Chapter 5:
Applications of Supply and Demand
ELASTICITY
 Definition:
 The responsiveness of quantities
demanded or supplied to changes in
price
 Review…
 When P  , Qd  (people buy more)
 But how much more?
Price Elasticity of Demand
 Definition:
 Change in quantity demanded for a
product whose price has changed
 Elasticity measures the reaction of
consumers to price changes
 Take an example of the market for MILK
and the market for CHIPS
 Example:
 If the product is a necessity a price
increase will not really affect the
quantity consumers purchase (i.e.
milk)
 If the product is not a necessity a
price increase will affect the quantity
consumers purchase (i.e. chips)
 An elastic demand is when a price change
causes a dramatic change in Qd (i.e.
chips)
 An inelastic demand is when a price
change causes a small change in Qd (i.e.
milk)
To calculate the Elasticity of Demand you
determine the Co-Efficient of Demand
Elasticity (Ed)
Effect of the
change
Ed =
% Change in Quantity Demanded
% Change in Price
Demanded
Cause of the
change
% Change in Quantity Demanded
Ed =
% Change in Price
Demanded
If Ed > 1 demand is ELASTIC
If Ed < 1 demand is INELASTIC
If Ed = 1 demand is UNITARY ELASTIC
 Example (pg. 95):
 A gas station sells 10 million litres of
gas at $.0.50 a litre.
 If they raise the price to $0.54/litre
the sales decline to 9.5 million litres.
% Change in Quantity Demanded
Ed =
% Change in Price
Demanded
If Ed > 1 demand is ELASTIC
If Ed < 1 demand is INELASTIC
If Ed = 1 demand is UNITARY ELASTIC
Elastic Demand
If Ed > 1 demand is ELASTIC
 Demand for a product that changes
substantially in response to small changes
in price
 Less steep line
Inelastic Demand
If Ed < 1 demand is INELASTIC
 When price changes do not result in
significant changes in quantity demanded
 Steep line
Unitary Elastic Demand
If Ed = 1 demand is UNITARY ELASTIC
 A change in price will result in an identical
change in demand
 Slope = 1
Total Revenue Approach to Price Elasticity of
Demand
 Concept deals with changes in total
amount of money consumers spend on a
product when the price changes
 Total money spent refers to Total Revenue
(TR)
 TR = P x Qd
ELASTIC DEMAND
When P increases; TR decreases
When P decreases; TR increases
INELASTIC DEMAND
When P increases; TR increases
When P decreases; TR decreases
UNITARY ELASTIC DEMAND
When P increases OR decreases; TR
remains constant
Factors Affecting Demand Elasticity
 Availability of Substitutes
 More close substitutes = Elastic
 Few close substitutes = Inelastic
 Nature of the Item
 Necessity items = Inelastic (i.e.
milk)
 Luxury items = Elastic (i.e. chips)
 Fraction of income spend on item
 Small portion of income = Inelastic
(i.e. pepper)
 Large portion of income = Elastic
(i.e. rent)
 Amount of time available
 Short timelines = Inelastic (i.e. gas
prices increase, reduce amount of
driving but not significantly)
 Long timelines = Elastic (i.e. gas
prices remain high over long
period of time, switch to smaller
cars)
Homework
 Pg. 97 #1, 3, 4
Price Elasticity of Supply
 Definition:
 Measures how responsive the
quantity supplied by a seller is to a
rise or fall in price
 We determine this by using a formula
 To calculate the Elasticity of Supply you
determine the Co-Efficient of Supply
Elasticity (ES)
Effect of the
change
Es =
% Change in Quantity Supplied
% Change in Price
Demanded
Cause of the
change
Price Elasticity of Supply
 Coefficients of Supply follow the same
rules as Demand in that:
If Es > 1 supply is ELASTIC
If Es < 1 supply is INELASTIC
If Es = 1 supply is UNITARY ELASTIC
 Example:
 Steel manufacturer
 Market price of steel rises from
$120 to $140
 Manufacturer expands production
from 1M tonnes a day to 1.2M
tonnes a day
 What will be the coefficient of
supply?
Factors Affecting Supply Elasticity
 Time
 Long term = elastic (i.e. longer
time period to increase production
through expansion)
 Short term = inelastic (it’s difficult
to change in the ST)
 Ease of Storage
 Easy to store products = elastic
(i.e. steel)
 Difficult to store products =
inelastic (i.e. vegetables)
 Cost Factors
 Lower input costs required to
produce product = elastic
 Higher costs required = inelastic
(i.e. car manufacturers)
Thinking Like An Economist (p. 101)
a) Home computers are Elastic (Demand):
Prices Fall=Revenue Rises
b) Milk is In Elastic: Prices Rise=Revenue
Rises
c) Cellphones are Elastic: Prices
Fall=Revenue Rises
d) Pharmaceutical Drugs are In Elastic: Prices
Fall=Revenue Fall
e) Non Business Class Seats are Elastic:
Prices Fall=Revenue Rises
f) Food is In Elastic: Prices Fall=Revenue Fall