Chapter 20:

Demand and Supply Elasticity

ECON 152 – PRINCIPLES OF MICROECONOMICS

Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.

2

Price Elasticity

Price Elasticity of Demand (Ep)

Ep = percentage change in quantity demanded

percentage change in price

The responsiveness of quantity demanded of a commodity to changes in its price

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Price Elasticity

ExamplePrice of oil increases 10 percentQuantity demanded decreases 1 percent

Ep = -1%

+10%= -.1

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Price Elasticity

Relative quantities onlyElasticity is measuring the change in quantity

relative to the change in price Always negative

An increase in price decreases the quantity demanded, ceteris paribus

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Calculating Elasticity

Elasticity formula:

change in Q

sum of quantities/2Ep =

change in P

sum of quantities/2

orchange in Q

(Q1 + Q2)/2Ep =

change in P

(P1 + P2)/2

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Price Elasticity Ranges Elastic Demand

Percentage change in quantity demanded is larger than the percentage change in price

Ep > 1

Unit Elasticity of Demand Percentage change in quantity demanded is equal to

the percentage change in price Ep = 1

Inelastic Demand Percentage change in quantity demanded is smaller

than the percentage change in price Ep < 1

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Price Elasticity Ranges

Extreme elasticitiesPerfectly Inelastic Demand

A demand curve that is a vertical line It has only one quantity demanded for each price No matter what the price, quantity demanded does

not change

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Extreme Price Elasticities

Quantity Demanded per Year(millions of units)

Pric

eD

Perfect inelasticity, or zero elasticity

80

Figure 21-1, Panel (a)

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Price Elasticity Ranges

Extreme elasticitiesPerfectly Elastic Demand

A demand curve that is a horizontal line It has only one price for every quantity The slightest increase in price leads to zero

quantity demanded

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Extreme Price Elasticities

Quantity Demanded per Year(millions of units)

Pric

e (c

ents

)

30

0

Perfect elasticity, or infinite elasticity

D

Figure 21-1, Panel (b)

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Policy Example:Who Pays Gasoline Taxes?

State and federal governments impose gasoline taxes that are assessed as a flat amount per gallon.

Who pays the tax depends on price elasticity of demand.

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Policy Example: Who Pays Gasoline Taxes?

Figure 21-2, Panels (a) and (b)

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Policy Example: Who Pays Gasoline Taxes?

Figure 21-2, Panel (c)

D

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Elasticity and Total Revenues When demand is elastic, a negative relationship

exists between small changes in price and changes in total revenue.

When demand is unit-elastic, changes in price do not change total revenue.

When demand is inelastic, a positive relationship exists between changes in price and total revenues.

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Determinants of Price Elasticity of Demand

Existence of substitutesThe closer the substitutes and the more

substitutes there are, the more elastic is demand.

Share of the budgetThe greater the share of the consumer’s total

budget spent on a good, the greater is the price elasticity.

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Determinants of Price Elasticity of Demand

The length of time allowed for adjustmentThe longer any price change persists, the

greater is the price elasticity of demand. Price elasticity is greater in the long-run than in the

short-run.

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Determinants of Price Elasticity of Demand

How to define the short run and the long runThe short run is a time period too short

for consumers to fully adjust to a price change.

The long run is a time period long enough for consumers to fully adjust to a change in price other things constant.

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Short-Run and Long-RunPrice Elasticity of Demand

In the short run, quantitydemanded falls slightly.However, with more timefor adjustment the demand curve becomesmore elastic and quantitydemanded falls by a greater amount.

D1

Pe

Q2

E

D2

Q1 Qe

P1

Pric

e pe

r U

nit

Quantity Demanded per Period

Figure 21-4

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Short-Run and Long-RunPrice Elasticity of Demand

In the short run, quantitydemanded falls slightly.However, with more timefor adjustment the demand curve becomesmore elastic and quantitydemanded falls by a greater amount.

D1

Pe

Q2

E

D2

Q1 Qe

P1

Q3

D3

Pric

e pe

r U

nit

Quantity Demanded per Period

Figure 21-4

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Example: Real-WorldElasticities of Demand

Table 21-2

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Cross PriceElasticity of Demand

Cross Price Elasticity of Demand (Exy)The percentage change in the demand for

one good (holding its price constant) divided by the percentage change in the price of a related good

The responsiveness of change in demand of one good to the change in prices of related goods

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Cross PriceElasticity of Demand

Formula for computing cross elasticity of demand

% change in demand for good X

%change in price of good YExy =

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Cross PriceElasticity of Demand

SubstitutesExy would be positive

An increase in the price of X would increase the quantity of Y demanded at each price.

ComplementsExy would be negative

An increase in the price of X would decrease the quantity of Y demanded at each price.

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Income Elasticity of Demand

Income Elasticity of Demand (Ei)The percentage change in demand for any

good, holding its price constant, divided by the percentage change in income

The responsiveness of demand to changes in income, holding the good’s relative price constant

refers to a horizontal shift in the demand curve in response to changes in income

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Income Elasticity of Demand

percentage change in demand

percentage change in incomeEi =

Ei for a normal good is positive.

Ei for an inferior good is negative.

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Income Elasticity of Demand Formula:

Change in Quantity ÷ Change in Income Average Quantity Average Income

The income elasticity of demand can be either negative or positive. Remember that, in calculating the income elasticity of demand, the price of the good is

assumed to be constant.

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Elasticity of Supply

Price Elasticity of Supply (Ei)The responsiveness of the quantity supplied

of a commodity to a change in its price The percentage change in quantity supplied

divided by the percentage change in price

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Elasticity of Supply

Formula for computing price elasticity of supply

percentage change in quantity supplied

percentage change in priceES =

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Elasticity of Supply

Classifying supply elasticitiesPerfectly Elastic Supply

Quantity supplied falls to zero when there is any decrease in price.

The supply curve is horizontal at a given price.

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Elasticity of Supply

Classifying supply elasticitiesPerfectly Inelastic Supply

Quantity supplied is constant no matter what happens to price.

The supply curve is vertical at a given price.

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The Extremes in Supply Curves

Q1

Pric

e pe

r U

nit

Quantity Supplied per Period

P1S

S’

Perfect elasticity

Perfect inelasticity

Figure 21-5

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Elasticity of Supply

Price elasticity of supply and length of time for adjustmentThe longer the time allowed for adjustment,

the more elastic is supply. Firms can find ways to increase (or decrease)

output. Resources can flow into (or out of) an industry

through expansion (or contraction) of existing firms.

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Short-Run and Long-Run Price Elasticity of Supply

Pe

Qe

Pric

e pe

r U

nit

Quantity Supplied per Period

Q1

S1

S2

P1

As time passes the

supply curve rotates to S2 then to S3 and quantity supplied rises first to Q1 and then to Q2.

E

S3

Figure 21-6

Q2

Chapter 20:

Demand and Supply Elasticity

ECON 152 – PRINCIPLES OF MICROECONOMICS

Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.