1. ELASTICITY
Elasticity is the concept economists use to
describe the steepness or flatness of curves
or functions.
In general, elasticity measures the
responsiveness of one variable to changes
in another variable.
Elasticity slide 1

2. PRICE ELASTICITY OF
DEMAND
Measures the responsiveness of quantity
demanded to changes in a good’s own
price.
The price elasticity of demand is the percent
change in quantity demanded divided by the
percent change in price that caused the
change in quantity demanded.
Elasticity slide 2

3. FACTS ABOUT ELASTICITY
It’s always a ratio of percentage changes.
That means it is a pure number -- there are no units
of measurement on elasticity.
Price elasticity of demand is computed along a
demand curve.
Elasticity is not the same as slope.
Elasticity slide 3

4. LOTS OF ELASTICITIES!
THERE ARE LOTS OF WAYS TO COMPUTE
ELASTICITIES. SO BEWARE! THE DEVIL IS
IN THE DETAILS.
MOST OF THE AMBIGUITY IS DUE TO THE
MANY WAYS YOU CAN COMPUTE A
PERCENTAGE CHANGE. BE ALERT HERE.
IT’S NOT DIFFICULT, BUT CARE IS
NEEDED.
Elasticity slide 4

5. What’s the percent increase in price here
because of the shift in supply?
S'
price S
pE = $2.50
pE = $2
D
QE Q
CIGARETTE MARKET
Elasticity slide 5

6. IS IT:
A) [.5/2.00] times 100?
B) [.5/2.50] times 100?
C) [.5/2.25] times 100?
Elasticity slide 6

7. From time to time economists have used ALL of
these measures of percentage change --
including the “Something else”!
Notice that the numerical values of the percentage
change in price is different for each case:
Go to hidden slide
Elasticity slide 7

8. A) [.5/2.00] times 100 = 25 percent
B) [.5/2.50] times 100 = 20 percent
C) [.5/2.25] times 100 = 22.22 percent
Elasticity slide 8

9. Economists usually use the “midpoint”
formula (option C), above) to compute
elasticity in cases like this in order to
eliminate the ambiguity that arises if we
don’t know whether price increased or
decreased.
Elasticity slide 9

10. Using the Midpoint Formula
% change in Q
Elasticity =
% change in P
% change in p = change in P times 100.
average P
∆P
) × 100
% change in p =
(
PMEAN
For the prices $2 and $2.50, the % change in p is
approx. 22.22 percent.
Elasticity slide 10

11. What’s the percent change in Q due to the
shift in supply?
S'
price S
pE’ = $2.50
pE = $2.00
D
QE’ = 7QE = 10 Q (millions)
CIGARETTE MARKET
Elasticity slide 11

12. Use the midpoint formula again.
% change in Q
Elasticity =
% change in P
change in Q
% change in Q =
average Q
∆Q
% change in Q = ( ) × 100
Q MEAN
For the quantities of 10 and 7, the % change in Q is
approx. -35.3 percent. (3/8.5 times 100)
Elasticity slide 12

13. NOW COMPUTE ELASTICITY
% change in p = 22.22 percent
% change in Q = -35.3 percent
E = -35.3 / 22.22 = -1.6
(approx.)
Elasticity slide 13

14. But you can do the other options as well:
A) If you use the low price, and its corresponding
quantity, as the base values, then elasticity = 1.2
B) If you use the high price, and its corresponding
quantity, as the base values, then elasticity = 2.1
(approx.)
C) And the midpoint formula gave 1.6 (approx.)
SAME PROBLEM...DIFFERENT ANSWERS!!!
Elasticity slide 14

15. MORE ELASTICITY
QUANTITY PRICE P
COMPUTATIONS
0 10 14
1 9 12
Compute elasticity between
Compute elasticity between
2 8 10
prices of $9 and $8.
prices of $9 and $8.
3 7 8
4 6 6
5 5 4
6 4 2
7 3 0 Q
8 2 0 2 4 6 8 10 12 14
9 1
10 0
Elasticity slide 15

16. USE THE MIDPOINT FORMULA.
The % change in Q =
The % change in P =
Therefore elasticity =
Go to hidden slide
Elasticity slide 16

17. The % change in Q = 66.67 = 1 / 1.5 times 100
The % change in P = 11.76 = 1 / 8.5 times 100
Therefore elasticity = -66.67 / 11.76 = -5.67 (approx.)
Elasticity slide 17

18. QUANTITY PRICE P
14
So elasticity between these prices
So elasticity between these prices
0 10 is -5.67.
is -5.67.
12
1 9
2 8 10
3 7 8
4 6 6
5 5 4
6 4 2
7 3 0 Q
8 2 0 2 4 6 8 10 12 14
9 1
10 0
Elasticity slide 18

19. Now we try different prices
QUANTITY PRICE
0 10
P
1 9 14
2 8 12 Compute elasticity between
Compute elasticity between
3 7 10 prices of $3 and $2.
prices of $3 and $2.
4 6 8
6
5 5
4
6 4
2
7 3 Q
0
8 2 0 2 4 6 8 10 12 14
9 1
10 0
Elasticity slide 19

20. The % change in Q =
The % change in P =
Therefore elasticity =
Go to hidden slide
Elasticity slide 20

21. The % change in Q = 13.33 = 1 / 7.5 times 100
The % change in P = 40 = 1 / 2.5 times 100
Therefore elasticity = -13.33 / 40 = -.33 (approx.)
Elasticity slide 21

22. QUANTITY PRICE P
14
0 10
12
1 9
10 So elasticity between these
So elasticity between these
2 8 prices is -.33.
8 prices is -.33.
3 7
6
4 6
4
5 5
2
6 4
0
7 3 Q
0 2 4 6 8 10 12 14
8 2
9 1
10 0
Elasticity slide 22

23. ELASTICITY IS NOT SLOPE!
QUANTITY PRICE P Note that elasticity is different
Note that elasticity is different
0 10 14 at the two points even though
at the two points even though
1 9 12 the slope is the same.
the slope is the same.
(Slope = -1)
(Slope = -1)
2 8 10
3 7 8 E = -5.67
4 6 6
E = -.33
5 5 4
6 4 2
7 3 0 Q
8 2 0 2 4 6 8 10 12 14
9 1
10 0
Elasticity slide 23

24. TERMS TO LEARN
Demand is ELASTIC when the numerical value of
elasticity is greater than 1.
Demand is INELASTIC when the numerical value of
elasticity is less than 1.
Demand is UNIT ELASTIC when the numerical
value of elasticity equals 1.
NOTE: Numerical value here means “absolute
value.”
Elasticity slide 24

25. LIKE THIS!
QUANTITY PRICE P
14
0 10
12
1 9 Demand is elastic here.
10 Demand is elastic here.
2 8
8
3 7 6
Demand is inelastic here.
Demand is inelastic here.
4 6 4
5 5 2
6 4 0 Q
7 3 0 2 4 6 8 10 12 14
8 2
9 1
10 0
Elasticity slide 25

26. There is an important relationship between what
happens to consumers’ spending on a good and
elasticity when there is a change in price.
Spending on a good = P Q.
Because demand curves are negatively sloped, a
reduction in P causes Q to rise and the net effect
on PQ is uncertain, and depends on the elasticity
of demand.
Elasticity slide 26

27. At P = $9, spending is $9 (= 1 times $9).
At P = $8, spending is $16 ( = 2 times $8).
When price fell from $9 to $8, spending rose. Q must
QUANTITY PRICE haveincreased by a larger percent than P decreased.
So...
0 10 P
1 9 14
2 8 12
3 7 10 Demand is elastic here.
Demand is elastic here.
4 6 8
5 5 6
6 4 4
7 3 2
8 2 0 Q
9 1 0 2 4 6 8 10 12 14
10 0
Elasticity slide 27

28. At P = $3, spending is $21 (= 7 times $3).
At P = $2, spending is $16 ( = 8 times $2).
When price fell from $3 to $2, spending fell. Q must have
increased by a smaller percent than P decreased. So...
QUANTITY PRICE
P
0 10 14
1 9 12
2 8 10
3 7 8
4 6 Demand is inelastic here.
Demand is inelastic here.
6
5 5
4
6 4
2
7 3
0
8 2 Q
0 2 4 6 8 10 12 14
9 1
10 0
Elasticity slide 28

29. There is an easy way to tell whether demand is
elastic or inelastic between any two prices.
If, when price falls, total spending increases, demand
is elastic.
If, when price falls, total spending decreases,
demand is inelastic.
Elasticity slide 29

30. But total spending is easy to see using a
demand curve graph:
P
QUANTITY PRICE
14
0 10
12 The shaded area is P times Q,
1 9 The shaded area is P times Q,
2 8
10 or total spending when P = $9.
or total spending when P = $9.
8
3 7
4 6 6
5 5 4
6 4 2
7 3 0 Q
0 2 4 6 8 10 12 14
8 2
9 1
10 0
Elasticity slide 30

31. P
14
QUANTITY PRICE 12 The shaded area is P times Q
The shaded area is P times Q
or total spending when P = $8.
or total spending when P = $8.
0 10 10
1 9 8
2 8 6
3 7 4
4 6 2
5 5 0 Q
6 4 0 2 4 6 8 10 12 14
7 3
8 2
9 1
10 0
Elasticity slide 31

32. = loss in TR = gain in TR due to
due to fall in P rise in Q
P
14 Total spending is higher at the price
QUANTITY PRICE Total spending is higher at the price
12 of $8 than it was at the price of $9.
of $8 than it was at the price of $9.
0 10
10
1 9
8
2 8
6
3 7
4
4 6
5 5 2
6 4 0 Q
0 2 4 6 8 10 12 14
7 3
8 2
9 1
10 0
Elasticity slide 32

33. P
14
QUANTITY PRICE The shaded area is total
The shaded area is total
0 10 12
spending (total revenue of
spending (total revenue of
1 9 10 sellers) when P = $3.
sellers) when P = $3.
2 8 8
3 7 6
4 6
4
5 5
2
6 4
7 3 0
0 2 4 6 8 10 12 14 Q
8 2
9 1
10 0
Elasticity slide 33

34. P
QUANTITY PRICE 14
0 10 12 Total revenue of sellers (total
Total revenue of sellers (total
1 9 10 spending by buyers) falls when
spending by buyers) falls when
2 8 price falls from $3 to $2.
price falls from $3 to $2.
8
3 7
6
4 6
4
5 5
6 4 2
7 3 0 Q
8 2 0 2 4 6 8 10 12 14
9 1
10 0
Elasticity slide 34

35. Here’s a convenient way to think of the
relative elasticity of demand curves.
p relatively more elastic
relatively more elastic
at p*
at p*
p*
relatively more inelastic
relatively more inelastic
at p*
at p*
Q
Q*
Elasticity slide 35

36. Examples of elasticity
Doctors through the AMA restrict the supply of
physicians. How does this affect the incomes of
doctors as a group?
A labor union negotiates a higher wage. How does
this affect the incomes of affected workers as a
group?
MSU decides to raise the price of football tickets.
How is income from the sale of tickets affected?
Airlines propose to raise fares by 10%. Will the
boost increase revenues?
Elasticity slide 36

37. MORE ...
MSU is considering raising tuition by 7%.
Will the increase in tuition raise revenues of
MSU?
CATA recently raised bus fares in the
Lansing area. Will this increase CATA’s
total receipts?
Elasticity slide 37

38. The answers to all of these questions depend
on the elasticity of demand for the good in
question. Be sure you understand how and
why!
Elasticity slide 38

39. DETERMINANTS OF DEMAND
ELASTICITY
The more substitutes there are available for a good,
the more elastic the demand for it will tend to be.
[Related to the idea of necessities and luxuries.
Necessities tend to have few substitutes.]
The longer the time period involved, the more elastic
the demand will tend to be.
The higher the fraction of income spent on the good,
the more elastic the demand will tend to be.
Elasticity slide 39

40. OTHER ELASTICITY MEASURES
In principle, you can compute the elasticity
between any two variables.
Income elasticity of demand
Cross price elasticity of demand
Elasticity of supply
Elasticity slide 40

41. Each of these concepts has the expected definition.
For example, income elasticity of demand is the
percent change in quantity demand divided by a
percent change income:
% change in Q
EINCOME =
% change in I
Income elasticity of demand will be positive for
normal goods, negative for inferior ones.
Elasticity slide 41