
=
13.3
→ 3
Since E d
is bigger than one, so demand is elastic.

d) Since E d
= 3, which equals the ratio of the percentage change in quantity to the percentage change in price, this can be rearranged to determine that the percentage change in quantity is equal to the elasticity of demand multiply with the percentage change in price. In this example, sales will increase by 12%. 12% = 3 x 4%.
Problem 2:
Suppose a firm sells 70 units when the price is $6, but sells 80 units when the price falls to $4. a) Calculate the firm's revenue at each of the prices. b) Use the total-revenue test to determine whether demand is elastic or inelastic over this range. c) Verify your previous answer by calculating the elasticity of demand using the midpoint formula.
Answers: a) Revenue equals price multiply quantity sold. At P = $6, revenue equals $420. $420 = $6 x 70. At P = $4, revenue = $4 x 80 = $320. b) Revenue falls when the price falls, suggesting demand is inelastic over this range. c) Elasticity of demand is:
𝐸 𝑑
=
Change in quantity
Sum of Quantities
2
Change in Price
Sum of Prices
2
→
80 − 70
150
2
6 − 4
10
2
→
10
75
2
5
→
0.133
0.4
→ 0.325
This is less than one, verifying that demand is inelastic.

Problem 3:
Suppose the market for watermelons can be described by the graph below. a) If Hassan is willing to pay as much as $8 for a watermelon, how much surplus would he receive if he pays the market price for a watermelon? b) Suppose Farhan Farms requires at least $5 per watermelon to be willing to sell in this market. What is Farhan's producer surplus for one watermelon in this market? c) How much total consumer surplus is received in this market? d) How much total producer surplus is received in this market? e) What is the combined consumer and producer surplus in the market?
Answers: a) Consumer surplus is the difference between the maximum Hassan is willing to pay and the price he actually pays. The equilibrium price in this market is $6, so his consumer surplus is $2. $2 = $8 – $6. b) Producer surplus is the difference between the market price and the minimum a seller requires to offer the product for sale. In this case,
Farhan's producer surplus is $6 – $5 = $1. c) Total consumer surplus is the area below the demand curve but above the market price. The area of this triangle on the graph is ½ x
($11 – $6) x 200 = $500.

d) Total producer surplus is the area above the supply curve but below the market price. The area of this triangle on the graph is ½ x ($6
– $4) x 200 = $200. e) The combined surplus is the sum of consumer and producer surplus, or $500 + $200 = $700.


Graph the accompanying demand data, and then use the midpoint formula for E d
to determine price elasticity of demand for each of the four possible $1 price changes. What can you conclude about the relationship between the slope of a curve and its elasticity?
Explain in a nontechnical way why demand is elastic in the northwest segment of the demand curve and inelastic in the southeast segment.
Product Price
$5
4
3
2
1
Quantity Demanded
1
2
3
4
5

Calculate total-revenue data from the demand schedule in question 1. Graph total revenue below your demand curve. Generalize about the relationship between price elasticity and total revenue.

How would the following changes in price affect total revenue?
That is, would total revenue increase, decline, or remain unchanged? a) Price falls and demand is inelastic. b) Price rises and demand is elastic. c) Price rises and supply is elastic. d) Price rises and supply is inelastic. e) Price rises and demand is inelastic. f) Price falls and demand is elastic. g) Price falls and demand is of unit elasticity

What are the major determinants of price elasticity of demand?
Use those determinants and your own reasoning in judging whether demand for each of the following products is probably elastic or

inelastic: ( a ) bottled water; ( b ) toothpaste; ( c ) Crest toothpaste; ( d ) ketchup; ( e ) diamond bracelets; ( f ) Microsoft Windows operating system

What is the formula for measuring the price elasticity of supply?
Suppose the price of apples goes up from $20 to $22 a box. In direct response, Goldsboro Farms supplies 1200 boxes of apples instead of
1000 boxes. Compute the coefficient of price elasticity (midpoints approach) for Goldsboro’s supply. Is its supply elastic, or is it inelastic?

Suppose the cross elasticity of demand for products A and B is
+3.6 and for products C and D is -5.4. What can you conclude about how products A and B are related Products C and D?

The income elasticity of demand for movies, dental services, and clothing have been estimated to be +3.4, +1, and +.5, respectively.
Interpret these coefficients. What does it mean if an income elasticity coefficient is negative?

Use the ideas of consumer surplus and producer surplus to explain why economists say competitive markets are efficient. Why are below- or above-equilibrium levels of output inefficient, according to these two sets of ideas?