Ch. 4 Elasticity: Price Elasticity of Demand

Ch.
4 Elasticity
Price Elasticity of Demand
Demand is said to be elastic when quantity demanded is quite
responsive to changes in price.
When quantity demanded is relatively unresponsive to changes in
price, demand is said to be inelastic.
The price elasticity of demand the measure of responsiveness of the

quantity of a product demanded to a change in that product’s price
d=Percentage change in quantity demanded
Percentage change in price
Percentage change in quantity demanded= (Q2-Q1)
(Q2+Q1)/2
Percentage change in price= (P2-P1)
(P2+P1)/2
Determining Elasticity of Demand:-

1. Availability of Substitutes- Products with close substitutes tend
to have elastic demands; products with no close substitutes
tend to have inelastic demands. Narrowly defined products
have more elastic demands than do more broadly defined
products.
2. Product in Consumers’ Budgets- Other things being equal,
demand for items that represent a small fraction of consumers’
budgets tend to be less elastic than the demand for items that
represent a larger fraction of consumers’ budgets.
3. Short Run and Long Run-The response to a price change, and
thus the measured price elasticity of demand, will tend to be
greater the longer the time span.
A short-run demand curve shows the immediate response of
quantity demanded to a change in price.
The long-run demand curve shows the response of quantity
demanded to a change in price after enough time has passed to
develop or switch to substitute products.
Summary:-
1. d=0, Perfectly inelastic- Quantity demanded does not change
as the price changes. Demand curve is vertical.
2. d<1, Inelastic- The percentage change in quantity demanded
is smaller than the percentage change in price.
3. d=1, Unit elastic- The percentage change in quantity
demanded is equal to the percentage change in price.
4. d>1, Elastic- The percentage change in quantity demanded is
larger than the percentage change in price.
5. d= infinity, Perfectly elastic, Buyers are prepared to buy all
they can at the given price. Demand curve is horizontal.
Elasticity & Total Expenditure

Total Expenditure= Price X Quantity
As an example, consider a price decline of 10 percent. If quantity

demanded rises by more than 10 percent (elastic demand), then the
quantity change will dominate, and total expenditure will rise. In
contrast, if quantity demanded increases by less than 10 percent
(inelastic demand), then the price change will dominate, and total
expenditure will fall. If quantity demanded increases by exactly 10
percent (unit elastic demand), then the two percentage changes
exactly offset each other, and total expenditure will remain
unchanged.
Price Elasticity of Supply
Price elasticity of supply measures the responsiveness of the quantity

supplied to a change in the product’s price.
s=Percentage change in quantity supplied
Percentage change in price
Percentage change in quantity supplied= (Q2-Q1)
(Q2+Q1)/2
Percentage change in price= (P2-P1)
(P2+P1)/2
Determining the Supply elasticity:-

1. Ease of Substitution- This depends in part on how easy it is for
producers to shift from the production of other products to the
one whose price has risen. If it is easy to shift, then it is more
elastic otherwise it is less elastic.
2. Short Run and Long Run- The short-run supply curve shows the
immediate response of quantity supplied to a change in price
given producers’ current capacity to produce the good.
The long-run supply curve shows the response of quantity
supplied to a change in price after enough time has passed to
allow producers to adjust their productive capacity.
The long-run supply for a product is more elastic than the
short-run supply.
Summary:-
1. s=0, Perfectly inelastic- Quantity supplied does not change as
the price changes. Supply curve is vertical.
2. s<1, Inelastic- The percentage change in quantity supplied is
smaller than the percentage change in price.
3. s=1, Unit elastic- The percentage change in quantity supplied
is equal to the percentage change in price.
4. s>1, Elastic- The percentage change in quantity supplied is
larger than the percentage change in price.
5. s= infinity, Perfectly elastic, Sellers are prepared to sell all they
can at the given price. Supply curve is horizontal.
Elasticity Matters for Excise Taxes
The burden of an excise tax is distributed between consumers and

sellers in a manner that depends on the relative elasticities of supply
and demand.
Note also that the quantity demanded at the consumer price is equal
to the quantity supplied at the seller price, a condition that is
required for equilibrium.
After the imposition of an excise tax, the difference between the

consumer and seller prices is equal to the tax. In the new
equilibrium, the quantity exchanged is less than what occured
without the tax.
When demand is inelastic relative to supply, consumers bear most of

the burden of excise taxes. When supply is inelastic relative to
demand, producers bear most of the burden.
Income Elasticity of Demand

The responsiveness of demand to changes in income is termed the
income elasticity of demand.
Y=Percentage change in quantity demanded
Percentage change in income
For most goods, an increase in income leads to an increase in
quantity demanded—their income elasticity is positive. These are
called normal goods
For some goods, however, an increase in income leads to a decrease
in quantity demanded—their income elasticity is negative. These are
called inferior goods.
Having positive income elasticities less than 1 (so an increase in
income of 10 percent leads to an increase in quantity demanded of
less than 10 percent). Such goods are often called necessities.
Having positive income elasticities greater than 1 (so an increase in
income of 10 percent leads to an increase in quantity demanded of
more than 10 percent). These products are often called luxuries
Inferior goods have a negative income elasticity because an increase

in income leads to a reduction in quantity demanded.
Summary:-
1. Y<0, Inferior good- An increase in income leads to a reduction
in quantity demanded.
2. Y>0, Normal good (income inelastic) (necessity)- The
percentage change in quantity demanded is smaller than the
percentage change in income.
3. Y>1, Normal good (income elastic) (luxury)- The percentage
change in quantity demanded is larger than the percentage
change in income.
Cross Elasticity of Demand

The responsiveness of quantity demanded to changes in the price of
another product is called the cross elasticity of demand.
XY=Percentage change in quantity demanded of good X
Percentage change in price of good Y
The change in the price of good Y causes the demand curve for good
X to shift. If X and Y are substitutes, an increase in the price of Y leads
to an increase in the demand for X. If X and Y are complements, an
increase in the price of Y leads to a reduction in demand for X.
Cross elasticity can vary from minus infinity to plus infinity.
Summary:-
1. XY<0, Complements- When the price of one good rises, the
quantity demanded of the other good falls.
2. XY>0, Substitutes- When the price of one good rises, the
quantity demanded of the other good increases.

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Ch.

The price elasticity of demand the measure of responsiveness of the

Determining Elasticity of Demand:-

Elasticity & Total Expenditure

As an example, consider a price decline of 10 percent. If quantity

Price Elasticity of Supply

Price elasticity of supply measures the responsiveness of the quantity

Determining the Supply elasticity:-

The burden of an excise tax is distributed between consumers and

After the imposition of an excise tax, the difference between the

When demand is inelastic relative to supply, consumers bear most of

Income Elasticity of Demand

Inferior goods have a negative income elasticity because an increase

Cross Elasticity of Demand

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