Chapter 6
Elasticity
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Price Elasticity of Demand
• Measures buyers’ responsiveness to price
changes
• Elastic demand
• Sensitive to price changes
• Large change in quantity
• Inelastic demand
• Insensitive to price changes
• Small change in quantity
LO1
6-2
Price Elasticity of Demand Formula
• Formula for price elasticity of demand
Ed =
LO1
percentage change in quantity
demanded of product X
percentage change in price
of product X
6-3
Price Elasticity of Demand Formula
• Use the midpoint formula
• Ensures consistent results
Ed =
LO1
Change in quantity
Sum of quantities/2
÷
Change in price
Sum of prices/2
6-4
Total Revenue Test
• Total Revenue = Price X Quantity
• Total Revenue Test
• Inelastic demand
• P and TR move in the same direction
• Elastic demand
• P and TR move in opposite directions
LO2
6-5
Determinants of Price Elasticity of
Demand
• Substitutability
• More substitutes, demand is more elastic
• Proportion of income
• Higher proportion of income, demand is
more elastic
LO3
6-6
Determinants of Price Elasticity of
Demand
• Luxuries versus necessities
• Luxury goods, demand is more elastic
• Time
• More time available, demand is more
elastic
LO3
6-7
Price Elasticity of Supply
• Measures sellers’ responsiveness to price
changes
• Elastic supply, producers are responsive to
price changes
• Inelastic supply, producers are not as
responsive to price changes
LO4
6-8
Price Elasticity of Supply
• Formula for price elasticity of supply
Es =
LO4
percentage change in quantity
supplied of Product X
percentage change in price
of product X
6-9
Price Elasticity of Supply
•
•
•
•
LO4
Es > 1 supply is elastic
Es = 1 supply is unit elastic
Es < 1 supply is inelastic
Additionally,
• Es = 0 supply is perfectly inelastic
6-10
Price Elasticity of Supply
• Time is primary determinant of elasticity of
supply
• Time periods considered
• Immediate market period
• Short run
• Long run
LO4
6-11
Es: The Immediate Market Period
• Perfectly inelastic supply
P
Sm
Pm
P0
D2
D1
Q0
LO4
Q
6-12
The Short Run
• Short run supply is more elastic than in the
immediate market period
P
Ss
Ps
P0
D2
D1
LO4
Q0 Qs
Q
6-13
The Long Run
• Long run supply is even more elastic than in
the short run
P
SL
Pl
P0
D2
D1
LO4
Q0
Ql
Q
6-14
Cross Elasticity of Demand
• Formula for cross elasticity of demand
Ex,y =
LO5
percentage change in quantity
demanded of product X
percentage change in price
of product Y
6-15
Cross Elasticity of Demand
• Measures responsiveness of purchases of one
good to change in the price of another good
• Substitute goods if elasticity is positive
• Complement goods if elasticity is negative
• Independent goods if elasticity is 0
LO5
6-16
Income Elasticity of Demand
• Formula for income elasticity of demand
percentage change in quantity demanded
Ei =
percentage change in income
LO5
6-17
Income Elasticity of Demand
• Measures responsiveness of buyers to
changes in their income
• Normal goods if elasticity is positive
• Inferior goods if elasticity is negative
LO5
6-18
Income Elasticity Insights
• High income elasticities
• Most affected by a recession
• Low or negative income elasticity
• Not affected that much by a recession
LO5
6-19