Price Elasticity of Demand
 A measure of the
responsiveness or sensitivity
of quantity demanded to
changes in the Price of a
product.
 When QD is relatively unresponsive to

a price change, Demand is said to be
inelastic
Conversely, Demand is said to be elastic
when it is relatively responsive to a price
change
Qualities That Affect Elasticity of
Demand
 Proportion of Income spent on the
product
 Availablity of close SUBSTITUTES
 Importance of the good-Luxury or
necessity. Is it habit forming?
 ability to Delay the purchase or
adjust purchasing behavior-Time
ELASTICITY COEFFICIENTS
 Percentage vs. absolute numbers
 The changes in QD and in P are
comparisons of consumer
responsiveness to price changes of
different products
 Absolute value (because P and QD are
inversely related)
Summarizing Price Elasticity of Demand
Elasticity
coefficient
Term
Description
Impact on
Total
Revenue
Impact on
Total
Revenue
Price
Increase
Price
Decrease
Greater
than 1
Єd > 1
Elastic
QD changes
by a larger
% than
does price
TR
decreases
TR
increases
Equal to 1
Єd = 1
Unit Elastic
QD changes
by the
same % as
does the
price
TR is
unchanged
TR is
unchanged
Less than 1
Єd < 1
Inelastic
QD changes TR
by a smaller increases
% than
does price
TR
Decreases
Supply and Demand
Elasticities and Government-Set Prices
Midpoint Formula
 A midpoint formula calculates price
elasticity across a price and quantity
range to overcome the problem of
selecting the reference points for
price and quantity. In this formula,
the average of the quantities and the
average of the two prices are used as
reference points
Note several points about the graph of the
demand curve and price elasticity of
demand
 Not the same
at all prices.
Typically D is
elastic at
higher prices
and inelastic
at lower prices
 Cannot be
judged from
the slope of
the D curve
Total Revenue Test – How does TR
change when price changes?
1. elastic-a decrease in price will
increase TR and an increase in price
will decrease TR
2. inelastic-a decrease in price will
decrease TR and an increase in price
will increase TR
3. unit elastic-an increase or decrease
in price will not affect TR
PRICE ELASTICITY OF SUPPLY
 Measures the sensitivity of Quantity
Supplied (Qs) to changes in the price
of a product
 general and mid-point formula are
similar to those for the price
elasticity of D. (Qs replaces QD)
 Depends primarily on the amount of
times sellers have to adjust to a price
change
Supply tends to be more price inelastic in
the short run than the long run
 short run-a period of time in which
producers are able to change the quantities
of some but not all of the resources they
employ. Some fixed cost and some variable
costs.
 long run-a period of time long enough to
allow producers to change the quantities of
all the resources they employ. All costs are
variable, none are fixed.
Price Elasticity of Supply
What is Cross
Elasticity of
Demand?
The percentage change in the
quantity demanded of one
commodity resulting from a 1
percent change in price of another
commodity
14
Cross Elasticity of
Demand
E
c
= %  Quantity of X
% Price of Y
15
If E c negative complements (steak & steak
sauce)
If E c positive - substitutes
(butter & margarine)
Unrelated goods should
have a
E
c close to zero
Applications
 Businesses concerned with
cannibalization of various products
 A low cross elasticity indicates 2
products (Coke/Sprite)are weak
substitutes. Lowering the price of Sprite,
thus increasing sales won’t impact Coke
sales.
 Government uses the concept in
analyzing the impact of a merger and
consequently the impact on competition.
A high cross elasticity would indicate
strong substitute, thus possibly reducing
competition
What is Income
Elasticity of
Demand?
 The ratio of the
percentage change in
quantity demanded to
the percentage change
in income
E i = %  QuantityD
% Income
•
•
•
•
E
E
E
0
> 0 Normal goods
i < 0 Inferior goods
i > 1 Luxury goods
< E i < 1 Necessities
i
What is a Price Ceiling?
 A maximum price set by
government below the market
generated equilibrium price
Price Ceilings
 Messing with the markets by the
man.
 PCs set by the government prevents
the guiding/rationing function of
prices in a market system.
 It creates a shortage at the
government set price.
 Another rationing method must be
found, so government often steps in
and establishes one, excluding others
in the process.
 Create illegal markets for those who
want to buy/sell outside of the gov’t
set price
 examples: rent control, interest rate
limits
What is a Price Floor?
 A minimum price set by
government above the market
equilibrium price
 Creates a surplus at the fixed price
 Distorts the market, governments
then have to figure out how to deal
with the surplus
 Many agricultural products, minimum
wage
 government interference with markets is
controversial and always entails tradeoffs.
 Rationing schemes must be devised to handle
the shortages or special programs to shift
demand or supply must be implemented.
 The intervention imposes costs on some
groups and benefits other groups.
 Many unintended consequences or side effects