This document discusses the concepts of price elasticity of demand and supply. It begins by introducing price elasticity and how it measures the responsiveness of quantity demanded or supplied to changes in price. It then provides formulas for calculating the price elasticity coefficient and discusses what values indicate elastic versus inelastic demand. The document also examines graphical analysis of elasticity and how it varies along a demand curve. It analyzes applications of elasticity concepts and discusses determinants of a good's price elasticity. Finally, it briefly introduces other types of elasticity like cross elasticity of demand and income elasticity of demand.

1. ELASTICITY OF DEMAND
AND SUPPLY
CHAPTER 20

2. Price Elasticity of Demand
Activity
• Do you ever wonder if a change in price
affects some goods more than others?
• Compare the piece of elastic with the piece of
yarn; which is more “responsive” to a change
in the force affecting it? Why?
• Now imagine that the force is a change in
price, try to decide which of the products on
the next slide are more responsive to this
change in price.
11/5/2012 2

3. Price Elasticity of Demand
Activity
1. Newspapers
2. Beer
3. Gasoline
4. Shoes
5. Restaurant meals
6. Bread
7. Filet mignon
8. Cars
9. Salt
11/5/2012 3

4. Price Elasticity of Demand
Activity
• This responsiveness of the quantity demanded
to a change in price is called the price
elasticity of demand.
• What are some characteristics of the good
that determine how elastic demand for it is
when a change in price occurs?
• Share your thoughts with your group, and
then we’ll discuss this in class.
11/5/2012 4

5. INTRODUCTION
A. Elasticity of demand measures how
much the quantity demanded changes
with a given change in price of the
item, change in consumer’s income, or
change in price of a related product.
B. Price elasticity is a concept that also
relates to supply.
5

6. PRICE ELASTICITY OF DEMAND
A. The law of demand tell us that
consumers will respond to a price
decrease by buying more of a product
(other things remaining constant), but
it does not tell us how much more.
B. The degree of responsiveness or
sensitivity of consumers to a change in
price is measured by the concept of
price elasticity of demand.
6

7. PRICE ELASTICITY OF DEMAND
1. If consumers are relatively responsive to
price changes, demand is said to be elastic.
2. If consumers are relatively unresponsive to
price changes, demand is said to be inelastic.
3. Note that with both elastic and inelastic
demand, consumers behave according to the
law of demand; that is, they are responsive
to price changes. The terms elastic or
inelastic describe the degree of
responsiveness.
7

8. PRICE ELASTICITY FORMULA
•
8

9. PRICE ELASTICITY FORMULA
1. Using the two price-quantity
combinations of a demand schedule,
calculate the percent change in quantity
by dividing the absolute change in
quantity by one of the two original
quantities. Then calculate the percentage
change in price by dividing the absolute
change in price by one of the two original
prices.
9

10. PRICE ELASTICITY FORMULA
2. If we calculate the elasticity
using the other original quantity and
price, the resulting elasticity would
be different. To eliminate this
problem, economists use the mid-
point formula, which uses the average
of the quantities and the prices as
denominators.
10

11. PRICE ELASTICITY FORMULA
3. Remember: what is being
compared are the percentage
changes not the absolute changes.
That is because the absolute changes
depend on the choice of units (a
change in price of a $10,000 car by
$1 is very different from a change in
price of $10 shirt by $1.
11

12. PRICE ELASTICITY FORMULA
Percentages also make it possible to
compare elasticities of demand for
different products.
12

13. PRICE ELASTICITY FORMULA
4. Because of the inverse relationship
between price and quantity demanded, the
actual elasticity of demand will be a
negative number. However, we will ignore
the minus sign and use the absolute value
of both percentage changes.
13

14. PRICE ELASTICITY FORMULA
5. The Coefficient of Elasticity:
• If the coefficient of elasticity of demand
is a number greater than one (Ed›1), we say
demand is elastic.
• In other words, the quantity demanded is
“relative responsive” when Ed is greater
than 1, and “relatively unresponsive” when
Ed is les than 1.
• A special case is if the coefficient equals
one, it is called unit elasticity.
14

15. PRICE ELASTICITY FORMULA
NOTE: Inelastic demand does not mean
that consumers are completely
unresponsive. This extreme situation is
called perfectly inelastic demand, and
would be very rare. In this case, the
demand curve would be vertical, as the
quantity demanded would not change at all
at any price.
15

16. PRICE ELASTICITY FORMULA
Likewise, an elastic demand does not mean
that consumers are completely responsive
to a price change. This extreme situation,
in which a small reduction in price would
cause buyers to increase their purchases
to all that is possible to obtain, is
perfectly elastic, and the demand curve
would be horizontal.
16

17. PRICE ELASTICITY FORMULA
•
17

18. LET’S PRACTICE! PROBLEM # 1
Get your calculator out!
On page 359, look at table 20.1. In your
notebook, compute the elasticity between
each two prices, using the midpoint
formula. Did you get the same numbers
from the table? Awesome! You’re ready
to move on to the next problem…
18

19. PROBLEM # 2
2. Complete the following table:
PRICE QUANTITY ELASTICITY CHARACTER
DEMANDED COEFFICIENT OF DEMAND
$1.00 300 - -
.90 400
.80 500
.70 600
.60 700
.50 800
.40 900
19

20. PROBLEM # 3
a) Graph the demand schedule shown below.
b) Determine the Ed between the prices.
c) Where is elastic demand found?
d) Where is the demand schedule inelastic?
PRICE QUANTITY DEMANDED
$5 1
4 2
3 3
2 4
1 5
20

21. PROBLEM # 3
e) What can you conclude about the
relationship between the slope of the
demand curve and its elasticity? How
are they different?
f) Explain in a nontechnical way why
demand is elastic in the northwest
segment and inelastic in the southeast
segment.
21

22. GRAPHICAL ANALYSIS
A. Elasticity varies over a range of
prices:
1. Demand is more elastic in the upper
left portion of the curve because when
the initial price is high and initial quantity
is low, a unit change in price is a low
percentage while the unit change in
quantity is a high percentage change. The
percent change in quantity exceeds the
percent change in price, making demand
elastic. 22

23. GRAPHICAL ANALYSIS
2. Demand is more inelastic in the lower
right portion of the curve because the
initial price is low and the initial quantity
is high, a unit change in price is a high
percentage change while a unit change in
quantity is a low percentage change. The
percentage change in quantity is less than
the percentage change in price, making
demand inelastic.
23

24. ELASTICITY AND SLOPE
It is impossible to judge the elasticity of
a single demand curve by its steepness or
flatness, since demand elasticity can
measure both elastic and inelastic at
different points on the same demand
curve.
24

25. ELASTICITY AND SLOPE
It is impossible to judge the elasticity of
a single demand curve by its steepness or
flatness, since demand elasticity can
measure both elastic and inelastic at
different points on the same demand
curve.
25

26. PART 2:
TOTAL REVENUE AND
ELASTICITY
26

27. THE TOTAL-REVENUE TEST
The total-revenue test is the easiest way
to judge whether demand is inelastic or
elastic. This test can be used in place of
the elasticity formula, unless there is a
need to determine the elasticity
coefficient.
1. Elastic demand and the total-revenue test:
Demand is elastic if a decrease in price results
in a rise in total revenue, or if an increase in
price results in a decline in total revenue (price
and revenue move in different directions-
indirectly related). 27

28. THE TOTAL-REVENUE TEST
2. Inelastic demand and the total-revenue test:
Demand is inelastic if a decrease in price
results in a fall in total revenue, or if an
increase in price results in a rise in total
revenue (price and revenue move in the same
direction-directly related).
3. Unit elasticity and the total revenue test:
Demand has unit elasticity if total revenue
does not change when the price changes.
28

29. THE TOTAL-REVENUE TEST
4. See the graphical representation of the
relationship between the relationship between
total revenue and price elasticity shown in the
data from the table on page 359 and the Figure
20.2 on page 360.
5. Table 20.2 on page 362 shows the summary
of the rules and concepts related to elasticity
of demand.
29

30. DETERMINANTS OF ELASTICITY
There are several determinants of the
price elasticity of demand.
1. Substitutes for the product:
Generally, the more substitutes for the
products, the more elastic the demand.
2. The proportion of price relative to
income: Generally, the larger the
expenditure is relative to one’s budget,
the more elastic the demand, because
buyers notice the change in price more.30

31. DETERMINANTS OF ELASTICITY
3. Whether the product is a necessity or
a luxury: Generally, the less necessary
the item, the more elastic the demand.
4. The amount of time involved:
Generally, the longer the time period
involved, the more elastic the demand
becomes.
31

32. DETERMINANTS OF ELASTICITY
See the table 20.3 from page 363, which
presents some real-world elasticities.
Use the determinants and to see if the
actual elasticities are equivalent to what
you would predict, based on the
characteristics of the good. Discuss your
thoughts with your neighbors.
32

33. APPLICATIONS OF ELASTICITY
There are many practical applications of
elasticity:
1. Inelastic demand for agricultural
products help explain why bumper
crops depress the prices and total
revenues for farmers.
33

34. APPLICATIONS OF ELASTICITY
2. Government looks at elasticity of
demand when levying excise taxes.
Excise taxes on products with
inelastic demand will raise the most
revenue (in taxes) and have the least
impact on quantity demanded for
those products.
34

35. APPLICATIONS OF ELASTICITY
3. Demand for cocaine is highly inelastic
and presents problems for law
enforcement. Stricter enforcement
reduces supply, raises prices and
revenues for sellers, and provides more
incentives for sellers to remain in
business. Crime may also increase as
buyers have to find more money to buy
their drugs.
35

36. APPLICATIONS OF ELASTICITY
a. Opponents of legalization think that
occasional users or “dabblers” have a
more elastic demand and would increase
their use at lower, legal prices.
b. Removal of the legal prohibitions might
make drug use more socially acceptable
and shift demand to the right.
4. The impact of minimum-wage laws will be
less harmful to employment if the
demand for minimum-wage workers is
inelastic. 36

37. PART 3:
PRICE ELASTICITY OF
SUPPLY
37

38. PRICE ELASTICITY OF SUPPLY
•
38

39. PRICE ELASTICITY OF SUPPLY
B. The time period involved is very
important in price elasticity of supply
because it will determine how much
flexibility a product has to adjust
his/her resources to a change in the
price. The degree of flexibility, and
therefore the time period, will be
different in different industries.
39

40. PRICE ELASTICITY OF SUPPLY
1. The market period is so short that
elasticity of supply is inelastic; it
could be almost perfectly inelastic or
vertical. In this situation, it is
virtually impossible for producers to
adjust their resources and change the
quantity supplied (for example, think
of adjustments on a farm once the
crop has been planted).
40

41. PRICE ELASTICITY OF SUPPLY
2. The short-run supply elasticity is
more elastic than the market period
and will depend on the ability of
producers to respond to price change.
Industrial producers are able to make
some output changes by having
workers work overtime or by bringing
on an extra shift.
41

42. PRICE ELASTICITY OF SUPPLY
3. The long-run supply elasticity is the
most elastic, because more
adjustments can be made over time and
quantity can be changes more relative
to a small change in price. The
producer has time to build a new plant.
42

43. CROSS ELASTICITY OF DEMAND
•
43

44. INCOME ELASTICITY OF DEMAND
•
44