Elasticity

Peng Shen

October 20, 2021

Peng Shen Price Elasticity of Demand October 20, 2021 1 / 26

Review of Lecture 7 part 2
Price elasticity of demand: the responsiveness of the quantity
demanded to a change in price. The conventional formula is:

∆Q d /Q d × 100% ∆Q d ∆P ∆Q d P 1 P
εdp = = d
÷ = × d = × d
∆P/P × 100% Q P ∆P Q Slope Q

Peng Shen Price Elasticity of Demand October 20, 2021 2 / 26

Review of Lecture 7 part 2
Price elasticity of demand: the responsiveness of the quantity
demanded to a change in price. The conventional formula is:

∆Q d /Q d × 100% ∆Q d ∆P ∆Q d P 1 P
εdp = = d
÷ = × d = × d
∆P/P × 100% Q P ∆P Q Slope Q

Use midpoint formula:

 
 
 (Q d −Q d ) (P2 −P1 )
dp

=  d d × 100% ÷ P2 +P1 × 100%
  2 1 

Q +Q
2 1 2
2

(Q2d − Q1d ) (P2 − P1 ) (Q2d − Q1d ) (P2 + P1 )

dp = d d
÷ = ×
(Q2d + Q1d )


Q2 + Q1 (P 2 + P 1 ) (P2 − P 1 )
1 P1 + P2
= × d
slope Q1 + Q2d

Peng Shen Price Elasticity of Demand October 20, 2021 2 / 26

Review of Lecture 7 part 2

Price elasticity of demand is always negative. In words, it is defined as

the percentage change in quantity demanded from a 1% change in price.
We compare elasticities by comparing their absolute value.
Although -3 is actually a smaller number than -2, we say that a price
elasticity of -3 is larger than a price elasticity of -2.

Peng Shen Price Elasticity of Demand October 20, 2021 3 / 26

Review of Lecture 7 part 2

Price elasticity of demand is always negative. In words, it is defined as

the percentage change in quantity demanded from a 1% change in price.
We compare elasticities by comparing their absolute value.
Although -3 is actually a smaller number than -2, we say that a price
elasticity of -3 is larger than a price elasticity of -2.

The demand between point A and B is

Elastic: the price elasticity is greater than -1 (e.g. -2).
Unit elastic: the price elasticity is equal to -1.
Inelastic: the price elasticity is smaller than -1 (e.g. -0.5).

Peng Shen Price Elasticity of Demand October 20, 2021 3 / 26

Review of Lecture 7 part 2

As we move down along the demand curve, the demand changes from
being elastic to being inelastic.

Peng Shen Price Elasticity of Demand October 20, 2021 4 / 26

Review of Lecture 7 part 2

If two demand curves intersect, on the intervals close to the intersection,

the flatter demand curve is more elastic.

Price elasticity of D1 between A and B is -1.6.

Price elasticity of D2 between A and C is -0.3.

Peng Shen Price Elasticity of Demand October 20, 2021 5 / 26

Review of Lecture 7 part 2

Figure 1: Perfectly elastic Figure 2: Elastic Figure 3: Unit elastic

Figure 4: Inelastic Figure 5: Perfectly inelastic

Peng Shen Price Elasticity of Demand October 20, 2021 6 / 26

Review of Lecture 7 part 2
Total revenue: total amount of funds it receives from selling a good or
service, calculated by multiplying price per unit by the number of units
sold (P × Q).

Peng Shen Price Elasticity of Demand October 20, 2021 7 / 26

List of price elasticity of demand

Figure 6: Estimated Real-World Price Elasticity of Demand

Peng Shen Price Elasticity of Demand October 20, 2021 8 / 26

The determinants of the price elasticity of demand

1 The availability of close substitutes

2 Passage of time (or the length of time period)
3 Whether the good is a luxury or a necessity
4 The definition of the market
5 The share of the good in the consumer’s budget

Peng Shen Price Elasticity of Demand October 20, 2021 9 / 26

The determinants of the price elasticity of demand

1. The availability of close substitutes

If a product has more substitutes available, it will have more elastic
demand.
If a product has fewer substitutes available, it will have less elastic
demand.
Example: Price elasticity of
Gasoline: -0.06
Grapes: -1.18

Peng Shen Price Elasticity of Demand October 20, 2021 10 / 26

The determinants of the price elasticity of demand

2. The passage of time

Over time, people can adjust their buying habits more easily.
Elasticity is higher in the long run than in the short run.
Example:
If the price of gasoline rises, it takes a while for people to adjust their
gasoline consumption. How might they do that?
Buying a more fuel-efficient car
Moving closer to work

Peng Shen Price Elasticity of Demand October 20, 2021 11 / 26

The determinants of the price elasticity of demand

3. Whether the good is a luxury or a necessity

People are more flexible with luxuries than with necessities, so price
elasticity of demand is higher for luxuries.
Example: Price elasticity of
Milk: -0.04; Bread: -0.40
Chevrolet automobiles: 4.0

Peng Shen Price Elasticity of Demand October 20, 2021 12 / 26

The determinants of the price elasticity of demand

3. Whether the good is a luxury or a necessity

People are more flexible with luxuries than with necessities, so price
elasticity of demand is higher for luxuries.
Example: Price elasticity of
Milk: -0.04; Bread: -0.40
Chevrolet automobiles: 4.0

4. The definition of the market

The more narrowly defined the market, the more substitutes are
available, and hence the more elastic is demand.
Example: Price elasticity of
Coca-Cola: -1.22
Soda: -0.70

Peng Shen Price Elasticity of Demand October 20, 2021 12 / 26

The determinants of the price elasticity of demand

5. The share of a good in a consumer’s budget

If a good is a small portion of your budget, you will likely not be very
sensitive to its price.
Example: Price elasticity of
Sugar: -0.04
New automobiles: -1.95

Peng Shen Price Elasticity of Demand October 20, 2021 13 / 26

Price elasticity of demand and shift in supply curve

$0.75 unit tax on soda

Goal: discouraging soda consumption
What is the effect of price elasticity of demand on discouraging soda
consumption?

Peng Shen Price Elasticity of Demand October 20, 2021 14 / 26

Price elasticity of demand and shift in supply curve

Demand inelastic Demand elastic

Decline in equilibrium quantity Smaller Larger
Increase in equilibrium price Larger Smaller
Effect on discouraging soda consumption Smaller effect Larger effect
Effect on city tax revenue More tax revenue Less tax revenue

Peng Shen Price Elasticity of Demand October 20, 2021 15 / 26

Other demand elasticities: Cross-price elasticity
Cross-price elasticity of demand measures the responsiveness of the
quantity demanded for a good to a change in the price of another good.

Cross-price elasticity of demand

percentage change in the quantity demanded of one good (good A)
=
percentage change in the price of another good (good B)

In words, it is defined as the percentage change in quantity demanded of

good A from a 1% change in the price of good B

Peng Shen Price Elasticity of Demand October 20, 2021 16 / 26

Other demand elasticities: Income elasticity

Income elasticity of demand: measures the responsiveness of the

quantity demanded to changes in income

Income elasticity of demand

percentage change in the quantity demanded
=
percentage change in income
In words, it is defined as the percentage change in quantity demanded
from a 1% change in income

Peng Shen Price Elasticity of Demand October 20, 2021 17 / 26

Price elasticity of supply

Price elasticity of supply measures the responsiveness of the quantity

supplied to a change in price.
percentage change in the quantity supplied
Price elasticity of supply =
percentage change in price
In words, the price elasticity of supply is defined as the percentage change
in quantity supplied from a 1% change in price.

Peng Shen Price Elasticity of Demand October 20, 2021 18 / 26

Price elasticity of supply

Price elasticity of supply measures the responsiveness of the quantity

supplied to a change in price.
percentage change in the quantity supplied
Price elasticity of supply =
percentage change in price
In words, the price elasticity of supply is defined as the percentage change
in quantity supplied from a 1% change in price.
Recall that supply equation as P = c + d · Q s , where d > 0, then

∆Q s /Q s × 100% ∆Q s ∆P
εsp = = s
÷
∆P/P × 100% Q P
P ∆Q s P 1 P 1
= × = × = × > 0
Qs ∆P Qs Slope Qs d

Peng Shen Price Elasticity of Demand October 20, 2021 18 / 26

Price elasticity of supply: midpoint formula

Similar to price elasticity of demand (we have εdp for conventional formula,
and dp for the midpoint formula), we also have a midpoint formula for the
price elasticity of supply (sp ).
   
(Q s − Q1s )
 2
(P − P1 )
 2
sp =  × 100% ÷
Q2s +Q1s
   × 100%
P2 +P1
2 2
(Q2s − Q1s ) (P2 − P1 ) (P2 + P1 ) (Q2s − Q1s )
= ÷ = ×
(Q2s + Q1s ) (P2 + P1 ) (Q2s + Q1s ) (P2 − P1 )
P1 + P2 1 P1 + P2 1
= × = × > 0
Q1s + Q2s slope Q1s + Q2s d

Peng Shen Price Elasticity of Demand October 20, 2021 19 / 26

Price elasticity of supply: midpoint formula

Similar to price elasticity of demand (we have εdp for conventional formula,
and dp for the midpoint formula), we also have a midpoint formula for the
price elasticity of supply (sp ).
   
(Q s − Q1s )
 2
(P − P1 )
 2
sp =  × 100% ÷
Q2s +Q1s
   × 100%
P2 +P1
2 2
(Q2s − Q1s ) (P2 − P1 ) (P2 + P1 ) (Q2s − Q1s )
= ÷ = ×
(Q2s + Q1s ) (P2 + P1 ) (Q2s + Q1s ) (P2 − P1 )
P1 + P2 1 P1 + P2 1
= × = × > 0
Q1s + Q2s slope Q1s + Q2s d

Therefore, price elasticity of supply is always positive.

Peng Shen Price Elasticity of Demand October 20, 2021 19 / 26

Price elasticity of supply

Similar to the case of demand. The supply is

elastic, if the price elasticity of supply is greater than 1.
unit elastic, if the price elasticity of supply is equal to 1.
inelastic, if the price elasticity of supply is smaller than 1.

Peng Shen Price Elasticity of Demand October 20, 2021 20 / 26

Price elasticity of supply

Similar to the case of demand. The supply is

elastic, if the price elasticity of supply is greater than 1.
unit elastic, if the price elasticity of supply is equal to 1.
inelastic, if the price elasticity of supply is smaller than 1.

If supply curve has a zero intercept, that is c = 0, then P = d · Q s and

P 1 d · Qs 1 d · (Q1s + Q2s ) 1
εsp = = = 1 ,  s
p = = 1.
Qs d Qs d Q1s + Q2s d

This means that if supply curve starts from the origin point (i.e. c = 0),
then it will have a constant price elasticity of supply and is unit elastic.

Peng Shen Price Elasticity of Demand October 20, 2021 20 / 26

Price elasticity of supply

When supply curve is a straight line and pass through the origin, the price
elasticity of supply between any two points is one.

Figure 7: Price elasticities of supply between A and B, C and D, E and F are all 1

Peng Shen Price Elasticity of Demand October 20, 2021 21 / 26

Price elasticity of supply

When supply curve is a straight line and starts from a point on

the vertical axis, that is, if we have c > 0 and d 6= 0, then the price
elasticity of supply between any two points is greater than one.
And the price elasticity of supply decreases as Q s increases.

Peng Shen Price Elasticity of Demand October 20, 2021 22 / 26

Price elasticity of supply

When supply curve is a straight line and starts from a point on

the vertical axis, that is, if we have c > 0 and d 6= 0, then the price
elasticity of supply between any two points is greater than one.
And the price elasticity of supply decreases as Q s increases.

When the supply curve is a straight line and starts from a point on
the horizontal axis, that is, if we have c < 0 and d 6= 0, then the price
elasticity of supply between any two points is smaller than one.
And the price elasticity of supply increases as Q s increases.

Peng Shen Price Elasticity of Demand October 20, 2021 22 / 26

Price elasticity of two supply curves

If two supply curves intersect (at a point other than the origin), on the
intervals close to the intersection, the flatter supply curve is more elastic.

Figure 8: Elastic Figure 9: Unit elastic Figure 10: Inelastic

Peng Shen Price Elasticity of Demand October 20, 2021 23 / 26

Two polar cases

If the price elasticity is infinity (i.e., If the price elasticity is 0 (i.e.,

supply is a horizontal line), then the supply is a vertical line), then the
supply curve is perfectly elastic. supply curve is perfectly inelastic.

Peng Shen Price Elasticity of Demand October 20, 2021 24 / 26

Determinants of the price elasticity of supply

Whether supply is elastic or inelastic depends on the ability and willingness

of firms to alter the quantity they produce as price increases.
1 Input Flexibility: if firm uses adaptable inputs, supply is more elastic
2 Mobility of Inputs: if resources can easily move to where it is needed,
then the supply is more elastic
3 Availability of Inputs Substitutes: if alternative inputs is easy to find,
then the supply is more elastic
4 Passage of Time (Length of Time Period): longer time, more elastic

Peng Shen Price Elasticity of Demand October 20, 2021 25 / 26

Price elasticity of supply and demand curve shifts

Peng Shen Price Elasticity of Demand October 20, 2021 26 / 26