Elasticity and its Application

Lets say price of laptops increase.

What will happen to the demand
of laptops?
By how much the demand for
laptops will change?
What is elasticity?
• Elasticity a measure of the responsiveness of quantity demanded or
quantity supplied to a change in one of its determinants
• Price elasticity: a measure of how much the quantity demanded of a
good responds to a change in the price of that good
• Income elasticity: a measure of how much the quantity demanded of
a good responds to a change in consumers’ income
• Cross price elasticity of demand: a measure of how much the
quantity demanded of one good responds to a change in the price of
another good
Determine the price elasticity with
• Availability of Close Substitutes
• Necessities versus Luxuries
• Definition of the Market
• Time horizon
Computing the Price Elasticity of Demand
Calculating Price Elasticity of Demand
• Price elasticity can be calculated by multiplying the slope of demand
(Q/P) times the ratio of price to quantity (P/Q)
Calculate the elasticities from point A to point
B and from point B to point A
• Point A: Price= 4 units Quantity=120
• Point B: Price=6 units Quantity=80
• Elasticity A to B
• Elasticity B to A
• Different elasticities because of different base
• Mid point theorem
• Elasticity
The Variety of Demand Curves
The Variety of Demand Curves
The Variety of Demand Curves
Total Revenue and the Price Elasticity of
Demand

Total Revenue: The

amount paid by
buyers and received
by sellers of a good,
computed as the
price of the good
times the quantity
sold
How Total Revenue Changes When Price
Changes
Elasticity of a Linear Demand Curve

• Even though the slope of a linear

demand curve is constant, the elasticity is
not.

• This is true because the slope is the ratio

of changes in the two variables

• Whereas the elasticity is the ratio of

percentage changes in the two variables.

• At points with a low price and high

quantity, the demand curve is inelastic.

• At points with a high price and low

quantity, the demand curve is elastic.
Practical Questions
• Does Drug Interdiction Increase or Decrease Drug-Related Crime?
• Can good news for farming be bad news for farmers?
• Why did OPEC fail to keep the price of oil high?
Does Drug Interdiction Increase or
Decrease Drug-Related Crime?
Can good news for farming be bad news
for farmers?
When an advance in farm
technology increases the
supply of wheat from S1 to
S2, the price of wheat falls.
Because the demand for
wheat is inelastic, the
increase in the quantity sold
from 100 to 110 is
proportionately smaller than
the decrease in the price from
$3 to $2. As a result, farmers’
total revenue falls from $300
($3 × 100) to $220 ($2 × 110).
 Engel Curve
• Engel curve: Curve relating the quantity of a good consumed to income.

3000

Income (Rs. Per

3000
Income (Rs. Per

2000
2000

month)
month)

1000
1000

Positively sloped for Inversely sloped for

normal goods inferior goods
0
0 4 8 12 16 Food (units per
4 8 12 16 Food (units per
month) month)
Question
• Suppose the demand curve for a product is given by Q = 10 - 2P + P S where P is the
price of the product and PS is the price of a substitute good. The price of the
substitute good is $2.00.
• a. Suppose P = $1.00. What is the price elasticity of demand? What is the cross-price
elasticity of demand?

• b. Suppose the price of the good, P, goes to $2.00. Now what is the price elasticity of
demand? What is the cross-price elasticity of demand?
• Solution
• a. P=1, Q=10 and slope=-2, Price elasticity of demand= -0.2
• b. Price elasticity of demand=-0.5
• Rice is traded in a competitive world market, and the world price is Rs. 900 per kg.
Unlimited quantities are available for import into India at this price. India’s domestic
demand and supply for various price level are shown as follows:

• What is the equation for demand? What is the equation for supply?
• At a price of Rs. 900, what is the price elasticity of demand? What is the price
elasticity at a price of Rs. 1200?
• What is the price elasticity of supply at Rs. 900 and Rs. 1200?
• In a free market, what will be the Indian price and level of rice imports?
Price (Rs.) India’s Supply (thousand kgs) India’s Demand (thousand
kgs)
300 2 34
600 4 28
900 6 22
1200 8 16
1500 10 10
1800 12 4