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Page 1: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Elasticity

04

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Page 2: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Price Elasticity of Demand

• Measures buyers’ responsiveness to price changes

• Elastic demand

• Sensitive to price changes

• Large change in quantity

• Inelastic demand

• Insensitive to price changes

• Small change in quantity

LO1 4-2

Page 3: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Price Elasticity of Demand Formula

• Formula for price elasticity of demand

Ed =

LO1

Percentage Change in QuantityDemanded of Product X

Percentage Change in Priceof Product X

4-3

Page 4: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Price Elasticity of Demand Formula

• Use the midpoint formula

• Ensures consistent results

Change in quantity Change in price

Sum of quantities / 2 Sum of prices / 2

LO1

Ed = ÷

4-4

Page 5: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Price Elasticity of Demand Formula

• Use percentages

• Unit free measure

• Compare responsiveness across products

• Eliminate the minus sign

• Easier to compare elasticities

LO1 4-5

Page 6: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Interpretation of Elasticity of Demand

• Ed > 1 demand is elastic

• Ed = 1 demand is unit elastic

• Ed < 1 demand is inelastic

• Extreme cases

• Perfectly inelastic

• Perfectly elastic

LO1 4-6

Page 7: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Extreme Cases

LO1

D1P

Perfectly inelastic demand

Perfectly inelastic demand(Ed = 0)

0

4-7

Page 8: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Extreme Cases

LO1

Perfectly elastic demand

P

D2

Perfectly elasticdemand(Ed = ∞)

0

4-8

Page 9: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Total Revenue Test

• Total Revenue = Price x Quantity

• Inelastic demand

• P and TR move in the same direction

• Elastic demand

• P and TR move in opposite directions

LO2 4-9

Page 10: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Summary of Price Elasticity of Demand

LO2

Price Elasticity of Demand: A Summary

Absolute Value of Elasticity Coefficient Demand Is Description

Impact on Total Revenue of a:

Price Increase Price Decrease

Greater than 1(Ed > 1)

Elastic or relatively elastic

Qd changes by a larger percentage than does price

Total revenue decreases

Total revenue increases

Equal to 1(Ed = 1)

Unit or unitary elastic

Qd changes by the same percentage as does price

Total revenue is unchanged

Total revenue is unchanged

Less than 1(Ed < 1)

Inelastic or relatively inelastic

Qd changes by a smaller percentage than does price

Total revenue increases

Total revenue decreases

4-10

Page 11: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Determinants of Elasticity of Demand

• Substitutability• More substitutes, demand is more elastic

• Proportion of Income• Higher proportion of income, demand is more

elastic

• Luxuries vs. Necessities• Luxury goods, demand is more elastic

• Time• More time available, demand is more elastic

LO1 4-11

Page 12: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Price Elasticity of Supply

• Measures sellers’ responsiveness to price changes

• Elastic supply, producers are responsive to price changes

• Inelastic supply, producers are not responsive to price changes

LO3 4-12

Page 13: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Price Elasticity of Supply

• Formula to compute elasticity

• Es > 1 supply is elastic

• Es < 1 supply is inelastic

LO3

Percentage Change in QuantitySupplied of Product X

Percentage Change in Priceof Product X

Es =

4-13

Page 14: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Cross Elasticity of Demand

• Measures responsiveness of sales to change in the price of another good

• Substitutes – positive sign

• Complements – negative sign

• Independent goods - zero

LO4

Percentage change in quantity demanded of product X

Ex,y = Percentage change in price of product Y

4-14

Page 15: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Income Elasticity of Demand

• Measures responsiveness of buyers to changes in income

• Normal goods – positive sign

• Inferior goods – negative sign

LO4

Percentage change in quantity demanded

Ei =

Percentage change in income

4-15

Page 16: Elasticity 04 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Ex,y and Ei

LO4

Cross and Income Elasticities of Demand

Value of Coefficient Description Type of Good(s)

Cross elasticity: Positive (Ewz > 0)

Negative (Exy < 0)

Quantity demanded of W changes in same direction as change in price of Z

Quantity demanded of X changes in opposite direction from change in price of Y

Substitutes

Complements

Income elasticity: Positive (Ei >0)

Negative (Ei<0)

Quantity demanded of the product changes in same direction as change in income

Quantity demanded of the product changes in opposite direction from change in income

Normal or superior

Inferior

4-16


Chapter 4: Elasticity of Demand and Supply. Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Price Elasticity

© 2002 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin

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