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Chapter 6Elasticity
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
6-2
Price Elasticity of Demand
• Measures buyers’ responsiveness to price changes
• Elastic demand• Sensitive to price changes• Large change in quantity
• Inelastic demand• Insensitive to price changes• Small change in quantity
LO1
6-3
Ed =
Price Elasticity of Demand Formula
• Formula for price elasticity of demand
percentage change in quantitydemanded of product X
percentage change in priceof product X
LO1
6-4
Price Elasticity of Demand Formula
• Use the midpoint formula• Ensures consistent results
Ed = ÷Change in quantity
Sum of quantities/2
Change in price
Sum of prices/2
LO1
6-5
Price Elasticity of Demand Formula
• Use percentages• Unit free measure• Compare elasticities across products
• Eliminate the minus sign• Easier to compare elasticities
LO1
6-6
Interpretation of Elasticity of Demand
• Ed > 1 demand is elastic
• Ed = 1 demand is unit elastic
• Ed < 1 demand is inelastic
• Extreme cases
• Ed = 0 demand is perfectly inelastic
• Ed = ∞ demand is perfectly elastic
LO1
6-9
Total Revenue Test
• Total Revenue = Price X Quantity• Total Revenue Test• Inelastic demand
• P and TR move in the same direction• Elastic demand
• P and TR move in opposite directions
LO2
6-10
Total Revenue Test
• Lower price and elastic demand• Blue gain exceeds orange loss
$3
2
1
0 10 20 30 40 Q
P
a
bD1
LO2
6-11
Total Revenue Test
• Lower price and inelastic demand• Orange loss exceeds blue gain
$4
3
2
1
0 10 20 Q
P
c
d
D2
LO2
6-12
Total Revenue Test
• Lower price and unit elastic demand• Blue gain equals orange loss
$3
2
1
0 10 20 30 Q
P
e
f
D3
LO2
6-13
Total Revenue Test
(1)Total Quantity of
Tickets Demandedper Week, Thousands
(2)Price per Ticket
(3)Elasticity
Coefficient (Ed)
(4)Total Revenue
(1) X (2)
(5)Total-Revenue
Test
12345678
$87654321
5.002.601.571.000.640.380.20
$ 8,00014,00018,00020,00020,00018,00014,000
8,000
ElasticElasticElastic
Unit-elasticInelasticInelasticInelastic
]]]]]]]
]]]]]]]
Price Elasticity of Demand for Movie Tickets as Measured by the Elasticity Coefficient and the Total Revenue Test
LO2
6-14
Elasticity and Total Revenue
0 1 2 3 4 5 6 7 8
0 1 2 3 4 5 6 7 8
Quantity demanded
Quantity demanded
Pric
eTo
tal r
even
ue(T
hous
ands
of d
olla
rs) $20
18161412108642
$87654321
a
bc
de
fg
h
ElasticEd > 1
Unit elasticEd = 1
InelasticEd < 1
D
TR
LO2
6-15
Summary of Price Elasticity of Demand
Price Elasticity of Demand: A Summary
Absolute Value of Elasticity Coefficient Demand Is: Description
Impact on Total Revenue of a:
Price Increase Price Decrease
Greater than 1(Ed > 1)
Elastic or relatively elastic
Qd changes by a larger percentage than does price
Total Revenue decreases
Total Revenue increases
Equal to 1(Ed = 1)
Unit or unitary elastic
Qd changes by the same percentage as does price
Total revenue is unchanged
Total revenue is unchanged
Less than 1(Ed < 1)
Inelastic or relatively inelastic
Qd changes by a smaller percentage than does price
Total revenue increases
Total revenue decreases
6-16
Determinants of Price Elasticity of Demand
• Substitutability• More substitutes, demand is more elastic
• Proportion of income• Higher proportion of income, demand is
more elastic
LO3
6-17
Determinants of Price Elasticity of Demand
• Luxuries versus necessities• Luxury goods, demand is more elastic
• Time • More time available, demand is more
elastic
LO3
6-18
Price Elasticity of DemandSelected Price Elasticities of Demand
Product or ServicePrice Elasticity of
Demand (Ed) Product or ServicePrice Elasticity of
Demand (Ed)
Newspapers .10 Milk .63
Electricity (household) .13 Household appliances .63
Bread .15 Liquor .70
MLB Tickets .23 Movies .87
Telephone Service .26 Beer .90
Cigarettes .25 Shoes .91
Sugar .30 Motor vehicles 1.14
Medical Care .31 Beef 1.27
Eggs .32 China, glassware 1.54
Legal Services .37 Residential land 1.60
Automobile repair .40 Restaurant meals 2.27
Clothing .49 Lamb and mutton 2.65
Gasoline .60 Fresh peas 2.83
6-19
Applications of Price Elasticity of Demand
• Large crop yields• Inelastic demand, lower total revenue
• Excise taxes• Inelastic demand, more total revenue
• Decriminalization of illegal drugs• Inelastic demand, more total revenue
LO3
6-20
Price Elasticity of Supply
• Measures sellers’ responsiveness to price changes
• Elastic supply, producers are responsive to price changes
• Inelastic supply, producers are not as responsive to price changes
LO4
6-21
Price Elasticity of Supply
• Formula for price elasticity of supply
LO4
percentage change in quantitysupplied of Product X
percentage change in priceof product X
Es =
6-22
Price Elasticity of Supply
• Es > 1 supply is elastic
• Es = 1 supply is unit elastic
• Es < 1 supply is inelastic
• Additionally,
• Es = 0 supply is perfectly inelastic
LO4
6-23
Price Elasticity of Supply
• Time is primary determinant of elasticity of supply
• Time periods considered• Immediate market period• Short run• Long run
LO4
6-25
The Short Run
• Short run supply is more elastic than in the immediate market period
D1
D2
Ss
Q0
Ps
P0
QsLO4
6-26
The Long Run
• Long run supply is even more elastic than in the short run
LO4
D1
D2
SL
Q0
Pl
P0
Ql
6-27
Applications of Elasticity of Supply
• Antiques• Inelastic supply
• Reproductions• More elastic supply
• Volatile gold prices• Inelastic supply
LO4
6-28
Cross Elasticity of Demand
• Formula for cross elasticity of demand
Ex,y =
percentage change in quantity
demanded of product X
percentage change in priceof product Y
LO5
6-29
Cross Elasticity of Demand
• Measures responsiveness of purchases of one good to change in the price of another good
• Substitute goods if elasticity is positive• Complement goods if elasticity is negative• Independent goods if elasticity is 0
LO5
6-30
Cross Elasticity of Demand
• Applications of cross elasticity of demand• Should a company change a price?• Should the government allow a merger?
LO5
6-31
Income Elasticity of Demand
• Formula for income elasticity of demand
LO5
Ei =percentage change in quantity demanded
percentage change in income
6-32
Income Elasticity of Demand
• Measures responsiveness of buyers to changes in their income
• Normal goods if elasticity is positive• Inferior goods if elasticity is negative
LO5
6-33
Income Elasticity Insights
• High income elasticities• Most affected by a recession
• Low or negative income elasticity• Not affected that much by a recession
LO5
6-34
Cross and Income Elasticit iesCross and Income Elasticities of Demand
Value of Coefficient Description Type of Good(s)
Cross elasticity: Positive (Ewz > 0)
Negative (Exy < 0)
Quantity demanded of W changes in same direction as change in price of Z
Quantity demanded of X changes in opposite direction from change in price of Y
Substitutes
Complements
Income elasticity: Positive (Ei >0)
Negative (Ei<0)
Quantity demanded of the product changes in same direction as change in income
Quantity demanded of the product changes in opposite direction from change in income
Normal or superior
Inferior
LO5