Chapter 20
Elasticity Supply and Demand
Price changes- do you still purchase it?
How do demand and supply change in
response to changes in price and quantity?
The response we provide relates to Elasticity
Elasticity of Demand and Elasticity of
Supply
Bottom Line on Elasticity of Supply
If producers are relatively responsive
to price changes supply is elastic
If producers are relatively insensitive
to price changes supply is inelastic
When a large percentage change in
price brings about a small
percentage change in quantity
supplied = inelastic….
(examples: Rise in costs of
computers… takes time to shift
resources)
Over Time… more plants built, more
engineers trained, and more
computers supplied
Other examples for inelastic
supply




Ranchers in Texas
Lavender fields
Solar panels
?
Antiques…. Supply elastic or
inelastic?
Inelastic…. Only a few authentic
pieces,
reproductions would be
elastic
Gold………Supply elastic or inelastic
Gold is perfectly inelastic…(supply
fixed)…
When a small percentage change in
price brings about a large
percentage change in quantity
supplied = elastic
Example: Cowboys beat Philadelphia
Eagles for wildcard playoff… T-shirt
producer can raise his price just a
“tad” and sell a ton more shirts…
Other examples of elastic
supply




Open up a home bakery.
Establish a sign-painting business.
Importing jewelry to sell.
Others?
MAIN DETERMINATION OF
ELASTICY OF SUPPLY?
 TIME
Many times this only has to do with the
producers ability to shift resources…
If resources are not shiftable, then new
mix of inputs has to be determined.
Ability to Respond to Price varies
Often the ability of an individual firm to
respond to an increase in price is
limited or constrained by its existing
scale of operations, or capacity, or
ability to obtain resources….. IN
SHORT RUN
Examples:
IN LONG RUN… can adjust. The greater
the amount of time producers have
to adjust, the greater their output
response.
TIME AND ELASTICITY OF SUPPLY
Ss
Sm
SL
D2
D1
D2
D2
D1
D1
Note: perfectly inelastic. (price)(quantity)
Inelastic (price) (quantity)
Elastic (price) (quantity)
See relationship between small percentage increase in P and Q that
follows.
Terms to remember
 Market Period = period that occurs
when the quantity output is fixed.
Producer will not produce more until
some is sold. No change in quantity
supplied.
 SR in Micro = period of time too
short to change plant capacity, but
long enough to use current capacity
more or less intensively.
Examples of adjusting to the market
period.
truck farmer (farmer’s market)
*limited growing season
*accepts price as it is brought to
market
*can’t hold back on what is sold
because of spoilage.
*has to take price even if cost of
production not met.
Perfectly elastic supply curve
Relatively elastic supply curve
Perfectly inelastic supply curve
Relatively inelastic supply curve
Supply tends to be inelastic in SR
Example:
After WWII… cars impossible to get at
any price.
Resources needed to be converted
back from tanks, jeeps and plane
production.
Even if you had the $1,000 it took to
buy a car… had to put name on year
waiting list.
Additional Trivia on WW II
Lester R. Brown, Mobilizing to Save Civilization . P.10

From early February 1942 through the end of
1944, nearly three years, essentially no cars
were produced in the United States. Car
production was banned.
 “In his State of the Union address on January
6, 1942, one month after the bombing of Pearl
Harbor, President Franklin D. Roosevelt
announced the country’s arms production
goals. The United States, he said, was planning
to produce 45,000 tanks, 60,000 planes,
20,000 anti-aircraft guns, and several
thousand ships. He added, “Let no man say it
cannot be done.”
1946 Billboard Ad by Ford
Returning to Practice and
Theory
We all have wish lists…
We all want to get the best price
possible.
That is no different than the supplier…
He also wants action…. But revenue and
profit are his major goals.
Remember… If butcher lowers his price….
He’s thinking revenue
Supplier is looking at revenue
Revenue Test = P x Q = TR
What is profit?
TR-TC
Question is: If I decrease the price of steak $1
what will happen to my revenue?
Math for Measuring Price Elasticity
Problem: Sirloin steak drops $4.00 to
$3.00
Butcher sales increase from 500 lbs to
1,000 lbs
e Formula: Pe = % Change in Q
% Change in P
500 lbs to 1000 lbs = 500 / 500 = 1
(Q change = 100%)
$4.00 to $3.00 = 1/ 4 = .25
1 / .25 = 4
The steak at this price is very elastic.
Anything over 1 is elastic.
Anything .01 to .99 is inelastic
Helpful Hints
To find coefficient of price
elasticity supply or demand simply:
Find % change in quantity and %
change in price, then divide Q/P
Hint: former-current/former
Price increase $1 to $2, quantity decrease 10 to 8
1/1 x 100 = 100% = P
2/10 x 100 = 20% = Q
20/100 = .2 = inelastic
Another Helpful Hint!
What is the first movement for
variables?
i.e.. When a producer wants to check if
he can get more $$ for increasing or
decreasing, what is the first thing he
does?
Price
OR Price
Then the quantity adjusts accordingly
P = trigger
Q = response
Elasticity of Demand
Logic Dictates that:
Firms contemplating a price hike want
to know how consumers will respond
GM advertises 0% financing for 60
months… huge reductions on
Suburban's, Tahoes,Trucks) What do
they expect consumers to do?
What do the dealers expect to receive?
Now let’s look at Demand!
Same rules---- To find percentage
changes
Q/P x 100….
Bottom Line for Elasticity of Demand
The responsiveness or (sensitivity) of
consumers to a price change is
measured by a product’s price
elasticity of demand
Inelastic demand
perfectly inelastic
totally elastic
Explanation of Perfectly Inelastic
Demand
Unit Elasticity (Percentage change in price
and resulting change in quantity
demanded are the same.
Where a price change results in no
change in quantity demanded, it =
“Perfectly Inelastic” or “Unit Elastic”
Example: Insulin for Diabetes
What else? (certain
medicines.. BP… Heart problems… etc.)
In these cases… price-elasticity coefficient is
zero (because no response to change in
price)
What is elasticity of demand?
Elasticity of demand measures the
percentage change in Quantity demanded
in response to a percentage change in
price.
Law of demand states that as P increases Q
decreases. But how much decrease?
Measure responsiveness of QD to change in P
by calculating the coefficient of price
elasticity of demand (Ep)
You have already done this!!
Ep = Percentage change in QD
Percentage Change in P
What does that mean?
If elasticity is greater than 1, demand
is elastic.
Price change causes revenue to change in opposite direction
Decrease in price will increase TR
Inelastic demand is defined as an
elasticity of less than 1 (anything
from 0 to .99)
Price changes causes TR to change in same direction. Decrease in
price causes TR to fall
Unit elastic is 1
No change
Price elasticity is 0 because an increase in price will not decrease
revenue…nor will it increase revenue… there is no change in
revenue with unit elastic.
Elastic Demand = A small percentage
change in price brings about a large
percentage change in QD
Example: cars, steak, gold jewelry,
movies, air travel
Inelastic Demand = Large percentage
change in price brings about a small
percentage change in QD.
Drugs, gasoline, cigarettes, personal
items, deodorant, furniture, coffee
All of the inelastic demand concepts
depend on available substitutes
 Price of steak goes too high…
substitute chicken
 Price of gasoline too high… no
substitute
Income Effect
Income effect simply indicates that at a
lower price one can afford more of
the good without giving up alternative
goods.
Decline in the price of a product will
increase purchasing power of one’s
money income
Higher price has opposite effect.
Substitution Effect = one has the
incentive to substitute the cheaper
good for similar goods which are
now relatively more expensive.
Cheap products for dear products
Determinants of Elasticity
 Necessity vs Luxuries ….examples:
critical medicines, addiction, gas to drive,
new car, boat, diamond ring….
 Availability of
Substitutes…Zirconia, salt substitute,
powdered milk, tea vs coffee…
 Proportion of Income…the higher
the price of a good relative to a
consumers’ income, the greater the price
elasticity of demand.
 Time….As a rule, product demand is
more elastic the longer the time period
under consideration.
Generally, the larger the number of
substitute goods that are available,
the greater the price elasticity of
demand..
(variety of beer options on the
market)
Elasticity of Demand depends on how
narrowly the product is defined.
(Coach Handbag)
Normal or Superior Goods

Income goes up… we buy more
expensive items…. (lobster/fish sticks)
Inferior or Poor Man’s Goods

Income goes down… take the bus
rather than fly…second-hand clothing
stores… garage sales.
How can we calculate coefficient of price
elasticities?
Let’s re-visit our last example
Let’s say that price is increased from
$1.00 to $2.00 for a candy bar…..
The quantity demanded decreases from
10 to 8….
How will this producer know if the price
increase brings in more $ relative to
decrease in demand or otherwise????
Percent change in P
1-2=1/1 x 100 = 100% change in P
Percent change in Q
10-8 = 2/10 = 20% change in Q
Response/trigger (Q/P) …..Hence:
E = 20/100 =.2 (% change in Q / %
change in P)
Trigger was the price…. Response the quantity
Price moves…(trigger)… quantity change
(response)
Because % change is less than 1, candy
producer will increase revenue by
increasing price. (candy went from $1 to
$2)
Meaning of Elasticity
 Elasticity is > than 1 … means
demand is elastic
(If elasticity is greater than 1,
percentage change in quantity must
be greater than percentage change
in price.)
 Inelasticity is anything < than 1
 If elasticity is equal to 1 then it is
unitary elastic
Couple of other problems.
(1)Cupcakes increase from $4.00 to
$5.00. Demand decreases from 30 –
15. (Elastic or inelastic?) Increased
revenue for baker or not?)
P =1/4 = .25
Q = 15/30 = .5
Q/P = 2 elastic revenue down.
Bottled Water increased from $3.00 to $5.00
The number of bottles purchased decreased
from 250 to 125.
Elastic or inelastic?
Revenue up or down?
Bottled water .75 (inelastic)
Inelastic –direct revenue relationship
elastic- indirect revenue relationship
Advertising Purpose
1) To sway the consumer. (Bayer and
St. Joseph’s aspirin for children)
which is better?
2) Producers through advertising want
to increase our demand curve and
make it more inelastic!
To be Discussed later
Total Revenue and Marginal Revenue….
If your company sold 4 computers at
$3,200 each how much total revenue?
(PxQ = $12,800)
Marginal Revenue = Increase in TR when
output sold goes up by one
unit.($12,800 +3,200=$16,000
The additional revenue derived from
selling one more unit. (see above)
Kiley Dog Horn- Not for sale!
THE END!