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Elasticity
©1999 South-Western College Publishing
1
What is Elasticity?
A term economists use to
describe sensitivity of quantity
demanded or supplied to a
change in price.
2
How do we measure the Price
Elasticity of Demand?
The percentage change in
quantity demanded
divided by the percentage
change in price
3
Price Elasticity of
Demand
Ed
%
change
in
Q
=
d
% change in P
Ed = %
in Qd
%
in P
4
Notes on Ed
• Ed negative, but ignore
negative
•use of % change-not
affected by units of
measurement
5
Classifying Ed
• Ed = 1 Unitary elasticity
• Ed > 1 Elastic demand
• Ed < 1 Inelastic demand
6
Extreme elasticities
• Ed = 0 Perfectly inelastic
(vertical demand curve)
• Ed =  Perfectly elastic
(horizontal demand curve)
7
Perfectly inelastic
demand
P
D
Perfectly elastic
demand
P
D
Q
Q
8
When consumers are very
sensitive to a price change
what does the demand curve
look like?
Very horizontal
9
When consumers are less
sensitive to a price change
what does the demand curve
look like?
Very vertical
10
Price
Qu
antity
Initial
New
Initial
New
25
30
100
40
%
%
Price
change change in Elasticity of
in Qd
P
Demand
Ed
=
%
%
in Qd
in P
60%
20%
3-elastic
60/100
5/25
.6/.2
40
70
120
90
25%
75%
0.33-inelastic
200
220
80
64
20%
10%
2-elastic
50
75
150
135
10%
50%
.2-inelastic
11
11
When price increases,
what two things happen?
• more revenue
per unit
•fewer units are sold
12
What factors influence Demand
Sensitivity (elasticity)?
• Number and closeness of
Substitute goods
• % of income a good makes up
• Basic goods or “needs”
• Time to adjust
13
What do substitutes have to
do with sensitivity?
The more substitutes a
good has, the more
sensitive consumers
are to a price change
14
A
P
P
D
D
0
Q
B
0
Q
Which demand curve is for spark
plugs and which for Coca-Cola?
15
What does % of income a good makes
up have to do with sensitivity?
The lower the % of ones
budget a good is, the less
sensitive consumers are to a
price change
SALT!
16
What do basic goods have
to do with sensitivity?
The greater the need a good
has to the consumer, the less
sensitive the consumer is to
a price change
WATER!
17
What does time have to
do with sensitivity?
The more time to adjust, the
more sensitive consumers
are to a price change
18
Elasticity and Total
Revenue (TR)
TR = PQ (price times quantity)
Ed
=
% change in Qd
% change in P
19
If a college raises tuition,
what happens to revenue?
If demand is elastic revenue goes down
If demand is inelastic revenue goes up
20
If total revenue does
not change when
price increases, the
demand curve is
unitary elastic,
value equals 1
21
If price increases and
the revenue gained is
less than the revenue
lost, the demand curve
is price elastic, > 1
22
If price increases and the
revenue gained is greater
than the revenue lost, the
demand curve is price
inelastic, < 1
23
Summary, elasticity, price changes,
and total revenue
Price
increase
Total
revenue
same
Price
Decrease
Total
revenue
same
Ed > 1
Total
revenue
falls
Total
revenue
rises
Ed < 1
Total
revenue
rises
Total
revenue
falls
Ed = 1
24
What is Price Elasticity
of Supply?
The ratio of the percentage
change in quantity
supplied to the percentage
change in price
25
E s = %  Q supplied
%  Price
• E s = 1 Unitary
• E s > 1 Elastic
• E s < 1 Inelastic
26
Extreme cases of E s
• E s = 0, perfectly inelastic
(vertical supply curve
P
S
Q
P
• E s = , perfectly elastic
(horizontal supply curve)
S
Q
27
Does time effect Supply
Elasticities?
Yes! The more time,
the more elastic the
supply curve
28
Which type of good
would be best to tax to
raise the most revenue?
Goods that face a price
inelastic demand curve will
generate the most revenue
29
What is Cross Elasticity
of Demand?
The percentage change in
the quantity demanded of
one commodity resulting
from a 1 percent change in
price of another commodity
30
Cross Elasticity of Demand
E c = %  Quantity of X
% Price of Y
31
If E c negative - complements (steak
& steak sauce)
If E c positive - substitutes (butter &
margarine)
Unrelated goods should have a E c
close to zero
32
What is Income
Elasticity of Demand?
The ratio of the percentage
change in quantity
demanded to the percentage
change in income
33
E i = %  Quantity
% Income
• E i > 0 Normal goods
• E i < 0 Inferior goods
• E i > 1 Luxury goods
• 0 < E i < 1 Necessities
34
When does a good face
an income elastic
demand curve?
A 1% change in income
generates a greater than
1% change quantity
demanded
35
When does a good face
an income inelastic
demand curve?
A 1% change in income
generates a less than
1% change quantity
demanded
36
What is an
Inferior Good?
Something that people
will buy less of as
their incomes increase
I bought Mac and Cheese in college,
but refuse to buy it now! What’s the
difference in my income?
37
What is a
Normal Good?
Something that people
will buy more of as their
incomes increase
I bought bologna in college, but now I
buy steak! What’s the difference in
my income?
38