Chapter

5
Elasticity

Prepared by:

Fernando & Yvonn

Quijano

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
 Elasticity 5
Chapter Outline

Price Elasticity of Demand

Slope and Elasticity
Types of Elasticity
CHAPTER 5: Elasticity

Calculating Elasticities
Calculating Percentage Changes
Elasticity Is a Ratio of Percentages
The Midpoint Formula
Elasticity Changes along a Straight-
Line
Demand Curve
Elasticity and Total Revenue
The Determinants of Demand
Elasticity
Availability of Substitutes
The Importance of Being Unimportant
The Time Dimension
Other Important Elasticities
Income Elasticity of Demand
Cross-Price Elasticity of Demand
Elasticity of Supply
Looking Ahead
Appendix: Point Elasticity

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 ELASTICITY

elasticity A general concept used to

quantify the response in one variable
when another variable changes.
CHAPTER 5: Elasticity

%A
elasticity of A with respect to B 
%B

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 PRICE ELASTICITY OF DEMAND

SLOPE AND ELASTICITY

CHAPTER 5: Elasticity

FIGURE 5.1 Slope Is Not a Useful Measure of Responsiveness

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 PRICE ELASTICITY OF DEMAND

price elasticity of demand The ratio of

the percentage of change in quantity
demanded to the percentage of change
in price; measures the responsiveness
of demand to changes in price.
CHAPTER 5: Elasticity

% change in quantity demanded

price elasticity of demand 
% change in price

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 PRICE ELASTICITY OF DEMAND

TYPES OF ELASTICITY
TABLE 5.1 Hypothetical Demand Elasticities for Four Products
% CHANGE
% CHANGE IN QUANTITY
INPRICE DEMANDED ELASTICITY
PRODUCT (% P) (% QD) (% QD ÷ %P)
CHAPTER 5: Elasticity

Insulin +10% 0% 0.0 Perfectly

inelastic
Basic telephone +10% -1% -0.1 Inelastic
service
Beef +10% -10% -1.0 Unitarily
elastic
Bananas +10% -30% -3.0 Elastic
perfectly inelastic demand Demand
in which quantity demanded does not
respond at all to a change in price.

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 PRICE ELASTICITY OF DEMAND
CHAPTER 5: Elasticity

FIGURE 5.2 Perfectly Elastic and Perfectly Inelastic Demand Curves

inelastic demand Demand that responds

somewhat, but not a great deal, to changes
in price. Inelastic demand always has a
numerical value between zero and -1.

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 PRICE ELASTICITY OF DEMAND

A warning: You must be very careful about signs. Because it is generally understood
that demand elasticities are negative (demand curves have a negative slope), they are
often reported and discussed without the negative sign. For example, a technical paper
might report that the demand for housing “appears to be inelastic with respect to price,
or less than 1 (0.6).” What the writer means is that the estimated elasticity is -.6, which
is between zero and -1. Its absolute value is less than 1.
CHAPTER 5: Elasticity

unitary elasticity A demand

relationship in which the
percentage change in quantity of
a product demanded is the same
as the percentage change in price
in absolute value (a demand
elasticity of -1).

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 PRICE ELASTICITY OF DEMAND

elastic demand A demand relationship

in which the percentage change in
quantity demanded is larger in
absolute value than the percentage
change in price (a demand elasticity
with an absolute value greater than 1).
CHAPTER 5: Elasticity

perfectly elastic demand Demand in

which quantity drops to zero at the
slightest increase in price.

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 PRICE ELASTICITY OF DEMAND

A good way to remember the difference

between the two “perfect” elasticities is:
CHAPTER 5: Elasticity

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 CALCULATING ELASTICITIES

CALCULATING PERCENTAGE CHANGES

To calculate percentage change in quantity

demanded using the initial value as the base,
the following formula is used:
CHAPTER 5: Elasticity

change in quantity demanded

% change in quantity demanded  x 100%
Q1

Q2 - Q1
 x 100%
Q1

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 CALCULATING ELASTICITIES

We can calculate the percentage change in price in a

similar way. Once again, let us use the initial value of
P—that is, P1—as the base for calculating the
percentage. By using P1 as the base, the formula for
calculating the percentage of change in P is simply:
CHAPTER 5: Elasticity

change in price
% change in price  x 100%
P1

P2 - P1
 x 100%
P1

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 CALCULATING ELASTICITIES

ELASTICITY IS A RATIO OF PERCENTAGES

Once all the changes in quantity demanded and

price have been converted into percentages,
calculating elasticity is a matter of simple division.
CHAPTER 5: Elasticity

Recall the formal definition of elasticity:

% change in quantity demanded

price elasticity of demand 
% change in price

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 CALCULATING ELASTICITIES

THE MIDPOINT FORMULA

midpoint formula A more precise way of
calculating percentages using the value
halfway between P1 and P2 for the base in
calculating the percentage change in
CHAPTER 5: Elasticity

price, and the value halfway between Q1

and Q2 as the base for calculating the
percentage
change in quantity demanded.

change in quantity demanded

% change in quantity demanded  x 100%
(Q1  Q2 ) / 2

Q2 - Q1
 x 100%
(Q1  Q2 ) / 2

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 CALCULATING ELASTICITIES

Using the point halfway between P1 and P2 as the

base for calculating the percentage change in price,
we get

change in price
% change in price  x 100%
CHAPTER 5: Elasticity

( P1  P2 ) / 2

P2 - P1
 x 100%
( P1  P2 ) / 2

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 CALCULATING ELASTICITIES

TABLE 5.2 Calculating Price Elasticity with the Midpoint Formula

First, Calculate Percentage Change in Quantity Demanded (%QD):
change in quantity demanded Q2 - Q1
% change in quantity demanded  x 100%  x 100%
(Q1  Q2 ) / 2 (Q1  Q2 ) / 2

By substituting the numbers from Figure 5.1(a): PRICE ELASTICITY COMPARES

THE PERCENTAGE CHANGE IN
10  5 5 QUANTITY DEMANDED AND THE
% change in quantity demanded  x 100%  x 100%  66.7%
CHAPTER 5: Elasticity

(5  10) / 2 7.5 PERCENTAGE CHANGE IN PRICE:

%QD 66.7%

Next, Calculate Percentage Change in Price (%P): %P - 40.0%
 1.67
change in price P2 - P1  PRICE ELASTICITY OF DEMAND
% change in price  x 100%  x 100%
( P1  P2 ) / 2 ( P1  P2 ) / 2 DEMAND IS ELASTIC

By substituting the numbers from Figure 5.1(a):

23 -1
% change in price  x 100%  x 100%  - 40.0%
(3  2) / 2 2.5

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 CALCULATING ELASTICITIES
ELASTICITY CHANGES ALONG A
STRAIGHT-LINE DEMAND CURVE

TABLE 5.3 Demand Schedule for

Office Dining Room
Lunches
PRICE QUANTITY
CHAPTER 5: Elasticity

(PER DEMANDED
LUNCH) (LUNCHES PER
MONTH)
$11 0
10 2
9 4
8 6
7 8
6 10
5 12
4 14
3 16
FIGURE 5.3 Demand Curve for
2 18 Lunch at the Office Dining Room
1 20
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 CALCULATING ELASTICITIES

ELASTICITY AND TOTAL REVENUE

In any market, P x Q is total revenue (TR)
received by producers:

TR = P x Q
CHAPTER 5: Elasticity

total revenue = price x quantity

When price (P) declines, quantity demanded (QD)

increases. The two factors, P and QD, move in
opposite directions:

Effects of price changes P  QD 

on quantity demanded: and
P  QD 

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 CALCULATING ELASTICITIES

Because total revenue is the product of P and Q,

whether TR rises or falls in response to a price
increase depends on which is bigger, the percentage
increase in price or the percentage decrease in
quantity demanded.

Effects of price increase on

a product with inelastic demand:  P x QD   TR 
CHAPTER 5: Elasticity

If the percentage decline in quantity demanded

following a price increase is larger than the
percentage increase in price, total revenue will fall.

Effects of price increase on

a product with inelastic demand:  P x QD   TR 

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 CALCULATING ELASTICITIES

The opposite is true for a price cut. When demand is

elastic, a cut in price increases total revenues:

effect of price cut on a product

with elastic demand:  P x QD   TR 
CHAPTER 5: Elasticity

When demand is inelastic, a cut in price

reduces total revenues:

effect of price cut on a product

with inelastic demand:  P x QD   TR 

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 THE DETERMINANTS OF DEMAND
ELASTICITY

AVAILABILITY OF SUBSTITUTES
Perhaps the most obvious factor affecting demand
elasticity is the availability of substitutes.

THE IMPORTANCE OF BEING UNIMPORTANT

CHAPTER 5: Elasticity

When an item represents a relatively small part of our

total budget, we tend to pay little attention to its price.

THE TIME DIMENSION

The elasticity of demand in the short run may be very different from the elasticity of
demand in the long run. In the longer run, demand is likely to become more elastic, or
responsive, simply because households make adjustments over time and producers
develop substitute goods.

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 OTHER IMPORTANT ELASTICITIES

INCOME ELASTICITY OF DEMAND

income elasticity of demand

Measures the responsiveness of
demand to changes in income.
CHAPTER 5: Elasticity

% change in quantity demanded

income elasticity of demand 
% change in income

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 OTHER IMPORTANT ELASTICITIES

CROSS-PRICE ELASTICITY OF DEMAND

cross-price elasticity of demand A

measure of the response of the
quantity of one good demanded to a
CHAPTER 5: Elasticity

change in the price of another good.

% change in quantity of Y demanded

cross - price elasticity of demand 
% change in price of X

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 OTHER IMPORTANT ELASTICITIES

ELASTICITY OF SUPPLY

elasticity of supply A measure of the

response of quantity of a good supplied
to a change in price of that good. Likely
to be positive in output markets.
CHAPTER 5: Elasticity

% change in quantity supplied

elasticity of supply 
% change in price

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 OTHER IMPORTANT ELASTICITIES

elasticity of labor supply A measure of the

response of labor supplied to a change in
the price of labor.
CHAPTER 5: Elasticity

% change in quantity of labor supplied

elasticity of labor supply 
% change in the wage rate

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 REVIEW TERMS AND CONCEPTS

cross-price inelastic demand

elasticity of midpoint formula
demand perfectly elastic
CHAPTER 5: Elasticity

elastic demand demand

elasticity perfectly
elasticity of labor
inelastic
supply
demand
elasticity of supply
price elasticity
income elasticity
of demand
of demand
unitary elasticity

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 Appendix

POINT ELASTICITY (OPTIONAL)

FIGURE 5A.1 Elasticity at

a Point Along a Demand Curve
CHAPTER 5: Elasticity

Consider the straight-line

demand curve in Figure
5A.1. We can write an
expression for elasticity at
point C as follows:

Q Q
 100
%Q Q Q1 Q P1
elasticity     
%P P P P Q1
 100
P P1
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 Appendix

Q/P is the reciprocal of the slope of the curve. To

calculate the reciprocal of the slope to plug into the
electricity equation, we take Q1B, or M1, and divide
by minus the length of line segment CQ1. Thus,
Q M 1

P CQ1
CHAPTER 5: Elasticity

Since the length of CQ1 is equal to P1, we can write:

Q M 1

P P1
By substituting we get:
M 1 P1 M 1 P1 M1
elasticity     
P1 Q1 P1 M 2 M 2
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 Appendix

FIGURE 5A.2 Point Elasticity

Changes
Along a Demand Curve
CHAPTER 5: Elasticity

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