Econ2 Micro ch05

Micro
McEachern ECON 2010-2011
Designed by
CHAPTER
Elasticity of
Amy McGuire, B-books, Ltd.

5 Demand and Supply
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 1
Price Elasticity of Demand
 Elasticity
– Responsiveness
 Price elasticity of demand
– Consumers’
responsiveness to a
change in price
– Percentage change in
quantity demanded
divided by percentage
change in price
LO1
Price Elasticity of Demand
%q
ED 
%p
q p
ED  
(q  q' ) / 2 ( p  p' ) / 2
 Law of demand
 ED negative
 Absolute value of ED positive
LO1
LO1 Demand Curve for Tacos
If the price of tacos drops from

$1.10 to $0.90, the quantity
Exhibit 1
demanded increases from

$1.10 a
95,000 to 105,000.
Price per taco
b
0.90
0 95 105 Thousands per day
Categories of ED
 If %∆q < %∆p

– ED between 0 and 1
– Inelastic D
 If %∆q > %∆p
– ED greater than 1
– Elastic D
 If %∆q = %∆p
– ED = 1
– Unit elastic D
LO1
Elasticity and Total Revenue
 Total revenue = price *

quantity demanded at
this price
 TR= p * q
 As p decreases
 If D elastic,
TR increases
 If D inelastic,
TR decreases
 If D unit elastic,
TR unchanged
LO1
Price Elasticity and the
Linear D Curve
 Linear D curve
– Constant slope
– Different elasticity
– D becomes less elastic as we move
downward
 D upper half: elastic
 D lower half: inelastic
 D midpoint: unit elastic
LO1
LO1 Exhibit 2
$100
90
(a) Demand and price elasticity Demand, Price
Elasticity, and
Price per unit
a Elastic, ED >1
80
b
Total Revenue
70
60 Unit elastic, ED =1
50
40 c Inelastic, ED <1 Where D is elastic, a
30 lower P increases TR
20
d Where D is inelastic, a
10 e D lower P decreases TR
0 100 200 500 800 900 1,000 Quantity per period
(b) Total revenue

$25,000
TR reaches a
Total revenue
Total
maximum at the rate
revenue of output where D is
unit elastic
0 500 1,000 Quantity per period

Constant-Elasticity
Demand Curves
 Perfectly elastic D curve

– Horizontal; ED = ∞
– Consumers don’t tolerate P increases
 Perfectly inelastic D curve
– Vertical; ED = 0
– ‘Price is no object’
 Unit-elastic D curve
– %∆p causes an exact opposite %∆q
LO1
LO1 Exhibit 3
Constant-Elasticity Demand Curves
(a) Perfectly elastic (b) Perfectly inelastic (c) Unit elastic
D’
Price per unit

Price per unit
Price per unit
ED ’’ = 1
ED’’ = 0
ED = ∞ $10 a
p D
b
6
D’’
0 Quantity per period 0 Q Quantity 0 60 100 Quantity

per period per period
Consumers demand all quantity
offered for sale at p, but demand Consumers demand Q Total revenue is the same
nothing at a price above p regardless of price for each p-q combination
LO1 Exhibit 4
Summary of Price Elasticity of Demand
Effects of a 10 Percent Increase in Price
Determinants of Price
Elasticity of D
 ED is greater:
– The greater the availability of substitutes,
and the more similar the substitutes
– The more important the good as a share of
the consumer’s budget
– The longer the period of adjustment (time)
LO2
LO2 Exhibit 5
Demand Becomes More Elastic over Time
Dw: one week after the price increase

Price per unit
$1.25 Dm: one month after the price increase
Dy: one year after the price increase

1.00 e
Dy
Dw Dm
0 50 75 95 100 Quantity per day

Dy is more elastic than Dm , which is more elastic than Dw
Elasticity Estimates
 Short run
– Consumers have little time to adjust
 Long run
– Consumers can fully adjust to a price change
 Demand is more elastic in the long run
LO2
LO2 Selected Price Elasticities of
Demand (Absolute Values)
Exhibit 6
LO2 Deterring Young Smokers
 Health hazard
 Kills 440,000 Americans a year
Case Study
 Lung cancer; Heart disease;
Emphysema; Stroke
 Cost to society
 $7.18 per pack sold
 Higher health cost
 Lost worker
productivity
 Total: $150 billion a year
 $3,400 per smoker
per year
LO2 Deterring Young Smokers
 Discouraging smoking
 Prohibit the sale of cigarettes to minors
Case Study
 Higher cigarette tax
 ED is higher for teens
 Big share of budget
 Less peer pressure
 Not an addiction yet
 Reduces teen smoking
 Change consumer tastes
Price Elasticity of Supply
 Elasticity
– Responsiveness
 Price elasticity of supply
– Producers’ responsiveness to a change
in price
– Percentage change in quantity supplied
divided by percentage change in price
LO3
%q
ES 
%p
q p
ES  
(q  q' ) / 2 ( p  p' ) / 2
 Law of supply
 ES positive
LO3
LO3 Exhibit 7
S
Price per unit
If the price increases from p

p’ to p’, the quantity supplied
increases from q to q’.
Price and quantity supplied
p move in the same direction,
so the price elasticity of
supply is a positive number.
0 q q’ Quantity per period
Categories of ES
 If %∆q < %∆p

– ES between 0 and 1
– Inelastic S
 If %∆q > %∆p
– ES greater than 1
– Elastic S
 If %∆q = %∆p
– ES = 1
LO3 – Unit elastic S
Constant-Elasticity Supply Curves
 Perfectly elastic S curve

– Horizontal; ES = ∞
– Producers supply 0 at a price below P
 Perfectly inelastic S curve
– Vertical; ES = 0
– Goods in fixed supply
 Unit-elastic S curve
– %∆p causes an exact opposite %∆q
LO3 – S curve is a ray from the origin
LO3 Exhibit 8
Constant-Elasticity Supply Curves
(a) Perfectly elastic (b) Perfectly inelastic (c) Unit elastic
Price per unit

S’
Price per unit

Price per unit
S’’
ES’’ = 1
ES’ = 0
ES = ∞ $10
p S
5
0 Quantity 0 Q Quantity 0 10 20 Quantity

per period per period per period
Firms supply any amount of
output demanded at p, but Quantity supplied is Any %∆p results in the
supply 0 at prices below p. independent of the price same %∆q supplied.
Determinants of Supply Elasticity
 ES is greater:
– If the marginal cost
rises slowly as
output expands
– The longer the
period of
adjustment (time)
LO3
LO3 Exhibit 9
Supply Becomes More Elastic over Time
Sw Sm
Sw: one week after the
Sy
price increase
$1.25
Price per unit
Sm: one month after the

price increase
1.00
Sy: one year after the
price increase
0 100 110 140 200 Quantity per day
Sw is less elastic than Sm, which is less elastic than Sy
Income Elasticity
of Demand
 Demand responsiveness to a change in
consumer income
 Percentage change in demand divided by
the percentage change in income that
caused it
 Inferior goods
– Negative income elasticity
 Normal goods
– Positive income elasticity
LO4
Income Elasticity
of Demand
 Normal goods
– Income inelastic
• Elasticity between 0 and 1
• Necessities
– Income elastic
• Elasticity > 1
• Luxuries
LO4
LO4 Exhibit 10
Selected Income Elasticities of Demand
LO4 The Market for Food and ‘The Farm Problem’
 1950: 10 million family farms
 Today: less than 3 million
Case Study
 Demand
 Price inelastic
 Total revenue falls
when P falls
 Income inelastic
 D increases
 Technological improvements
 S increases
The Demand for Grain
The D for grain tends to be inelastic.
As the market P falls, so does TR.
Price per bushel
$5
1
D
LO4 0 5 10 11 Billions of bushels per year
LO4 The Effect on Increases in Demand and
Supply on Farm Revenue
S
Exhibit 11
$8 S’
Technological advance
Price per bushel
- sharp increase in S
Increase in consumer income
4 - small increase in D
Drop in P
Drop in total revenue
D’
D
0 5 10 14
Billions of bushels per year
Cross-Price Elasticity
of Demand
 Responsiveness of D for one good to

changes in P of another good
 %∆ in demand for one good divided by
%∆ in price of another good
– If positive: substitutes
– If negative: complements
– If zero: unrelated
LO4
Price Elasticity and Tax
Incidence
Appendix
 Tax
– Decrease in S by the amount of tax
 Tax incidence
– Consumers: high P
– Producers: net-of-tax receipt
Price Elasticity and Tax
Incidence
Appendix
 The more price elastic the D:

– The more tax producers pay
– The less tax consumers pay
 The more elastic the S:

– The less tax producers pay
– The more tax consumers pay
Exhibit A
Effects of Price Elasticity of D on Tax Incidence
(a) Less elastic demand (b) More elastic demand
$0.20 Tax
St St
$1.15
S $1.05 S
Price per ounce
1.00 1.00
Price per ounce

0.95 $0.20 Tax 0.85
D’
0 9 10 Millions of ounces per day 7 10
The more elastic the D curve, the more tax is paid by producers (lower net-of-tax receipt)
Exhibit B
Effects of Price Elasticity of Supply on Tax Incidence
(a) More elastic supply (b) Less elastic supply
$0.20 Tax St”

St’
S”
$1.15
S’ $1.05
1.00 1.00 $0.20 Tax
Price per ounce

Price per ounce
0.95 0.85
D’’ D’’
0 8 10 Millions of ounces per day 9 10
The more elastic the S curve, the more tax is paid by consumers as a higher price.

Econ2 Micro ch05

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Econ2 Micro ch05

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Micro

McEachern ECON 2010-2011

Amy McGuire, B-books, Ltd.

If the price of tacos drops from

demanded increases from

0 95 105 Thousands per day

 If %∆q < %∆p

 Total revenue = price *

0 100 200 500 800 900 1,000 Quantity per period

(b) Total revenue

0 500 1,000 Quantity per period

 Perfectly elastic D curve

Price per unit

0 Quantity per period 0 Q Quantity 0 60 100 Quantity

Dw: one week after the price increase

$1.25 Dm: one month after the price increase

Dy: one year after the price increase

0 50 75 95 100 Quantity per day

If the price increases from p

0 q q’ Quantity per period

 If %∆q < %∆p

 Perfectly elastic S curve

Price per unit

Price per unit

0 Quantity 0 Q Quantity 0 10 20 Quantity

Sm: one month after the

0 100 110 140 200 Quantity per day

Sw is less elastic than Sm, which is less elastic than Sy

LO4 0 5 10 11 Billions of bushels per year

 Responsiveness of D for one good to

 The more price elastic the D:

 The more elastic the S:

Price per ounce

0 9 10 Millions of ounces per day 7 10

$0.20 Tax St”

Price per ounce

0 8 10 Millions of ounces per day 9 10

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