Elasticity: The Responsiveness of Demand and Supply

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed.

c h a p t e rc h a p t e rsixsix

Prepared by: Fernando & Yvonn Quijano

Elasticity: The Responsiveness ofDemand and Supply

2 of 29© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed.

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Elasticity: The Responsiveness of Demand and Supply

Elasticity A measure of how much one economic variable responds to changes in another economic variable.


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The Price Elasticity of Demand and Its MeasurementLEARNING OBJECTIVE1

Price elasticity of demand The responsiveness of the quantity demanded to a change in price, measured by dividing the percentage change in the quantity demanded of a product by the percentage change in the product’s price.

Measuring the Price Elasticity of Demand


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The Price Elasticity of Demand and Its Measurement

Elastic Demand and Inelastic Demand

Elastic demand Demand is elastic when the percentage change in quantity demanded is greater than the percentage change in price, so the price elasticity is greater than 1 in absolute value.

Inelastic demand Demand is inelastic when the percentage change in quantity demanded is less than the percentage change in price, so the price elasticity is less than 1 in absolute value.

Unit-elastic demand Demand is unit-elastic when the percentage change in quantity demanded is equal to the percentage change in price, so the price elasticity is equal to –1.


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An Example of Computing Price Elasticities6 - 1

Elastic and Inelastic Demand Curves


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The Midpoint Formula

Price elasticity of demand =


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Calculating the Price Elasticity of Demand for Wheat Using the Midpoint Formula

6 - 1LEARNING OBJECTIVE1

Verify that the price elasticity of demand is –0.4.

YEARPRICE

(PER BUSHEL)QUANTITY

(BILLIONS OF BUSHELS)2010 $3.00 3.02011 $3.60 2.8


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Polar Cases of Perfectly Elastic and Perfectly Inelastic Demand

Perfectly inelastic demand Demand is perfectly inelastic when a change in price results in no change in quantity demanded.

Perfectly elastic demand Demand is perfectly elastic when a change in price results in an infinite change in quantity demanded.


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The Price Elasticity of Demand

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The Price Elasticity of Demand

6 – 1 (continued)

Don’t Confuse Inelastic with Perfectly Inelastic


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What Determines the Price Elasticity of Demand for a Product?

LEARNING OBJECTIVE2

The key determinants of price elasticity of demand are as follows:

Availability of close substitutes

Passage of time

Necessities versus luxuries

Definition of the market

Share of good in the consumer’s budget


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The Relationship Between Price Elasticity and Total Revenue

LEARNING OBJECTIVE3

Total revenue The total amount of funds received by a seller of a good or service, calculated by multiplying price per unit by the number of units sold.

6 - 2The Relationship Between Price Elasticity and Total Revenue


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The Relationship Between Price Elasticity and Total Revenue

Elasticity and Revenue with a Linear Demand Curve

IF DEMAND IS . . . THEN . . . BECAUSE . . .

elastic an increase in price reduces revenue

the decrease in quantity demanded is proportionally greater than the increase in price.

elastic a decrease in price increases revenue

the increase in quantity demanded is proportionally greater than the decrease in price.

inelastic an increase in price increases revenue

the decrease in quantity demanded is proportionally smaller than the increase in price.

inelastic a decrease in price reduces revenue

the increase in quantity demanded is proportionally smaller than the decrease in price.

unit-elastic an increase in price does not affect revenue

the decrease in quantity demanded is proportionally the same as the increase in price.

unit-elastic a decrease in price does not affect revenue

the increase in quantity demanded is proportionally the same as the decrease in price.

The Relationship between Price Elasticity and Revenue

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Other Demand ElasticitiesLEARNING OBJECTIVE4

Cross-Price Elasticity of Demand

Cross-price elasticity of demand The percentage change in quantity demanded of one good(X) divided by the percentage change in the price of another good(Y).

IF THE PRODUCTS ARE . . .THEN THE CROSS-PRICE ELASTICITYOF DEMAND WILL BE . . . EXAMPLE

Substitutes Positive Two brands of printers

Complements Negative Printers and toner cartridges

Unrelated Zero Printers and peanut butter

Summary of Cross-Price Elasticity of Demand

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Other Demand Elasticities

Income Elasticity of Demand

Income elasticity of demand A measure of the responsiveness of quantity demanded to changes in income, measured by the percentage change in quantity demanded divided by the percentage change in price.

IF THE INCOME ELASTICITYOF DEMAND IS . . . THEN THE GOOD IS . . . EXAMPLE

Positive, but less than 1 Normal and a necessity Milk

Positive and greater than 1 Normal and a luxury Caviar

Negative Inferior High-fat meat

Summary of Income Elasticity of Demand

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Price Elasticity, Cross-Price Elasticity, and Income Elasticity in the Market for Alcoholic Beverages

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An “Inferior Good?”

Price elasticity of demand for beer -0.23

Cross-price elasticity of demand between beer and wine 0.31

Cross-price elasticity of demand between beer and spirits 0.15

Income elasticity of demand for beer -0.09

Income elasticity of demand for wine 5.03

Income elasticity of demand for spirits 1.21


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The Price Elasticity of SupplyLEARNING OBJECTIVE6

Measuring the Price Elasticity of Supply

Price elasticity of supply The responsiveness of the quantity supplied to a change in price, measured by dividing the percentage change in the quantity supplied of a product by the percentage change in the product’s price.


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The Price Elasticity of Supply


6 – 5

Polar Cases of Perfectly Elastic and Perfectly Inelastic Supply


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6 – 5 (continued)

Polar Cases of Perfectly Elastic and Perfectly Inelastic Supply


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Cross-price elasticity of demand

Elastic demandElasticityIncome elasticity of

demandInelastic demandPerfectly elastic demand

Perfectly inelastic demand

Price elasticity of demandPrice elasticity of supplyTotal revenueUnit-elastic demand

Elasticity: The Responsiveness of Demand and Supply

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