ELASTICITY
Elasticity is the concept economists use to
describe the steepness or flatness of curves
or functions.
In general, elasticity measures the
responsiveness of one variable to changes in
another variable.
Elasticity
slide 1
PRICE ELASTICITY OF
DEMAND
Measures the responsiveness of quantity
demanded to changes in a good’s own price.
The price elasticity of demand is the percent
change in quantity demanded divided by the
percent change in price that caused the
change in quantity demanded.
Elasticity
slide 2
FACTS ABOUT ELASTICITY
It’s always a ratio of percentage changes.
That means it is a pure number -- there are no units
of measurement on elasticity.
Price elasticity of demand is computed along a
demand curve.
Elasticity is not the same as slope.
Elasticity
slide 3
LOTS OF ELASTICITIES!
THERE ARE LOTS OF WAYS TO COMPUTE
ELASTICITIES. SO BEWARE! THE DEVIL IS
IN THE DETAILS.
MOST OF THE AMBIGUITY IS DUE TO THE
MANY WAYS YOU CAN COMPUTE A
PERCENTAGE CHANGE. BE ALERT HERE.
IT’S NOT DIFFICULT, BUT CARE IS NEEDED.
Elasticity
slide 4
What’s the percent increase in price here
because of the shift in supply?
S'
price
S
pE = $2.50
pE = $2
D
QE
Q
CIGARETTE MARKET
Elasticity
slide 5
IS IT:
A) [.5/2.00] times 100?
B) [.5/2.50] times 100?
C) [.5/2.25] times 100?
D) Something else?
Elasticity
slide 6
From time to time economists have used ALL of
these measures of percentage change -including the “Something else”!
Notice that the numerical values of the percentage
change in price is different for each case:
Go to hidden slide
Elasticity
slide 7
Economists usually use the “midpoint”
formula (option C), above) to compute
elasticity in cases like this in order to
eliminate the ambiguity that arises if we
don’t know whether price increased or
decreased.
Elasticity
slide 9
Using the Midpoint Formula
Elasticity =
% change in Q
% change in P
% change in p =
% change in p =
change in P
average P
times 100.
P
(
)  100
PMEAN
For the prices $2 and $2.50, the % change in p is
approx. 22.22 percent.
Elasticity
slide 10
What’s the percent change in Q due to the
shift in supply?
S'
price
S
pE’ = $2.50
pE = $2
D
QE’ = 7 QE = 10
Q (millions)
CIGARETTE MARKET
Elasticity
slide 11
Use the midpoint formula again.
% change in Q
Elasticity =
% change in P
change in Q
% change in Q =
average Q
% change in Q = (  Q )  100
Q MEAN
For the quantities of 10 and 7, the % change in Q is
approx. -35.3 percent. (3/8.5 times 100)
Elasticity
slide 12
NOW COMPUTE ELASTICITY
% change in p = 22.22 percent
% change in Q = -35.3 percent
E = -35.3 / 22.22 = -1.6 (approx.)
Elasticity
slide 13
But you can do the other options as well:
A) If you use the low price, and its corresponding
quantity, as the base values, then elasticity = 1.2
B) If you use the high price, and its corresponding
quantity, as the base values, then elasticity = 2.1
(approx.)
C) And the midpoint formula gave 1.6 (approx.)
SAME PROBLEM...DIFFERENT ANSWERS!!!
Elasticity
slide 14
QUANTITY PRICE
0
10
1
9
2
8
3
7
4
6
5
5
6
4
7
3
8
2
9
1
10
0
Elasticity
MORE ELASTICITY
COMPUTATIONS
P
14
12
Compute elasticity between
prices of $9 and $8.
10
8
6
4
2
Q
0
0
2
4
6
8
10
12
14
slide 15
USE THE MIDPOINT FORMULA.
The % change in Q =
The % change in P =
Therefore elasticity =
Go to hidden slide
Elasticity
slide 16
Now we try different prices
QUANTITY PRICE
0
10
P
1
9 14
2
8 12
3
7 10
8
4
6
6
5
5
4
6
4
2
7
3
0
8
2
0
9
1
10
0
Elasticity
Compute elasticity between
prices of $3 and $2.
Q
2
4
6
8
10
12
14
slide 19
The % change in Q =
The % change in P =
Therefore elasticity =
Go to hidden slide
Elasticity
slide 20
ELASTICITY IS NOT SLOPE!
QUANTITY PRICE P
14
0
10
12
1
9
10
2
8
8
3
7
4
6
6
5
5
4
6
4
2
7
3
0
0
8
2
9
1
10
0
Elasticity
Note that elasticity is different
at the two points even though
the slope is the same.
(Slope = -1)
E = -5.67
E = -.33
Q
2
4
6
8
10
12
14
slide 23
TERMS TO LEARN
Demand is ELASTIC when the numerical value of
elasticity is greater than 1.
Demand is INELASTIC when the numerical value of
elasticity is less than 1.
Demand is UNIT ELASTIC when the numerical
value of elasticity equals 1.
NOTE: Numerical value here means “absolute
value.”
Elasticity
slide 24
LIKE THIS!
QUANTITY PRICE
0
10
1
9
2
8
3
7
4
6
5
5
6
4
7
3
8
2
9
1
10
0
Elasticity
P
14
12
Demand is elastic here.
10
8
Demand is inelastic here.
6
4
2
Q
0
0
2
4
6
8
10
12
14
slide 25
A FINAL ELASTICITY
MEASURE
POINT ELASTICITY OF DEMAND
If you know or can see the demand curve for a
good (you don’t know just two points), you
can compute “point elasticity of demand” at
a single point on the demand curve.
Here’s the idea:
Elasticity
slide 26
The % change in price can be written as:
P)/Pbase times 100
The % change in quantity can be written as:
Q)/Qbase times 100
So elasticity is: (Q)/ (P)) ( Pbase / Qbase)
Elasticity
slide 27
So elasticity is Q)/ (P) multiplied by the
ratio of base price to base quantity.
Point elasticity uses this formula to compute
the elasticity of demand AT A POINT on a
demand curve.
Elasticity
slide 28
EXAMPLE
P
Elasticity at a price of $3
is .90.
6
$3
D
10
Elasticity
18
Q
slide 29
There is an important relationship between what
happens to consumers’ spending on a good and
elasticity when there is a change in price.
Spending on a good = P Q.
Because demand curves are negatively sloped, a
reduction in P causes Q to rise and the net effect
on PQ is uncertain, and depends on the elasticity
of demand.
Elasticity
slide 30
At P = $9, spending is $9 (= 1 times $9).
At P = $8, spending is $16 ( = 2 times $8).
price fell from $9 to $8, spending rose. Q must have
QUANTITY PRICE When
increased by a larger percent than P decreased. So...
0
10
P
14
1
9
12
2
8
Demand is elastic here.
3
7
10
4
6
8
5
5
6
6
4
4
7
3
2
8
2
0
Q
9
1
0
2
4
6
8
10
12
14
10
0
Elasticity
slide 31
At P = $3, spending is $21 (= 7 times $3).
At P = $2, spending is $16 ( = 8 times $2).
QUANTITY
0
1
2
3
4
5
6
7
8
9
10
Elasticity
When price fell from $3 to $2, spending fell. Q must have
PRICE increased by a smaller percent than P decreased. So...
P
10
14
9
8
7
6
5
4
3
2
1
0
12
10
8
Demand is inelastic here.
6
4
2
0
0
2
4
6
8
10
12
14
slide 32
Q
There is an easy way to tell whether demand is
elastic or inelastic between any two prices.
If, when price falls, total spending increases, demand
is elastic.
If, when price falls, total spending decreases,
demand is inelastic.
Elasticity
slide 33
But total spending is easy to see using a
demand curve graph:
QUANTITY PRICE
0
10
1
9
2
8
3
7
4
6
5
5
6
4
7
3
8
2
9
1
10
0
Elasticity
P
14
12
The shaded area is P times Q
or total spending when P = $9.
10
8
6
4
2
0
Q
0
2
4
6
8
10
12
14
slide 34
P
14
QUANTITY PRICE
0
10
1
9
2
8
3
7
4
6
5
5
6
4
7
3
8
2
9
1
10
0
Elasticity
12
The shaded area is P times Q
or total spending when P = $8.
10
8
6
4
2
0
Q
0
2
4
6
8
10
12
14
slide 35
= loss in TR
due to fall in P
QUANTITYPRICE
0
10
1
9
2
8
3
7
4
6
5
5
6
4
7
3
8
2
9
1
10
0
Elasticity
= gain in TR due to
rise in Q
P
14
12
10
Total spending is higher at the price
of $8 than it was at the price of $9.
8
6
4
2
0
Q
0
2
4
6
8
10
12
14
slide 36
P
QUANTITY PRICE
0
10
1
9
2
8
3
7
4
6
5
5
6
4
7
3
8
2
9
1
10
0
Elasticity
14
12
The shaded area is total
spending (total revenue of
sellers) when P = $3.
10
8
6
4
2
0
0
2
4
6
8
10
12
14
slide 37
Q
P
QUANTITYPRICE
0
10
1
9
2
8
3
7
4
6
5
5
6
4
7
3
8
2
9
1
10
0
Elasticity
14
12
Total revenue of sellers (total
spending by buyers) falls when
price falls from $3 to $2.
10
8
6
4
2
0
Q
0
2
4
6
8
10
12
14
slide 38
Here’s a convenient way to think of the
relative elasticity of demand curves.
p
relatively more elastic
at p*
p*
relatively more inelastic
at p*
Q
Q*
Elasticity
slide 39
Examples of elasticity
Doctors through the AMA restrict the supply of
physicians. How does this affect the incomes of
doctors as a group?
A labor union negotiates a higher wage. How does
this affect the incomes of affected workers as a
group?
MSU decides to raise the price of football tickets.
How is income from the sale of tickets affected?
Airlines propose to raise fares by 10%. Will the
boost increase revenues?
Elasticity
slide 40
MORE ...
MSU is considering raising tuition by 7%.
Will the increase in tuition raise revenues of
MSU?
CATA recently raised bus fares in the Lansing
area. Will this increase CATA’s total
receipts?
Elasticity
slide 41
The answers to all of these questions depend
on the elasticity of demand for the good in
question. Be sure you understand how and
why!
Elasticity
slide 42
DETERMINANTS OF DEMAND
ELASTICITY
The more substitutes there are available for a good,
the more elastic the demand for it will tend to be.
[Related to the idea of necessities and luxuries.
Necessities tend to have few substitutes.]
The longer the time period involved, the more elastic
the demand will tend to be.
The higher the fraction of income spent on the good,
the more elastic the demand will tend to be.
Elasticity
slide 43
OTHER ELASTICITY MEASURES
In principle, you can compute the elasticity
between any two variables.
Income elasticity of demand
Cross price elasticity of demand
Elasticity of supply
Elasticity
slide 44
Each of these concepts has the expected definition.
For example, income elasticity of demand is the
percent change in quantity demand divided by a
percent change income:
EINCOME =
% change in Q
% change in I
Income elasticity of demand will be positive for
normal goods, negative for inferior ones.
Elasticity
slide 45