3
THE CONCEPT OF ELASTICITY AND
CONSUMER AND PRODUCER SURPLUS
_______________________________________________________________________
CHAPTER OUTLINE
Elasticity of Demand
Alternative Ways to Understand Elasticity
More on Elasticity
Consumer and Producer Surplus
Kick It Up a Notch: Deadweight Loss
Summary
LEARNING OBJECTIVES
LO1: Define “elasticity” as the responsiveness of quantity to changes in price, recognize its importance in
economics, and apply the concept to various real-world goods and services.
LO2: Connect the relationship between the concept of elasticity and the appearance of the demand curve.
LO3: Illustrate that a market equilibrium provides both buyers and sellers with benefits. Consumers pay less than
they are willing to pay and producers make a profit. Economists call the former "consumer surplus" and the latter,
"producer surplus."
LO4: Define "deadweight loss" as the measure of inefficiency that exists when prices are too high or too low and
apply this to various policies.
KEY TERMS
Elasticity- the responsiveness of quantity to a change in another variable.
Price elasticity of demand- the responsiveness of quantity demanded to a change in price.
Price elasticity of supply- the responsiveness of quantity supplied to a change in price.
Income elasticity of demand- the responsiveness of quantity to a change in income.
Cross-price elasticity of demand- the responsiveness of quantity of one good to a change in the price of another
good.
Elastic- the circumstance when the percentage change in quantity is larger than the percentage change in price.
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Chapter 3
Inelastic- the circumstance when the percentage change in quantity is smaller than the percentage change in price.
Unitary elastic- the circumstance when the percentage change in quantity is equal to the percentage change in
price.
Total expenditure rule- if the price and the amount you spend both go in the same direction, then demand is
inelastic, whereas if they go in opposite directions, demand is elastic.
Perfectly inelastic- the condition of demand when price changes have no effect on quantity.
Perfectly elastic- the condition of demand when price cannot change.
Consumer surplus- the value you get that is in excess of what you pay to get it.
Producer surplus- the money the firm gets that is in excess of its marginal costs.
Market failure- the circumstance where the market outcome is not the economically efficient outcome.
Exclusivity- the degree to which the consumption of the good can be restricted by a seller to only those who pay
for it.
Rivalry- the degree to which one person’s consumption reduces the value of the good for the next consumer.
Purely private good- a good with the characteristics of both exclusivity and rivalry.
Purely public good- a good with neither of the characteristics of exclusivity and rivalry.
Excludable public good- a good with the characteristics of exclusivity but not of rivalry.
Congestible public good- a good with the characteristics of rivalry but nor of exclusivity.
PROBLEMS
1. a. Using the data listed below, calculate the slope of a straight-line demand curve, which has a constant slope.
Estimate:
i. the P (Take the difference between a price and the next highest price.)
__________________________________________________________
ii. the Q that occurs when the above change in price occurs
__________________________________________________________
The Concept of Elasticity and Consumer and Producer Surplus
3
iii. the slope (P / Q)
__________________________________________________________
b. List the elasticity formula.
_____________________________________________________________________
c. Estimate the elasticity coefficients of all the data points on the demand curve and list them in the table on
the next page. Identify the level of elasticity by indicating if the curve is elastic, inelastic, or has unit
elasticity at each point.
d. Estimate the consumers’ expenditure (producers’ revenue) for each price level, and list it in the table on
the next page.
e. Use the data from the demand schedule below to plot the demand curve in the chart on the following page.
Use a marker to highlight the elastic portion.
THE DEMAND AND SUPPLY OF RYE PER MONTH
______________________________________________________________________________________________________________________________
Price
Per Bushel
$2.00
1.75
1.50
1.25
1.00
0.75
Quantity Demanded
(Thousands of bushels)
7
12
17
22
27
32
Elasticity
Coefficient
Level of
Elasticity
________
________
________
________
________
________
________
________
________
________
________
________
Producers’ Revenue
(P  Q)
________
________
________
________
________
________
______________________________________________________________________________________________________________________________
f. Plot the revenue data on the vertical axis and the output level on the horizontal axis in the chart below the
demand curve on the following page. Use a marker to highlight the elastic portion.
g. Note how the two charts illustrate the total expenditure rule.
If price and the amount that you spend move in opposite directions, then the curve is _________________.
If price and the amount that you spend move in the same direction, then the curve is _________________.
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Chapter 3
The Demand for Rye per Month
THE DEMAND FOR RYE
$2.00
Price
$1.50
$1.00
$0.50
$0.00
0
4
8
12
16
20
24
28
32
Thousands of Bushels/Month
The Total Expenditure on Rye or Producers’ Total Revenue
TOTAL REVENUE
32
Revenue
24
16
8
0
0
4
8
12
16
20
24
Thousands of Bushels/Month
28
32
The Concept of Elasticity and Consumer and Producer Surplus
5
2. What will be the effect of the following events on the total level of consumer expenditures?
Indicate whether the total level of consumer expenditures, which is the same as the revenue received by
producers, will increase, decrease, or remain the same when:
a. The price increases and demand is elastic. ________________________________________________
b. The price decreases and demand is inelastic. _______________________________________________
c. The price increases and demand is inelastic. ________________________________________________
d. The price increases and demand has unit elasticity. __________________________________________
e. The price decreases and demand is elastic. _________________________________________________
f. The price decreases and demand has unit elasticity. __________________________________________
3. Draw horizontal stripes to indicate the consumer surplus and vertical stripes to mark the producer surplus on
the demand and supply diagram below.
Price
S
P
0
_ _ _ _ _ _ _ _ _
|
|
|
|
|
Q
D
Quantity/time
4. One way to get an understanding of the effect of elasticity on demand and supply is to rotate a demand or
supply curve to make it more vertical (inelastic) or more horizontal (elastic). Rotate the demand curve in
the previous problem around the equilibrium point to make it more elastic (more horizontal), while keeping
the supply curve unchanged. What happens to the consumer and producer surpluses as a result of demand
becoming more elastic?
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Chapter 3
5. Using the graph in Problem 3 above, rotate the demand curve to make it less elastic (more vertical), while
keeping the supply curve and equilibrium point unchanged. What happens to the consumer and producer
surpluses as a result of demand becoming less elastic?
6. Now let’s see what happens when we change the elasticity of supply. Using the graph in Problem 3 above,
rotate the supply curve to make it more elastic (more horizontal, while keeping the demand curve and
equilibrium point unchanged. What happens to the consumer and producer surpluses as a result of supply
becoming more elastic?
7. Using the graph in Problem 3 above, rotate the supply curve to make it less elastic (more vertical), while
keeping the demand curve and equilibrium point unchanged. What happens to the consumer and producer
surpluses as a result of supply becoming less elastic?
8. So, given your answers to Problems 4 thru 7, which side (the more elastic side or the less elastic side) of a
market enjoys the larger surplus?
9. Do you agree or disagree with the following statements? Explain your answers.
a. Because an excise tax on ice cream cones reduces their consumption, it creates a deadweight loss.
b. Because a subsidy for ice cream cones increases their consumption, it does not create a deadweight loss.
The Concept of Elasticity and Consumer and Producer Surplus
SELF TEST --- MULTIPLE-CHOICE QUESTIONS
1. If the elasticity coefficient is greater than 1, economists describe the demand curve as
a. being unitary elastic.
b. inelastic.
c. elastic.
d. perfectly inelastic.
2. If there are many close substitutes for a product, we would expect the demand to be
a. very elastic.
b. perfectly inelastic.
c. unresponsive to a price changes.
d. very inelastic.
3. If the demand has unit elasticity, we expect that the percentage change in quantity demanded will be
a. greater than the percentage change in price.
b. less than the percentage change in price.
c. zero given any percentage change in price.
d. equal to the percentage change in price.
4. If the demand is inelastic, we expect that the percentage change in quantity demanded will be
a. greater than the percentage change in price.
b. less than the percentage change in price.
c. zero given any percentage change in price.
d. equal to the percentage change in price.
5. If the demand is perfectly inelastic, we expect that the percentage change in quantity demanded will be
a. greater than the percentage change in price.
b. less than the percentage change in price.
c. zero given any percentage change in price.
d. equal to the percentage change in price.
6. If the demand is elastic, we expect that the percentage change in quantity demanded will be
a. greater than the percentage change in price.
b. less than the percentage change in price.
c. zero given any percentage change in price.
d. equal to the percentage change in price.
7. If the demand is perfectly elastic, the elasticity coefficient is
a. equal to one.
b. equal to infinity.
c. greater than zero, but less than one.
d. equal to zero.
8. If the price falls and the demand curve is elastic, the total expenditure by consumers
a. will decrease.
b. will remain unchanged.
c. will be indeterminate.
d. will increase.
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Chapter 3
9. If the price is $2.00 and it increases to $3.00 while the quantity demanded falls from 10 units to 8 units,
the elasticity coefficient is equal to
a. 2.50
b. 0.40
c. 0.53
d. 0.83
10. If the demand curve is linear, and it is a straight downward sloping line,
a. the elasticity and the slope are both constant throughout the demand curve.
b. the elasticity is constant, but the slope is constantly changing throughout the demand curve.
c. the elasticity is lower in the upper left portion of the curve and higher in the lower right.
d. the elasticity is higher in the upper left portion of the curve and lower in the lower right.
11. If an ice cream parlor decides to raise prices, total sales will increase only if
a. demand is unitary elastic.
b. demand is elastic.
c. demand is inelastic.
d. supply is elastic.
12. Which of the following determinants would indicate that the demand for product is inelastic?
a. the product has many substitutes
b. one has a long time to come up with alternatives to paying the high price
c. the product is a small proportion of one’s income
d. the good is a luxury item
13. Which of the following determinants would indicate that the demand for product is elastic?
a. the product has few or no substitutes
b. one has a very short time to come up with alternatives to paying the high price
c. the product is a small proportion of one’s income
d. the good is a necessity item
14. Which elasticity concept would be relevant if one wanted to find the responsiveness of the quantity
demanded of compact disk players and compact disks?
a. price elasticity of demand
b. price elasticity of supply
c. income elasticity of demand
d. cross price elasticity of demand
15. Which elasticity concept would be relevant if one wanted to find the responsiveness of the quantity
demanded of compact disk players when income rose?
a. price elasticity of demand
b. price elasticity of supply
c. income elasticity of demand
d. cross price elasticity of demand
The Concept of Elasticity and Consumer and Producer Surplus
Use the diagram below to answer Questions 16 and 17.
Price
L
S
P*
M
O
_ _ _ _ _ _ _ _
N
|
|
|
|
|
Q*
D
Quantity/time
16. Consumer surplus is represented by the area
a. OLD
b. LP*N
c. MP*N
d. P*NQ*O
17. Producer surplus is represented by the area
a. OLD
b. LP*N
c. MP*N
d. P*NQ*O
18. Consumer surplus is defined as
a. the benefit to a firm when a consumer buys a good or service.
b. the value you get that is in excess of what you pay to get a good or service.
c. the money that firms get, which is in excess of the marginal costs of producing the good.
d. the excess of the marginal benefit over the marginal cost for the next unit bought by the
consumer.
19. Producer surplus is defined as
a. the benefit to a firm when a consumer buys a good or service.
b. the value you get that is in excess of what you pay to get it.
c. the money that firms get, which is in excess of the marginal costs of producing the good.
d. the excess of marginal benefit over marginal cost to a firm.
20. Which of the following is not associated with a dead-weight loss or a loss in social welfare?
a. price of output greater than equilibrium
b. price of output less than equilibrium
c. price at equilibrium
d. none of the above
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Chapter 3
21. The elasticity of demand for notebooks is 1.25. If the price of notebooks increases by 10%, what
happens to the quantity demand for notebooks, other things held constant?
a. not enough information is given to answer this question
b. it decreases by 1.25%
c. it decreases by 12.5%
d. it increases by 12.5%
22. You manage a clothing store, and you know that the elasticity of demand for your products is 1.05.
Your boss tells you that unless you increase your store’s total revenues (sales), you will lose your job.
What do you do to keep your job?
a. not enough information is given to answer this question
b. start looking for another job
c. increase the prices of the products in your store
d. decrease the prices of the products in your store
The Concept of Elasticity and Consumer and Producer Surplus
11
SELF TEST --- TRUE / FALSE QUESTIONS
T
F
1. The elasticity at any given point will be more inelastic if the demand curve is flatter.
T
F
2. Points in the lower right of a demand curve tend to be inelastic.
T
F
3. The cross price elasticity measures the change in quantity of one good in response to a change
in the price of another related good.
T
F
4. The income elasticity measures the change in the price of a good in response to a change in the
income level in the region.
T
F
5. The benefit to society from the free market is the sum of the consumer and producer surpluses.
T
F
6. If revenue falls when the price of a good goes up, one can conclude that the demand for the
good is inelastic.
T
F
7. If the demand curve for a product is horizontal, then the firm can raise its price to maximize its
revenue.
T
F
8. If the demand for a good is unitary elastic, then the firm can either raise or lower price to
increase its sales revenue.
T
F
9. Insulin is a good example of a good with inelastic demand.
T
F
10. If a good costs $15 and you are willing to pay $10 for the good, your consumer surplus is $25.
T
F
11. If the production and consumption of a good is greater than or less than the equilibrium
quantity, then a deadweight loss will exist.
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Chapter 3
ANSWERS TO STUDY QUESTIONS
PROBLEMS
1. a. i. P = $0.25
ii. Q = 5 units
iii. (P/ Q) = $0.25 / 5 = 0.05
b. Ed = (% Q) / (% P) = (Q / Q) / (P/ P) = (Q / P)  (P / Q)
Note that the formula contains the inverse of the slope.
(Q / P) = 1/ (P / Q) = 1/ slope = 1/ (0.05) = 20
c. and d.
THE DEMAND AND SUPPLY OF RYE PER MONTH
________________________________________________________________________________________________________________________
Price
Per Bushel
$2.00
1.75
1.50
1.25
1.00
0.75
Quantity Demanded
(Thousands of bushels)
7
12
17
22
27
32
Elasticity
Coefficient
Level of
Elasticity
5.714
2.917
1.765
1.136
0.741
0.469
elastic
elastic
elastic
elastic
inelastic
inelastic
Producers’ Revenue
(P  Q)
$14.00 thousand
21.00
25.50
27.50
27.00
24.00
________________________________________________________________________________________________________________________
(e. and f. See next page.)
g. If price and the amount that you spend move in opposite directions, then the curve is elastic.
If price and the amount that you spend move in the same direction, then the curve is inelastic.
2. Consumer expenditure, as well as the revenue received by producers, will:
a. decrease
b. decrease
c. increase
d. remain the same
e. increase
f. remain the same
The Concept of Elasticity and Consumer and Producer Surplus
THE DEMAND FOR RYE
$2.00
Price
$1.50
$1.00
$0.50
$0.00
0
4
8
12
16
20
24
28
32
Thousands of Bushels/Month
TOTAL REVENUE
32
Revenue
24
16
8
0
0
4
8
12
16
20
24
Thousands of Bushels/Month
28
32
13
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Chapter 3
3.
Consumer and Producer Surpluses
Price
__
_____
S
______
Consumer
Surplus
Pe
_ _ _ _ _ _ _ _ _ _ _
| | | | | | | | |
|Producer |
|Surplus
| | |
0
|
|
|
|
|
Qe
D
Quantity/time
4. A more elastic demand curve with the supply curve the same, reduces consumer surplus while producer
surplus remains constant.
5. A less elastic demand curve with the supply curve the same, increases consumer surplus while producer
surplus remains constant.
6. A more elastic supply curve with the demand curve the same, increases producer surplus while consumer
surplus remains constant.
7. A less elastic supply curve with the demand curve the same, reduces producer surplus while consumer surplus
remains unchanged.
8. The less elastic side of a market enjoys the greater surplus.
9. a. Agree, because taxes produce a deadweight loss.
b. Disagree, because subsidies also produce a deadweight loss.
The Concept of Elasticity and Consumer and Producer Surplus
MULTIPLE-CHOICE QUESTIONS
1.
2.
3.
4.
5.
C
A
D
B
C
6.
7.
8.
9.
10.
A
B
D
B
D
11.
12.
13.
14.
15.
C
C
D
D
C
TRUE / FALSE QUESTIONS
1.
2.
3.
4.
5.

F
T
T
F
T
6.
7.
8.
9.
10.
F
F
F
T
F
11. T
16.
17.
18.
19.
20.
B
C
B
C
C
21. C
22. D
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