ECONOMICS
Elasticity
Learning Objectives
• Define and calculate the price elasticity of
demand
• Use a total revenue test and an expenditure
test to estimate the price elasticity of
demand
• Explain the factors that influence the price
elasticity of demand
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-2
Learning Objectives (cont.)
• Define and calculate the cross elasticity of
demand
• Define and calculate the income elasticity
of demand
• Define and calculate the elasticity of supply
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-3
Learning Objectives
• Define and calculate the price elasticity of
demand
• Use a total revenue test and an expenditure
test to estimate the price elasticity of
demand
• Explain the factors that influence the price
elasticity of demand
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-4
The Price Elasticity of Demand
You know that 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?
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-5
The Price Elasticity of Demand
The price elasticity of demand is a unitsfree measure of the responsiveness of the
quantity demanded of a good to a change in
its price when all other influences on
buyers’ plans remain the same.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-6
Price (dollars per pizza)
How a Change in Supply
Changes Price and Quantity
40.00
S0
30.00… a large
fall in price...
S1
An increase
in supply
brings ...
Large price change and
small quantity change
20.00
10.00
… and a small
increase in quantity...
5.00
0
5
10 13 15
Da
20
25
Quantity (pizza per hour)
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-7
Price (dollars per pizza)
How a Change in Supply
Changes Price and Quantity
An increase
in supply
S0
brings ...
40.00
S1
30.00 … a small
fall in price...
20.00
15.00
Db
10.00
0
Copyright © 1998 Addison Wesley Longman, Inc.
Small price change and
large quantity change
… and a large
increase in quantity...
5
10
25
15 17 20
Quantity (pizza per hour)
TM 5-8
The Price Elasticity of Demand
Calculating Elasticity
Price elasticity of demand =
Percent change in quantity demanded
Percent change in price
Express the changes in price and quantity demanded
as percentages of the average price and the
average quantity.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-9
The Price Elasticity of Demand
Calculating Elasticity (cont.)
The original price is $20.50 and the new price is $19.50,
so the average price is $20.
The $1.00 price decrease is 5 percent of the average price.
∆P/Pavg = ($1/$20) x 100 = 5%
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-10
The Price Elasticity of Demand
Calculating Elasticity (cont.)
The original quantity demanded is 9 pizzas and the new
quantity demanded is 11 pizzas.
The 2 pizza increase in the quantity demanded is 20 percent
of the average quantity.
∆Q/Qavg = (2/10) x 100 = 20%
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-11
The Price Elasticity of Demand
Calculating Elasticity (cont.)
%Q
Price elasticity of demand 
%P
20%
= 4
=
5%
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-12
Price (dollars per pizza)
Calculating the Elasticity of Demand
Original
point
20.50
P = $1
20.00
Elasticity = 4
New
point
Pavg = $20
19.50
Q = 2
9
Copyright © 1998 Addison Wesley Longman, Inc.
Qavg = 10
10
D
11
Quantity (pizza per hour)
TM 5-13
The Price Elasticity of Demand
Average Price and Quantity
We use the average price and average
quantity to avoid having two values for the
elasticity of demand at a single point on the
demand curve, depending whether the price
falls or rises.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-14
The Price Elasticity of Demand
Percentages and Proportions
Elasticity is the ratio of the percentage
change in the quantity demanded to the
percentage change in the price.
Equivalently, the proportionate change in
the quantity demanded divided by the
proportionate change in price.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-15
The Price Elasticity of Demand
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.
And the ratio of the two percentages is a
number without units.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-16
The Price Elasticity of Demand
Minus Sign and Elasticity
The price elasticity of demand is a negative
number.
But, it is the magnitude, or absolute value, of
the price elasticity of demand that tells us how
elastic demand is.
We use the magnitude and ignore the minus
sign.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-17
The Price Elasticity of Demand
Inelastic and Elastic Demand
Perfectly inelastic demand
Implies that quantity demanded remains
constant when price changes occur.
Price elasticity of demand = 0
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-18
The Price Elasticity of Demand
Inelastic and Elastic Demand (cont.)
Unit elastic demand
Implies that the percentage change in quantity
demanded equals the percentage change in
price.
Price elasticity of demand = 1
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-19
Inelastic and Elastic Demand
Inelastic and Elastic Demand (cont.)
Perfectly elastic demand
Implies that if price changes by any percentage,
quantity demanded will fall to 0.
Price elasticity of demand =
Copyright © 1998 Addison Wesley Longman, Inc.

TM 5-20
Inelastic and Elastic Demand
Inelastic and Elastic Demand (cont.)
Inelastic demand
Implies the percentage change in quantity
demanded is less than the percentage change in
price.
Price elasticity of demand > 0 and < 1.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-21
Inelastic and Elastic Demand
Inelastic and Elastic Demand (cont.)
Elastic demand
Implies the percentage change in quantity
demanded is greater than the percentage change
in price.
Price elasticity of demand > 1.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-22
Inelastic and Elastic Demand
Price
Perfectly inelastic demand
D1
Elasticity = 0
12
6
0
Copyright © 1998 Addison Wesley Longman, Inc.
Quantity
TM 5-23
Inelastic and Elastic Demand
Price
Unit elastic demand
Elasticity = 1
12
6
D2
0
Copyright © 1998 Addison Wesley Longman, Inc.
1
2
3
Quantity
TM 5-24
Inelastic and Elastic Demand
Price
Perfectly elastic demand
Elasticity =
12

D3
6
0
Copyright © 1998 Addison Wesley Longman, Inc.
Quantity
TM 5-25
Inelastic and Elastic Demand
Elasticity Along a Straight-Line
Demand Curve
Along a straight-line demand curve, the
elasticity varies.
At high prices and small quantities, the
elasticity is large and at low prices and large
quantities, the elasticity is small.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-26
Price (dollars per pizza)
Elasticity Along a Straight-Line
Demand Curve
25.00
Elasticity = 4
20.00
Elastic
Elasticity = 1
15.00
12.50
Inelastic
10.00
Elasticity = 1/4
5.00
0
Copyright © 1998 Addison Wesley Longman, Inc.
10
20 25 30 40
50
Quantity (pizza per hour)
TM 5-27
Learning Objectives
• Define and calculate the price elasticity of
demand
• Use a total revenue test and an expenditure
test to estimate the price elasticity of
demand
• Explain the factors that influence the price
elasticity of demand
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-28
Total Revenue and Elasticity
When a price changes, the
change in producers’ total
revenue
depends
on
the
elasticity of demand.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-29
Total Revenue and Elasticity
Elastic demand: a 1 percent price cut
increases the quantity sold by more than 1
percent and total revenue increases.
Unit elastic demand: a 1 percent price cut
increases the quantity sold by 1 percent and
so total revenue does not change.
Inelastic demand: a 1 percent price cut
increases the quantity sold by less than 1
percent and total revenue decreases.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-30
Total Revenue and Elasticity
Total Revenue Test
Price elasticity of demand can be
estimated by observing the change in
total revenue that results from a price
change (ceteris paribus).
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-31
Total Revenue and Elasticity
Total Revenue Test
If a price cut increases total revenue, demand is
elastic.
If a price cut decreases total revenue, demand is
inelastic.
If a price cut leaves total revenue unchanged,
demand is unit elastic.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-32
Elasticity and Total Revenue
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-33
Elastic
demand
When demand
is elastic,
price cut
increases
total revenue
Total Revenue (billions of dollars)
Price (dollars per pizza)
25.00
20.00
15.00
Unit
elastic
12.50
10.00
Inelastic
demand
5.00
0
350.00
312.50
300.00
25
50
Maximum
total revenue
250.00
When demand
is inelastic,
price cut decreases
total revenue
200.00
150.00
100.00
50.00
0
Copyright © 1998 Addison Wesley Longman, Inc.
25
50
Quantity (pizza per hour)
TM 5-34
Total Revenue and Elasticity
Your Expenditure and Your Elasticity
If your demand is elastic, a 1 percent price cut
increases the quantity you buy by more than 1
percent and your expenditure on the item
increases.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-35
Total Revenue and Elasticity
Your Expenditure and Your Elasticity
(cont.)
If your demand is unit elastic, a 1 percent price
cut increases your quantity bought by 1 percent
and so your expenditure on the item does not
change.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-36
Total Revenue and Elasticity
Your Expenditure and your Elasticity
(cont.)
If your demand is inelastic, a 1 percent price cut
increases your quantity bought by less than 1
percent and so your expenditure on the item
decreases.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-37
Some Real-World Price
Elasticities of Demand
Good or Service
Elastic Demand
Metals
Electrical engineering products
Mechanical engineering products
Furniture
Motor vehicles
Instrument engineering products
Professional services
Transportation services
Inelastic Demand
Gas, electricity, and water
Oil
Chemicals
Beverages (all types)
Clothing
Tobacco
Banking and insurance services
Housing services
Agricultural and fish products
Books, magazines, and newspapers
Food
Copyright © 1998 Addison Wesley Longman, Inc.
Elasticity
1.52
1.30
1.30
1.26
1.14
1.10
1.09
1.03
0.92
0.91
0.89
0.78
0.64
0.61
0.56
0.55
0.42
0.34
0.12
TM 5-38
Learning Objectives
• Define and calculate the price elasticity of
demand
• Use a total revenue test and an expenditure
test to estimate the price elasticity of
demand
• Explain the factors that influence the price
elasticity of demand
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-39
Factors That Influence Elasticity
the Elasticity of Demand
Closeness of Substitutes.
The closer the substitutes, the more elastic the
demand.
• necessities
• luxuries
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-40
Factors That Influence Elasticity
the Elasticity of Demand
Proportion of Income Spent on the Good
The greater the proportion of income spent on
food, the more elastic the demand.
Time Elapsed Since Price Change
The longer the time, the more elastic the demand.
• Short-run demand
• Long-run demand
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-41
Price Elasticities in 20 Countries
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-42
Learning Objectives
• Define and calculate the cross elasticity of
demand
• Define and calculate the income elasticity
of demand
• Define and calculate the elasticity of supply
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-43
More Elasticities of Demand
Cross elasticity of demand
Measures the responsiveness of the demand for
a good to a change in the price of a substitute or
complement good.
Cross elasticity
of demand
Copyright © 1998 Addison Wesley Longman, Inc.
=
Percentage change
in quantity demanded
Percentage change in price of
a substitute or complement
TM 5-44
Price of pizzas
Cross Elasticity of Demand
Price of a burger,
a substitute, falls.
Positive cross elasticity.
0
Copyright © 1998 Addison Wesley Longman, Inc.
Price of soda,
a complement,
falls. Negative
cross elasticity.
D1
D0
D2
Quantity of pizzas
TM 5-45
Learning Objectives
• Define and calculate the cross elasticity of
demand
• Define and calculate the income elasticity
of demand
• Define and calculate the elasticity of supply
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-46
Income Elasticity of Demand
Income elasticity
Measures the responsiveness of the demand to a
change in income.
Income elasticity
of demand
Copyright © 1998 Addison Wesley Longman, Inc.
=
Percentage change
in quantity demanded
Percentage change in income
TM 5-47
Income Elasticity of Demand
Income elasticity can be:
1 ) Greater than 1 (normal good, income elastic)
2 ) Between zero and 1 (normal good, income
inelastic)
3 ) Less than zero (inferior good)
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-48
Income Elasticity of Demand
Income
elastic
Elasticity less than 1
and becomes negative
Quantity demanded
Elasticity between
zero and 1
Quantity demanded
Quantity demanded
Elasticity greater
than 1
Income
inelastic
Positive
income
elasticity
Income
Copyright © 1998 Addison Wesley Longman, Inc.
Income
Negative
income
elasticity
m Income
TM 5-49
Some Real-World Income
Elasticities of Demand
Elastic Demand
Airline Travel
Movies
Foreign Travel
Electricity
Restaurant meals
Local buses and trains
Haircutting
Cars
Inelastic Demand
Tobacco
Alcoholic beverages
Furniture
Clothing
Newspapers and magazines
Telephone
Food
Copyright © 1998 Addison Wesley Longman, Inc.
5.82
3.41
3.08
1.94
1.61
1.38
1.36
1.07
0.86
0.62
0.53
0.51
0.38
0.32
0.14
TM 5-50
Income Elasticities in
15 Countries
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-51
Learning Objectives
• Define and calculate the cross elasticity of
demand
• Define and calculate the income elasticity
of demand
• Define and calculate the elasticity of supply
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-52
Elasticity of Supply
Elasticity of supply measures the
responsiveness of quantity supplied to a
change in price.
Elasticity
of supply
Copyright © 1998 Addison Wesley Longman, Inc.
Percentage change in quantity supplied
=
Percentage change in price
TM 5-53
Price (dollars per pizza)
How a Change in Demand Changes
Price and Quantity
40.00
An increase
in demand
brings ...
Sa
Large price change and
small quantity change
30.00
20.00
10.00
… a large
price rise...
D1
… and a small
quantity increase...
0
Copyright © 1998 Addison Wesley Longman, Inc.
5
10 13 15
20
25
D0
Quantity (pizza per hour)
TM 5-54
Price (dollars per pizza)
How a Change in Demand
Changes Price and Quantity
40.00
30.00
21.00
20.00
10.00
An increase
in demand
brings ...
Small price change and
large quantity change
Sb
… a small
price rise...
D1
… and a large
quantity increase...
0
5
D0
10
15
20
25
Quantity (pizza per hour)
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-55
Elasticity of Supply
Supply elasticity depends on:
• Resource substitution possibilities
• Time frame for the supply decision
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-56
Inelastic and Elastic Demand
Price
Perfectly inelastic supply
0
Copyright © 1998 Addison Wesley Longman, Inc.
S1
Elasticity of
supply = 0
Quantity
TM 5-57
Inelastic and Elastic Demand
Price
Unit elastic supply
S1
Elasticity of
supply = 1
0
Copyright © 1998 Addison Wesley Longman, Inc.
Quantity
TM 5-58
Inelastic and Elastic Demand
Price
Perfectly elastic supply
Elasticity of
supply =

S3
0
Copyright © 1998 Addison Wesley Longman, Inc.
Quantity
TM 5-59
Elasticity of Supply
Resource Substitution Possibilities
The more unique the resource, the more
inelastic the supply.
• Van Gogh painting - Van Gogh
• Wheat/corn — farmland
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-60
Elasticity of Supply
Time Frame for Supply Decisions
• Momentary supply
• Long-run supply
• Short-run supply
The longer producers have to adjust to a price
change, the more elastic is supply.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-61
A Compact Glossary of Elasticities
PRICE ELASTICITIES OF DEMAND
A relationship is
described as
When its
magnitude is
Which means that
Perfectly elastic
or infinitely elastic
Infinity
The smallest possible increase in price causes
an infinitely large decrease in quantity demanded
Elastic
Less than infinity
but greater than 1
The percent decrease in the quantity demanded
exceeds the percent increase in price
Unit elastic
1
The percent decrease in the quantity demanded
equals the percent increase in price
In elastic
Greater than zero
but less than 1
The percentage decrease in the quantity demanded
is less than the percent increase in price.
Perfectly inelastic
Zero
or completely inelastic
Copyright © 1998 Addison Wesley Longman, Inc.
The quantity demanded is the same at all prices
TM 5-62
A Compact Glossary of Elasticities
CROSS ELASTICITIES OF DEMAND
A relationship is
described as
When its
magnitude is
Which means that
Perfect substitutes
Infinity
The smallest possible increase in price of one
good causes an infinitely large in the demand
of the other good.
Substitutes
Positive, less
than infinity
If the price of one good increases, the quantity
demanded of the other good also increases.
Independent
Zero
The demand for one good remains constant,
regardless of the price of the other good.
Complements
Less than zero
The demand for one good decreases when the
price of the other good increases.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-63
A Compact Glossary of Elasticities
INCOME ELASTICITIES OF DEMAND
A relationship is
described as
When its
magnitude is
Which means that
Income elastic
(normal good)
Greater than 1
The percent increase in the quantity demanded
is greater than the percentage increase in income.
Income inelastic
(normal good)
Less than 1 but
greater than zero
The percent increase in the quantity demanded
is less than the percentage increase in income.
Negative income elastic
(inferior good)
Less than zero
When income increases, quantity demanded
decreases.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-64
A Compact Glossary of Elasticities
ELASTICITIES OF SUPPLY
A relationship is
described as
When its
magnitude is
Which means that
Perfectly elastic
Infinity
The smallest possible increase in price causes an
infinitely large increase in the quantity supplied.
Elastic
Less than infinity
but greater than 1
The percent increase in the quantity supplied
exceeds the percentage increase in the price.
Inelastic
Greater than zero
but less than 1
The percentage increase in the quantity supplied
is less than the percentage increase in price.
Perfectly inelastic
Zero
The quantity supplied is the same at all prices.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 5-65