Chapter 5
Price Elasticity of
Demand and Supply
• Key Concepts
• Summary
• Practice Quiz
• Internet Exercises
©2002 South-Western College Publishing
How is the percent
increase or decrease
of two numbers
calculated?
Percent change is the
difference between the
two numbers divided by
the original number
2
Suppose the price of
a rock concert
increases by 10%,
what effect will this
have on sales?
That all depends on the
price elasticity of demand
for this rock concert
3
What is elasticity?
A term economists use to
describe responsiveness,
or sensitivity, to a change
in price
4
What is price
elasticity of demand?
The ratio of the
percentage change in the
quantity demanded of a
product to a percentage
change in its price
5
Price Elasticity of Demand
6
Supposing a university’s
enrollment drops by 20%
because tuition rises by
10%, what is the price
elasticity of demand?
7
8
Why is elasticity 2 in
the previous example
and not -2?
Economists drop the
negative sign because we
know from the law of
demand that quantity
demanded and price are
inversely related
9
If there is an
increase from 3 units
to 5, what is the
percentage increase?
2/3 = 66%
10
If there is a decrease
from 5 units to 3, what
is the percentage
decrease?
2/5 = 40%
11
Problem - When we
move along a demand
curve between two points,
we get different answers to
elasticity depending on
whether we are moving up
or down the demand curve
12
P
A
2
B
3
D
Q
13
Economists can solve this
problem of different base
points by using the midpoints
as the base points of
changes in prices and
quantity demanded
14
Price elasticity equals the
 in quantity demanded
sum of quantities/2
divided by
 in price
sum of prices/2
15
What is elastic demand?
A condition in which the
percentage change in
quantity demanded is
greater than the
percentage change in price
16
P
$40
$30
Elastic Demand Ed > 1
A
B
$20
$10
10
20
30
40
Q
17
Why is the demand
curve in the previous
slide elastic?
The percentage change
in the quantity
demanded is greater
than the percentage
change in price
18
Elastic Demand
Increase in
total revenue
Price
decrease
19
10
% change in Q =
= .66
15
10
% change in P =
= .40
25
%
change
in
Q
.66
Ed =
=
% change in P
.40
Ed = 1.65
20
$40
$30
Inelastic Demand Ed < 1
A
B
$20
$10
10
20
30 40
21
Why is the demand
curve in the previous
slide inelastic?
The percentage change in
the quantity demanded is
less than the percentage
change in price
22
Inelastic Demand
Decrease in
total revenue
Price
decrease
23
5
% change in Q =
= .38
13
10
% change in P =
= .40
25
% change in Q .38
Ed =
=
% change in P .40
24
What is a unitary
elastic demand curve?
The percentage change in
the quantity demanded is
equal to the percentage
change in price
25
Unitary Elastic Demand Ed = 1
$40
$30
E
F
$20
D
$10
10
20
30 40
26
Unitary Elastic Demand
No change in
total revenue
Price
decrease
27
What is a perfectly
elastic demand curve?
A condition in which a
small percentage
change in price brings
about an infinite
percentage change in
the quantity demanded
28
$40
$30
$10
Perfectly Elastic Demand Ed =
8
$20
10
20
30 40
29
Perfectly Elastic Demand
Infinite change in
quantity demanded
Price change
30
What is a perfectly
inelastic demand curve?
A condition in which the
quantity demanded
does not change as
the price changes
31
Perfectly Inelastic Demand Ed = 0
$40
$30
$20
$10
10
20
30 40
32
Perfectly Inelastic Demand
Zero change in
quantity demanded
Price change
33
If a college raises
tuition, what happens
to revenue?
If demand is elastic total revenue goes down
If demand is inelastic total revenue goes up
34
If price increases and
the revenue gained is
greater than the
revenue lost, the
demand curve is price
inelastic, < 1
35
If price increases and
the revenue gained is
less than the revenue
lost, the demand curve
is price elastic, > 1
36
If total revenue does
not change when
price increases, the
demand curve is
unitary elastic,
value equals 1
37
$40
$35
$30
$25
$20
$15
$10
$5
Price Elasticity of
Demand Ranges
5 10 15 20 25 30 35 40 45
38
$400
$350
$300
$250
$200
$150
$100
Total Revenue Curve
$50
5 10 15 20 25 30 35 40 45
39
What factors influence
demand sensitivity?
• Availability of substitutes
• Share of budget on the
product
• Adjustment to a price
change over time
40
What do substitutes
have to do with a
price change?
The more substitutes a
product has, the more
sensitive consumers are
to a price change, and
the more elastic the
demand curve
41
P
A
P
D
D
0
Q
B
0
Q
Which demand curve is for a vital
medicine and which is for candy?
42
Why is A the demand
curve for medicine?
Because medicine is a
necessity with few
substitutes, and the
price can change with
little effect on the
quantity demanded
43
Why is B the demand
curve for candy?
Because candy has
many substitutes, a
price change can bring
about a big change in
the quantity demanded
44
What does the share
of one’s budget
have to do with a
price change?
The larger the purchase is
to one’s budget, the
more sensitive
consumers are to a price
change, and the more
elastic the demand curve
45
What does time have
to do with sensitivity?
The longer consumers
have to adjust, the more
sensitive they are to a
price change, and the
more elastic the
demand curve
46
What are other
elasticity measures?
Income elasticity of demand
Cross-elasticity of demand
47
What is Income
elasticity of demand?
The ratio of the percentage
change in the quantity
demanded of a good to a
given percentage change
in income
48
Income Elasticity of Demand
49
What is crosselasticity of demand?
The ratio of the
percentage change in
quantity demanded of a
good to a given
percentage change in
price of another good
50
Cross-elasticity of Demand
51
What is the price
elasticity of supply?
The ratio of the percentage
change in the quantity
supplied of a product to
the percentage change in
its price
52
Price Elasticity of Supply
53
$40
$30
8
$20 Perfectly Elastic Supply =
$10
10
20
30 40
54
$40
$30
$20
Perfectly Inelastic Supply Es = 0
$10
10
20
30 40
55
$40
$30
$20
Unit Elastic Supply Es = 1
S
.5%
.5%
$10
10
20
30 40
56
Who pays the tax
levied on sellers of
goods such as
gasoline, cigarettes,
and alcoholic
beverages?
It all depends; the
corporation pays all, some,
or very little of the tax
57
What decides who
pays what part of
the tax increase?
The more elastic the
demand, the more the
corporation pays; the
less elastic the
demand, the more the
consumer pays
58
Partially shifted tax to buyers
$2.00
$1.7
5
$1.50
$1.25
$1.00
$.75
$.50
$.25
s2
Buyers
Sellers
s1
D
5 10 15 20 25 30 35 40 45
59
Consumers and
suppliers share
burden of tax
Decrease in
supply
Increase in
gasoline tax
60
$2.00
$1.75
$1.50
$1.25
$1.00
$.75
$.50
$.25
Fully shifted tax to buyers
s2
s1
Buyers
D
5 10 15 20 25 3035 40 45
61
Consumers bear
full burden of tax
Decrease in
supply
Increase in
gasoline tax
62
Key Concepts
63
Key Concepts
•
•
•
•
•
•
What is elasticity?
What is price elasticity of demand?
What is elastic demand?
What is a unitary elastic demand curve?
What is a perfectly elastic demand curve?
What is a perfectly inelastic demand curve?
64
Key Concepts cont.
•
•
•
•
•
What factors influence demand sensitivity?
What are other elasticity measures?
What is Income elasticity of demand?
What is cross-elasticity of demand?
What is the price elasticity of supply?
65
Summary
66
Price elasticity of demand is a
measure of the responsiveness of
the quantity demanded to a change
in price. Specifically, price elasticity
of demand is the ratio of the
percentage change in quantity
demanded to the percentage
change in price.
67
Price Elasticity of Demand
68
What is the midpoint formula for the
price elasticity of demand?
69
Price elasticity equals the
 in quantity demanded
sum of quantities/2
divided by
 in price
sum of prices/2
70
Elastic demand is a change of more
than one percent in quantity
demanded in response to a one
percent change in price. Demand is
elastic when the elasticity
coefficient is greater than one and
total revenue (price time quantity)
varies inversely with the direction of
the price change.
71
Elastic Demand
$40
$30
$20
$10
10
20
30 40
72
Inelastic demand is a change of
less than one percent in quantity
demanded in response to a one
percent change in price. Demand
is inelastic when the elasticity
coefficient is less than one and
total revenue varies directly with
the direction of the price change.
73
Inelastic Demand
$40
$30
$20
$10
10
20
30 40
74
Unitary elastic demand is a one
percent change in quantity
demanded in response to a one
percent change in price. Demand is
unitary elastic when the elasticity
coefficient equals one and total
revenue remains constant as the
price changes.
75
Unitary elastic Demand
$40
$30
$20
$10
10
20
30 40
76
Perfectly elastic demand is a
decline in quantity demanded to
zero for even the slightest rise or
fall in price. This is an extreme case
in which the demand curve is
horizontal and the elasticity
coefficient equals infinity.
77
$40
$30
8
$20 Perfectly Elastic Supply =
$10
10
20
30 40
78
Perfectly inelastic demand is no
change quantity demanded in
response to price changes. This is
an extreme case in which the the
demand curve is vertical and the
elasticity coefficient equals zero.
79
$40
$30
$20
Perfectly Inelastic Supply Es = 0
$10
10
20
30 40
80
Determinants of price elasticity of
demand include (a) the availability
of substitutes, (b) the percentage of
budget spent on the product, and
(c) the length of time allowed for
adjustment. Each of these factors is
directly related to the elasticity
coefficient.
81
Income elasticity of demand is the
percentage change in quantity
demanded divided by the
percentage change in income. For
a normal good or service, income
elasticity of demand is positive. For
an inferior good or service, income
elasticity of demand is negative.
82
Cross elasticity of demand is the
percentage change in the quantity
demanded of one product caused
by a change in the price of another
product. When the cross-elasticity
of demand is negative, the two
products are complements.
83
Price elasticity of supply is a
measure of the responsiveness of
the quantity demanded to a
change in price. Price elasticity of
supply is the ratio of the
percentage change in quantity
supplied to the percentage
change in price.
84
Tax incidence is the share of a
tax ultimately paid by buyers and
sellers. Facing a downwardsloping demand curve and an
upward-sloping supply curve,
sellers cannot raise the price by
the full amount of the tax. If the
demand curve is vertical, sellers
will raise the price by the full
amount of a tax.
85
$2.00
$1.75
$1.50
$1.25
$1.00
$.75
$.50
$.25
Fully shifted tax to buyers
Buyers
s2
s1
D
5 10 15 20 25 3035 40 45
86
Partially shifted tax to buyers
$2.00
$1.75
$1.50
$1.25
$1.00
$.75
$.50
$.25
Buyers
Sellers
s2
s1
D
5 10 15 20 25 30 35 40 45
87
Chapter 5 Quiz
©2002 South-Western College Publishing
88
1. If an increase in bus fares in Charlotte,
North Carolina, reduces total revenue of
the public transit system, this is evidence
that demand is
a. price elastic.
b. price inelastic
c. unitary elastic
A. When price increases and the total
revenue decreases, by definition, this
represents an elastic demand curve. The
revenue lost from selling fewer units is
not offset by the revenue gained by
charging a higher price.
89
2. Which of the following results in an
increase in total revenue?
a. Price increases when demand is elastic.
b. Price decreases when demand is elastic.
c. Price increases when demand is unitary
elastic.
d. Price decreases when demand is
inelastic.
B. When price decreases and the total
revenue increases, the revenue
gained by the increase in sales more
than offsets the revenue lost from the
lower price. By definition, this
represents an elastic demand curve. 90
3. You are on a committee that is
considering ways to raise money for
your city’s symphony program. You
would recommend increasing the price
of symphony tickets only if you thought
the demand curve for these tickets was
a. inelastic.
b. elastic.
c. unitary elastic.
d. perfectly elastic.
A. When the demand curve is inelastic, the
revenue gained from the higher price
more than offsets the revenue lost from
the decline in sales.
91
4. The price elasticity of demand
for a horizontal demand curve is
a. perfectly elastic.
b. perfectly inelastic.
c. unitary elastic.
d. inelastic.
A. A perfectly elastic demand curve
exists when any increase in price
leads to zero sales. The only curve
that would illustrate this would be a
horizontal line at the beginning price.
92
5. Suppose the quantity of steak
purchased by the Jones family is 110
pounds per year when the price is $3.90
per pound and 90 pounds per year
when the price is $2.10 per pound. The
price elasticity of demand coefficient
for this family is
a. 0.33.
b. 0.50.
c. 1.00.
d. 2.00.
A. 20/100 divided by $1.80/$3.00 = .33
93
6. If a 5 percent reduction in the price of
a good produces a 3 percent increase
in the quantity demanded, the price
elasticity of demand over this range of
the demand curve is
a. elastic.
b. perfectly elastic.
c. unitary elastic.
d. inelastic.
e. perfectly elastic.
D. Since the percentage change in quantity
demanded is less than the percentage
change in price, this range is defined
inelastic
94
7. A manufacturer of Beanie Babies hires
an economist to study the price
elasticity of demand for this product.
The economist estimates that the price
elasticity of demand coefficient for a
range of prices close to the selling
price is greater than 1. The relationship
between changes in price and quantity
demanded for this segment of the
demand curve is
a. elastic.
b. inelastic.
c. perfectly elastic.
d. perfectly inelastic.
A. Elasticity > 1 = elastic demand
95
8. A downward-sloping demand curve will
have a
a. higher price elasticity of demand
coefficient along the top of the demand
curve.
b. lower price elasticity coefficient along
the top of the demand curve.
c. constant price elasticity of demand
coefficient throughout the length of the
demand curve.
d. positive slope.
A. The quantity demanded by consumers
is more sensitive to a price change at
higher prices than at lower prices.
96
9. The price elasticity of demand
coefficient for a good will be less
a. if there are few or no substitutes
available.
b. if a small portion of the budget will be
spent on it.
c. in the short run than in the long run.
d. all of the above cases.
D. A low elasticity of demand means
that there is a low sensitivity to a
change in price. When the good has
few substitutes, or the purchase
represents a small portion of one’s
budget, or they do not have much
time to adjust to the price change,
price elasticity of demand is inelastic.97
10. The income elasticity of demand for
shoes is estimated to be 1.50. We can
conclude that shoes
a. have a relatively steep demand curve.
b. have a relatively flat demand curve.
c. are a normal good.
d. are an inferior good.
B. A flat demand curve would illustrate
that when the price changes the
quantity demanded changes a lot.
This would be represented by a
relatively flat demand curve.
98
11. To determine whether two goods are
substitutes or complements, an
economist would estimate the
a. price elasticity of demand.
b. income elasticity of demand.
c. cross-elasticity of demand.
d. price elasticity of demand.
C. Cross-elasticity of demand shows
what will happen to the demand for
one good if the price of a
complementary good, or a good that
is a substitute, changes.
99
12. If the government wanted to raise tax
revenue and shift most of the tax burden to
the sellers, it would impose a tax on a good
with a
a. steep (inelastic) demand curve and a
steep (inelastic) supply curve.
b. steep (inelastic) demand curve and a flat
(elastic) supply curve.
c. flat (elastic) demand curve and a steep
(inelastic) supply curve.
d. flat (elastic) demand curve and a flat
(elastic) supply curve.
C. A steep supply curve would mean that
higher taxes will shift the supply curve to
the left, but will have a small effect on the
quantity supplied. A flat demand curve
would mean that higher prices would not
100
effect the quantity demanded very much.
END