Percentages and Elasticity

•Which of the following seem more serious:

– An increase of 50 cents or an increase of
50% in the price of a hamburger
– An increase of $100 or an increase of 1% in
the price of a new car
•Percentage changes are often more important
than the amount of change
– Therefore economists often use elasticities
to examine percentage change or
responsiveness
1
Price Elasticity
• Price Elasticity of Demand (Ep)
– The responsiveness of quantity demanded
of a commodity to changes in its price
– Related to the slope, but concerned with
percentage changes

2
Impact of a Change in Supply &
Therefore Price on the Quantity Demanded
Price (dollars per pizza)

40.00 … a S0
large An increase S1
30.00 fall in in supply
price... brings ... Large price
change and
20.00 small quantity
change
10.00
… and a small
5.00 increase in quantity
Da
0 5 10 13 15 20 25
Quantity (pizzas per hour) 3
 Impact of a Change in Supply…

An increase
Price (dollars per pizza)

40.00 in supply
S0
brings ... S1
30.00 … a small Small price
fall in price...
change and
20.00 large quantity
change
15.00
Db
10.00
… and a large
increase in quantity

0 5 10 15 17 20 25
Quantity (pizzas per hour) 4
Price Elasticity

Price Elasticity of Demand

Percentage change in quantity demanded
Ep 
Percentage change in price

%Q d
Ep 
%P
The ratio of the two percentages is a
number without units. 5
Price Elasticity
• Example
– Price of oil increases 10%
– Quantity demanded decreases 1%

-1%
Ep   .1
10 %

When calculating the price elasticity of

demand, we ignore the minus sign for
% change in Q. 6
TYPES OF ELASTICITY
Hypothetical Demand Elasticities for 4 Products
Product % Change in % Change in Elasticity
price (%P) quantity (%QD/%P)
demanded
(%QD)

Insulin + 10% 0% 0  Perfectly

inelastic
Basic
Telephone + 10%  -1% .1  Inelastic
service

Beef + 10%  -10% 1.0 

Unitarily
elastic

Bananas + 10%  -30% 3.0Elastic

7
Price Elasticity Ranges: Extreme Price Elasticities

D P1 never touches
the demand curve
Perfect
inelasticity, Perfect
P1 P1 elasticity,
zero elasticity,
infinite
no matter how
elasticity,
Price

much Price
the slightest
changes, 30
D increase
Quantity
P0 in price will
Price
stays the
lead to
same;
zero sales.
insulin

0 8 0 Quantity Demanded per Year

Quantity Demanded per Year
(millions of units) (millions of units) 8
Price Elasticity Ranges
Summary from Table

 Elastic Demand
%Q  %P; E P  1
 Unit Elastic
%Q  %P ; E P  1
 Inelastic Demand
%Q  %P; E P  1
9
Elasticity of Demand
• Calculating elasticity
Change in Q Change in P
Ep 
Sum of quantities/2 Sum of prices/2

Change in Q Change in P
or Ep 
(Q1  Q2 )/2 (P1  P2 )/2

w ay s use Q P
Al
id - p o int or Ep 
the m
la
Avg. Q Avg. P
fo rm u
10
 Calculating the Elasticity of Demand
Price (dollars/pizza)
Original
point
20.50
Q /Qave 2/10
Elasticity = = =4
P/Pave 1/20
ΔP=1 20.00 New
point
19.50
D
Quantity (pizzas/hour)
9 10 11
Qave =1/2(11+9)=10
Pave =1/2(20.50+19.50)=20 11
ΔQ=2
 Elasticity of Demand (mid-point)
Q = 2
X 100
Q Q1 + Q2 (9 + 11)
=20% = 10
2 20%
Ed = = Ed = = 4
5%
P = $1.00
X 100
P P1 + P2 ($20.50 + $19.50)
=5% = $20
2
Always use the mid-point formula for calculating elasticity
12
Changes in Elasticity Along a Linear
Demand
1.10
1.00 Elastic (EP > 1)
.90
Unit-elastic (EP = 1)
.80
Price per Minute ($)

.70 Inelastic (EP < 1)

.60
.50 Demand,
.40 or average
.30 revenue curve
.20 D
.10

0 1 2 3 4 5 6 7 8 9 10 11
Quantity per Period (billions of minutes)
13
The Relationship Between Price Elasticity of Demand and
Total Revenues for Cellular Phone Service

Quantity Total Elasticity

Price Demanded Revenue Ep

$1.10 0 0
21.000
1.00 1 1.0
.90 2 6.333
1.8
.80 3 3.400 Elastic
2.4
.70 4 2.143
2.8
.60 5 1.144
3.0
.50 6 1.000 Unit-elastic
.40 7 3.0
.692
.30 8 2.8
.467
.20 9 2.4 Inelastic
.294
.10 10 1.8
.158 14
1.0
Total Revenue and Elasticity

Total Revenue
=
Price Per Good
X
# of Goods Sold

TR = P X Q

Assumption : Costs are constant

15
 1.10 Elastic
demand
Elasticity and Total Revenue
.80
Unit

Price
elastic
.55
Inelastic
demand

0 Quantity
55 110
3.00 Maximum
total revenue
Total Revenue
(dollars)

When demand
is inelastic,
When demand is price cut decreases
elastic, price cut total revenue
increases total
revenue
Quantity
0 55 110 16
 Relationship Between Price
Elasticity of Demand and Total Revenues

Price Elasticity Effect of Price Change

of Demand on Total Revenues (TR)

Price Price
Decrease Increase

Inelastic (EP < 1) TR  TR 

Unit-elastic (EP = 1) No change  No change

Elastic (EP > 1) TR  TR 

17
Total Revenue and Elasticity

Total Revenue Test:

Estimate the price elasticity of demand by

observing the change in total revenue that
results from a change in price (ceteris
paribus).

Note that revenue is maximized when

elasticity of demand = -1.
18
Question
• 2 drivers - Tom & Jerry each drive to to a gas
station.
• Before looking at the price, each places an
order.
• Tom says, “I’d like 10 litres of gas”.
• Jerry says, “I’d like $10 of gas”.
• What is each driver’s price elasticity of
demand?

19
Determinants of
Price Elasticity of Demand

• Existence of substitutes
• The length of time allowed for
adjustment
• More specifically a good is defined
(more specific = more substitutes)
• Necessity or not
• Share of budget

20
Demand Elasticity and Time

D2 D1

D3
Price per Unit

P1

Pe As time passes, the

demand curve rotates
to D2 and then to D3
and quantity demanded
lowers first to Q1 and
then to Q2

Q3 Q2 Q1
Quantity Supplied per Period 21
Elasticity: Example
• You are the consulting economist to the Guelph
transportation commission,
• The current fare is $.80
• There are 25,000 riders per day
• For each $.01 increase (decrease) in the fare, rider
ship decreases (increases) by 500 riders per day.
• What is the price elasticity of demand at the current
fare?
• Should fares be raised or lowered?
• What fare will maximize revenue?

22
Elasticity of Supply
• Calculating elasticity

Change in Q Change in P
Ep 
Sum of quantities/2 Sum of prices/2

Change in Q Change in P
or Ep 
(Q1  Q2 )/2 (P1  P2 )/2

Q P
Alw ay s u se or Ep 
i d - point Avg. Q Avg. P
th e m a
l
formu
23
How a Change in Demand Changes Price and Quantity

An increase
in demand
40.00 brings ... Sa
Price (dollars per pizza)

Large price change and

small quantity change
30.00
20.00
… a large
price rise...
10.00
… and a small
D1
quantity increase
D0
0 5 10 13 15 20 25 24
Quantity (pizzas per hour)
How a Change in Demand Changes Price and Quantity

An increase Small price

in demand change and
Price (dollars per pizza)

40.00 brings ... large quantity

change
30.00
21.00 Sb
20.00
… a small
10.00 price rise... … and a large
quantity increase D1

D0
0 5 10 15 20 25
Quantity (pizzas per hour) 25
Elasticity of Supply
• Elasticity of supply ranges
– (from) Perfectly Elastic Supply
• Quantity supplied falls to 0 when there is
any decrease in price

– (to) Perfectly Inelastic Supply

• Quantity supplied is constant no matter
what happens to price

Notice: There is no total revenue test for supply

since price and quantity are directly related
26
 Supply Elasticity Ranges
S
Price

Elasticity of

Price
supply = 0
Elasticity of
supply = 
S
Quantity supplied is
the same for any Suppliers will offer
price! ANY quantity at this
price

0 Quantity 0 Quantity
27
 Elasticity of Supply: Depends On:
1. Resource substitution possibilities,
-The more unique the resource, the more
inelastic the supply.

2. Time frame for the supply decision,

Momentary supply
Long-run supply
Short-run supply
- The longer producers have to adjust to a price
change, the more elastic is supply.
28
Supply Elasticity and Time

S1 S2

S3
Price per Unit

P1

Pe As time passes, the

supply curve rotates
to S2 and then to S3
and quantity supplied
rises first to Q1 and
then to Q2

Qe Q1 Q2
Quantity Supplied per Period 29
Elasticity: example-Tax Burden
• Government levies a tax on a good:
– who actually pays the tax,
– what is the incidence of the tax,
• who bears the burden of the tax.

• Suppose that the tax is levied on the seller;

i.e., the seller has to pay the tax

Supply is affected
30
Explain the Effects of the Sales Tax
• A $10 sales (excise) tax per MP3 player is imposed
on the sellers of MP3 players.

• There are now two “prices” for MP3 players: an after-

tax price faced by buyers, and an after-tax price faced
by sellers.

• Will the price faced by buyers increase $10 after

introducing the sales tax? By how much?
• Will the price faced by sellers change? By how
much?
31
Sales Tax Imposed on the Sellers
Supply is affected
S + tax

110 S
Price (dollars per player)

$10 tax
105
Tax After Tax
revenue Market Price
100

95
DA

3 4 5 6
Quantity (thousands of MP3 players per week) 32
Sales Tax: Who Pays?
Tax Wedge
S + tax

110 S
Price (dollars per player)

$10 tax
After Tax
105 Market Price
Buyer pays t
100 a Original Market Price
Seller pays x
95 After Tax
Price to Seller
DA
3 4 5 6
Quantity (thousands of MP3 players per week) 33
Summary:
• Taxes discourage market activity
• Burden is shared, buyers pay more,
sellers receive less,
and

•Tax burden falls most heavily on the

side of the market that is least elastic
in its response to a price change.

34
The Sales Tax: Who Pays?
Demand Relatively Inelastic
S + tax

110 S
Price (dollars per player)

108 $10 tax

105

100
98
95
DA
3 4 5 6
Quantity (thousands of MP3 players per week) 35
The Sales Tax: Who Pays? Demand
Relatively More Elastic.
Tax Wedge S + tax

110 S
Price (dollars per player)

DA $10 tax
105
103
100 Original Market Price

95
93

3 4 5 6
Quantity (thousands of MP3 players per week) 36
Sales Tax: Who Pays When Tax
Is Imposed on the Buyer?

110 S
Price (dollars per player)

D-tax
105

$10 tax
100 Original Market Price

95
DA
3 4 5 6
Quantity (thousands of MP3 players per week) 37