Elasticity of Demand and Supply

Micro
ECON 2019-2020
Elasticity of
Demand and Supply
Designed by Reported by:
Amy McGuire, B-books, Ltd. JOEMAR R. RAMOS MAED-TSS 1
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 1
PRICE ELASTICITY OF DEMAND
Think About It...
THE LAW OF DEMAND SAYS...
Consumers will buy more when prices
go down and less when prices go up
HOW MUCH MORE OR LESS?
DOES IT MATTER?
to whom?
Price Elasticity Provides an Answer
Price Elasticity of Demand
 Elasticity
– Responsiveness
 Price elasticity of demand
– Consumers’
responsiveness to a
change in price
– Percentage change in
quantity demanded
divided by percentage
change in price
LO1
Price Elasticity of Demand
%q
ED 
%p
q p
ED  
(q  q' ) / 2 ( p  p' ) / 2
 Law of demand
 ED negative
 Absolute value of ED positive
LO1
LO1 Demand Curve for Tacos
If the price of tacos drops from

$1.10 to $0.90, the quantity
Exhibit 1
demanded increases from

$1.10 a
95,000 to 105,000.
Price per taco
b
0.90
0 95 105 Thousands per day
Categories of ED
 If %∆q < %∆p

– ED between 0 and 1
– Inelastic D
 If %∆q > %∆p
– ED greater than 1
– Elastic D
 If %∆q = %∆p
– ED = 1
– Unit elastic D
LO1
Elasticity and Total Revenue
 Total revenue = price *

quantity demanded at
this price
 TR= p * q
 As p decreases
 If D elastic,
TR increases
 If D inelastic,
TR decreases
 If D unit elastic,
TR unchanged
LO1
Price Elasticity and the
Linear D Curve
 Linear D curve
– Constant slope
– Different elasticity
– D becomes less elastic as we move
downward
 D upper half: elastic
 D lower half: inelastic
 D midpoint: unit elastic
LO1
LO1 Exhibit 2
$100
90
(a) Demand and price elasticity Demand, Price
Elasticity, and
Price per unit
a Elastic, ED >1
80
b
Total Revenue
70
60 Unit elastic, ED =1
50
40 c Inelastic, ED <1 Where D is elastic, a
30 lower P increases TR
20
d Where D is inelastic, a
10 e D lower P decreases TR
0 100 200 500 800 900 1,000 Quantity per period
(b) Total revenue

$25,000
TR reaches a
Total revenue
Total
maximum at the rate
revenue of output where D is
unit elastic
0 500 1,000 Quantity per period

Constant-Elasticity
Demand Curves
 Perfectly elastic D curve

– Horizontal; ED = ∞
– Consumers don’t tolerate P increases
 Perfectly inelastic D curve
– Vertical; ED = 0
– ‘Price is no object’
 Unit-elastic D curve
– %∆p causes an exact opposite %∆q
LO1
LO1 Exhibit 3
Constant-Elasticity Demand Curves
(a) Perfectly elastic (b) Perfectly inelastic (c) Unit elastic
D’
Price per unit

Price per unit
Price per unit
ED ’’ = 1
ED’’ = 0
ED = ∞ $10 a
p D
b
6
D’’
0 Quantity per period 0 Q Quantity 0 60 100 Quantity

per period per period
Consumers demand all quantity
offered for sale at p, but demand Consumers demand Q Total revenue is the same
nothing at a price above p regardless of price for each p-q combination
LO1 Exhibit 4
Summary of Price Elasticity of Demand
Effects of a 10 Percent Increase in Price
Determinants of Price
Elasticity of D
 ED is greater:
– The greater the availability of substitutes,
and the more similar the substitutes
– The more important the good as a share of
the consumer’s budget
– The longer the period of adjustment (time)
LO2
LO2 Exhibit 5
Demand Becomes More Elastic over Time
Dw: one week after the price increase

Price per unit
$1.25 Dm: one month after the price increase
Dy: one year after the price increase

1.00 e
Dy
Dw Dm
0 50 75 95 100 Quantity per day

Dy is more elastic than Dm , which is more elastic than Dw
Elasticity Estimates
 Short run
– Consumers have little time to adjust
 Long run
– Consumers can fully adjust to a price change
 Demand is more elastic in the long run
LO2
LO2 Selected Price Elasticities of
Demand (Absolute Values)
Exhibit 6
LO2 Deterring Young Smokers
 Health hazard
 Kills 440,000 Americans a year
Case Study
 Lung cancer; Heart disease;
Emphysema; Stroke
 Cost to society
 $7.18 per pack sold
 Higher health cost
 Lost worker
productivity
 Total: $150 billion a year
 $3,400 per smoker
per year
LO2 Deterring Young Smokers
 Discouraging smoking
 Prohibit the sale of cigarettes to minors
Case Study
 Higher cigarette tax
 ED is higher for teens
 Big share of budget
 Less peer pressure
 Not an addiction yet
 Reduces teen smoking
 Change consumer tastes
Price Elasticity of Supply
 Elasticity
– Responsiveness
 Price elasticity of supply
– Producers’ responsiveness to a change
in price
– Percentage change in quantity supplied
divided by percentage change in price
LO3
%q
ES 
%p
q p
ES  
(q  q' ) / 2 ( p  p' ) / 2
 Law of supply
 ES positive
LO3
LO3 Exhibit 7
S
Price per unit
If the price increases from p

p’ to p’, the quantity supplied
increases from q to q’.
Price and quantity supplied
p move in the same direction,
so the price elasticity of
supply is a positive number.
0 q q’ Quantity per period
Categories of ES
 If %∆q < %∆p

– ES between 0 and 1
– Inelastic S
 If %∆q > %∆p
– ES greater than 1
– Elastic S
 If %∆q = %∆p
– ES = 1
LO3 – Unit elastic S
Constant-Elasticity Supply Curves
 Perfectly elastic S curve

– Horizontal; ES = ∞
– Producers supply 0 at a price below P
 Perfectly inelastic S curve
– Vertical; ES = 0
– Goods in fixed supply
 Unit-elastic S curve
– %∆p causes an exact opposite %∆q
LO3 – S curve is a ray from the origin
LO3 Exhibit 8
Constant-Elasticity Supply Curves
(a) Perfectly elastic (b) Perfectly inelastic (c) Unit elastic
Price per unit

S’
Price per unit

Price per unit
S’’
ES’’ = 1
ES’ = 0
ES = ∞ $10
p S
5
0 Quantity 0 Q Quantity 0 10 20 Quantity

per period per period per period
Firms supply any amount of
output demanded at p, but Quantity supplied is Any %∆p results in the
supply 0 at prices below p. independent of the price same %∆q supplied.
Determinants of Supply Elasticity
 ES is greater:
– If the marginal cost
rises slowly as
output expands
– The longer the
period of
adjustment (time)
LO3
LO3 Exhibit 9
Supply Becomes More Elastic over Time
Sw Sm
Sw: one week after the
Sy
price increase
$1.25
Price per unit
Sm: one month after the

price increase
1.00
Sy: one year after the
price increase
0 100 110 140 200 Quantity per day
Sw is less elastic than Sm, which is less elastic than Sy
Income Elasticity
of Demand
 Demand responsiveness to a change in
consumer income
 Percentage change in demand divided by
the percentage change in income that
caused it
 Inferior goods
– Negative income elasticity
 Normal goods
– Positive income elasticity
LO4
Income Elasticity
of Demand
 Normal goods
– Income inelastic
• Elasticity between 0 and 1
• Necessities
– Income elastic
• Elasticity > 1
• Luxuries
LO4
LO4 Exhibit 10
Selected Income Elasticities of Demand
LO4 The Market for Food and ‘The Farm Problem’
 1950: 10 million family farms
 Today: less than 3 million
Case Study
 Demand
 Price inelastic
 Total revenue falls
when P falls
 Income inelastic
 D increases
 Technological improvements
 S increases
The Demand for Grain
The D for grain tends to be inelastic.
As the market P falls, so does TR.
Price per bushel
$5
1
D
LO4 0 5 10 11 Billions of bushels per year
LO4 The Effect on Increases in Demand and
Supply on Farm Revenue
S
Exhibit 11
$8 S’
Technological advance
Price per bushel
- sharp increase in S
Increase in consumer income
4 - small increase in D
Drop in P
Drop in total revenue
D’
D
0 5 10 14
Billions of bushels per year
Cross-Price Elasticity
of Demand
 Responsiveness of D for one good to

changes in P of another good
 %∆ in demand for one good divided by
%∆ in price of another good
– If positive: substitutes
– If negative: complements
– If zero: unrelated
LO4
Price Elasticity and Tax
Incidence
Appendix
 Tax
– Decrease in S by the amount of tax
 Tax incidence
– Consumers: high P
– Producers: net-of-tax receipt
Price Elasticity and Tax
Incidence
Appendix
 The more price elastic the D:

– The more tax producers pay
– The less tax consumers pay
 The more elastic the S:

– The less tax producers pay
– The more tax consumers pay
Exhibit A
Effects of Price Elasticity of D on Tax Incidence
(a) Less elastic demand (b) More elastic demand
$0.20 Tax
St St
$1.15
S $1.05 S
Price per ounce
1.00 1.00
Price per ounce

0.95 $0.20 Tax 0.85
D’
0 9 10 Millions of ounces per day 7 10
The more elastic the D curve, the more tax is paid by producers (lower net-of-tax receipt)
Exhibit B
Effects of Price Elasticity of Supply on Tax Incidence
(a) More elastic supply (b) Less elastic supply
$0.20 Tax St”

St’
S”
$1.15
S’ $1.05
1.00 1.00 $0.20 Tax
Price per ounce

Price per ounce
0.95 0.85
D’’ D’’
0 8 10 Millions of ounces per day 9 10
The more elastic the S curve, the more tax is paid by consumers as a higher price.

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Micro

If the price of tacos drops from

demanded increases from

0 95 105 Thousands per day

 If %∆q < %∆p

 Total revenue = price *

0 100 200 500 800 900 1,000 Quantity per period

(b) Total revenue

0 500 1,000 Quantity per period

 Perfectly elastic D curve

Price per unit

0 Quantity per period 0 Q Quantity 0 60 100 Quantity

Dw: one week after the price increase

$1.25 Dm: one month after the price increase

Dy: one year after the price increase

0 50 75 95 100 Quantity per day

If the price increases from p

0 q q’ Quantity per period

 If %∆q < %∆p

 Perfectly elastic S curve

Price per unit

Price per unit

0 Quantity 0 Q Quantity 0 10 20 Quantity

Sm: one month after the

0 100 110 140 200 Quantity per day

Sw is less elastic than Sm, which is less elastic than Sy

LO4 0 5 10 11 Billions of bushels per year

 Responsiveness of D for one good to

 The more price elastic the D:

 The more elastic the S:

Price per ounce

0 9 10 Millions of ounces per day 7 10

$0.20 Tax St”

Price per ounce

0 8 10 Millions of ounces per day 9 10

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