Elasticity of Demand and Supply

CHAPTER 4
ELASTICITY OF DEMAND
AND SUPPLY
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TYPES
-Definition
-The importance
of ea!ticit"
Reation!hip
#et$een price
ea!ticit" of %eman%
an% tota re&en'e
Factor! that
inf'ence
-Perfect" inea!tic
-Inea!tic
-Unitar" ea!tic
-Ea!tic
-Perfect" ea!tic
(Price Ea!ticit" of Deman%
(Income Ea!ticit"
(Cro!! Ea!ticit"
(Price Ea!ticit" of S'pp"
TOTAL
RE)ENUE
AND
ELASTICITY
DETERMINANTS
OF ELASTICITY
DE*REE OF
ELASTICITY
THE CONCEPT OF
ELASTICITY
ELASTICITY OF DEMAND AND SUPPLY
This illustration is a part of Building Plan. See the whole presentation at slideshop.com/value-chain
Example of Case Study
Drug Problem
Source !!!.bi"ed.co.u#/current/research...$$%&.htm
Definition of Elasticity
Elasticity is a measure of the

responsi'eness of one 'ariable to
another.
(he greater the elasticity) the greater the

responsi'eness.
Elasticity of Demand * (he Concept
(he responsi'eness of ho! responsi'e

demand is to price changes
+hen price rises) !hat happens

to demand,
Demand falls
B-(.
/o! much does demand fall,
(he responsi'eness of ho! responsi'e

supply is to price changes
+hen price rises) !hat happens

to supply,
Supply rises.
B-(.
/o! much does supply rises,

Elasticity of Supply * (he Concept
+h" Economi!t! U!e Ea!ticit"
Economists !ant to compare apples and

0e!els all the time.
1s oil mar#et demand more price

sensiti'e than !heat demand,
1s the labor supply of !omen more !age

sensiti'e than the labor supply of men,
1f you are a #'!ine!!per!on and

!ant to increa!e re&en'e!) one
important 2uestion is !hether !e
increa!e price or %ecrea!e price,
(ells suppliers ho! their tota re&en'e

!ill change if their price changes
(he ans!er is the concept of elasticity

The Importance of Ea!ticit"
1nelastic Economic 3elations
+hen an elasticity is small 4E5$6) !e call

the relation that it describes inelastic.
1nelastic demand means that the

2uantity demanded is not &er"
!en!iti&e to the price.
1nelastic supply means that the 2uantity

supplied is not &er" !en!iti&e to the
price.
1nelastic of Demand/Supply
Changes in 2uantity demanded is less

than changes in price
E5$
Example Ed 7$/2
1f the price increase $8) 2uantity
demanded decrease %.98
1f the price decrease $%8) 2uantity
demanded increase ::::8
Ea!tic Economic Reation!
+hen an elasticity is large 4E;$6) !e call

the relation that it describes elastic
Elastic demand means that the

2uantity demanded is sensiti'e to the
price.
Elastic supply means that the 2uantity

supplied is sensiti'e to the price.
Elastic of Demand / Supply
Changes in 2uantity demanded is

greater than changes in price
E;$
Example Ed 7 < means

1f the price increase $8) 2uantity
demanded !ill decrease <8
1f the price increase $%8) 2uantity
demanded !ill decrease :::::::8
(ypes of Demand Elasticity
Price elasticity of demand 4Ed6
1ncome elasticity of demand 4Ey6
Cross elasticity of demand 4Ec6

Price Elasticity of Demand
=easure the sensiti'ity/responsi'eness

of the 2uantity demanded due to a
change in its price
/o! sensiti'e is the 2uantity demanded

to a change in the price of the good.
1ncome Elasticity of Demand
=easure of the sensiti'ity /

responsi'eness of the 2uantity
demanded due to a change in income
Ey;% 4positi'e > elastic6 * luxury goods
Ey;% 4positi'e > inelastic6 * normal

goods
Ey5% * inferior goods
Ey 7 % * necessity goods
Determinants of Elasticity of
Demand
?'ailability of substitutes
Elastic for goods/ser'ices !ith close

substitutes
Example Cars and buses
1nelastic for goods/ser'ices !ith no close

subtitutes
Example tobacco
Demand
Share of budget spent on the product
Elastic * if the budget is spending large on

the products/ser'ices
Example College fees
1nelastic * if only small budget ta#en into

account
Example price of salt

Demand
?d0ustment to a price change o'er time
Short-run inelastic
@ong-run elastic
=easure of the sensiti'ity /

responsi'eness of the 2uantity
demanded for one product 4Ax6 due
to a change in the price of related
product 4Py6
Ec ; % * substitutes
Ec 5 % - complementary
Cross Elasticity of Demand
(BPES CD DE=?ED
E@?S(1C1(1ES
Elasticity
Price ($)
Quantity Demanded
The demand curve can be a
range of shapes each of which
is associated with a different
relationship between price and
the quantity demanded.
Digure $ (he Price Elasticity of Demand
Cop"ri-ht./001 So'th$e!tern2Thom!on Learnin-
3a4 Perfect" Inea!tic Deman%5 Ea!ticit" E6'a! 0
F9
<
7'antit"
Demand
$%% %
$. ?n
increase
in price . . .
2. . . . lea'es the 2uantity demanded unchanged.
Price
3#4 Inea!tic Deman%5 Ea!ticit" I! Le!! Than 8
7'antit" %
F9
G%
Demand
$. ? 228
increase
in price . . .
Price
2. . . . leads to an $$8 decrease in 2uantity demanded.
<
$%%
2. . . . leads to a 228 decrease in 2uantity demanded.
3c4 Unit Ea!tic Deman%5 Ea!ticit" E6'a! 8
7'antit"
<
$%% %
Price
F9
H%
$. ? 228
increase
in price . . .
Demand
3%4 Ea!tic Deman%5 Ea!ticit" I! *reater Than 8
Demand
7'antit"
<
$%% %
Price
F9
9%
$. ? 228
increase
in price . . .
2. . . . leads to a IJ8 decrease in 2uantity demanded.
3e4 Perfect" Ea!tic Deman%5 Ea!ticit" E6'a! Infinit"
7'antit" %
Price
F< Demand
2. ?t exactly F<)
consumers !ill
buy any 2uantity.
$. ?t any price
abo'e F<) 2uantity
demanded is "ero.
&. ?t a price belo! F<)
2uantity demanded is infinite.
3E@?(1CES/1P CD
E@?S(1C1(B ?ED (C(?@
3EKEE-E
Elastic and (otal 3e'enue
Price
Quantity Demanded (s)
D
The importance of elasticity
is the information it
provides on the effect on
total revenue of changes in
price.
$!
"
Total revenue is price #
quantity sold. $n this
e#ample% T& ' $! # "%
' $!%.
This value is represented by
the grey shaded rectangle.
Total &evenue
Elastic and (otal 3e'enue
Price
Quantity Demanded (s)
D
$f the firm decides to
decrease price to (say) $(%
the degree of price elasticity
of the demand curve would
determine the e#tent of the
increase in demand and the
change therefore in total
revenue. $!
"
$(
")
Total &evenue
Dirm Decisions =a#ing
Price ($)
Quantity Demanded
"
D
!
!
*
+ , Price ' -!+
+ , Quantity Demanded ' ./+
Ped ' -.) ($nelastic)
Total &evenue would fall
Producer decides to lower price to attract sales
0ot a good move1
Dirm Decisions =a#ing
Price ($)
Quantity Demanded
D
"
!
/
Producer decides to reduce price to increase sales
2
+ , in Price ' - (+
+ , in Demand ' . (+
Ped ' - " (3lastic)
Total &evenue rises
4ood 5ove1
Elasticity
If %eman% i! price
ea!tic5
1ncreasing price
!ould re%'ce (3
48L Ad ; 8 L P6
3educing price
!ould increa!e (3
48L Ad ; 8 L P6
If %eman% i! price
inea!tic5
1ncreasing price
!ould increa!e (3
48L Ad 5 8 L P6
3educing price
!ould re%'ce (3
48L Ad 5 8 L P6
Elasticity) (otal 3e'enue) and
Demand
1f E
D
is elastic 4E
D
> $6) a rise in price
lo!ers total re'enue.
Price and total re'enue mo'e in opposite

directions.
Elasticity) (otal 3e'enue) and
Demand
1f E
D
is unit elastic 4E
D
7 $6) a rise in price
lea'es total re'enue 'nchan-e%.
1f E
D
is inelastic 4E
D
< $6) a rise in price
increa!e! total re'enue.
1f E
D
is elastic 4E
D
> $6) a rise in price
%ecrea!e! total re'enue.
Elasticity and (otal 3e'enue
A
Unit Ea!tic Deman%
E 9 8
TR con!tant
C
0
:
P
r
i
c
e
7'antit"
;80
<
:
4
/
8 / 1 4 = > < ?
B
E
Lo!t
re&en'e
F
*aine% re&en'e
TR
E
9 ;4@:9;/4
TR
F
9 ;:@49;/4
A
P
r
i
c
e
Inea!tic Deman%
E A 8
7'antit"
;80
<
:
4
/
0 8 / 1 4 = : > < ?
TR ri!e! if price increa!e!
C
H
G
Lo!t
re&en'e
*aine%
re&en'e
TR
*
9 ;8 @ ? 9 ;?
TR
H
9 ;/ @ < 9 ;8:
B
C
B
A
P
r
i
c
e
Ea!tic Deman%
E C 8
7'antit"
;80
<
:
4
/
0
8 / 1 4 = : > < ?
TR fa! if price increa!e!D
K
J
Lo!t
re&en'e
*aine%
re&en'e
TR
E
9 ;< @ / 9 ;8:
TR
F
9 ;? @ 8 9 ;?
(otal 3e'enue ?long a Demand
Cur'e
Mraph
Ea!tic E
D
C 8
E
D
9 8
Inea!tic E
D
A 8
P
r
i
c
e
7'antit"
0
0
7'antit"
T
o
t
a

r
e
&
e
n
'
e
7
0
7
0
Elasticity of 1ndi'idual and
=ar#et Demand
Price discrimination occurs !hen a

firm separates the people !ith less
elastic demand from those !ith more
elastic demand.
Dirms charge more to the indi'iduals !ith

inelastic demand and less to indi'iduals
!ith elastic demands.
Elasticity of 1ndi'idual and
=ar#et Demand
Examples of price discrimination include
?ir ?siaNs =ad-mad Deals specials.
(he phenomenon of selling ne! cars.
(he almost-continual-sale phenomenon.
=o'ie tic#ets for ladies night only

PRICE ELASTICITY OF
SUPPLY
Price Elasticity of Supply 4Es6
=easure the sensiti'ity / responsi'eness

of the 2uantity supplies due to a change
in its price
+hen supply is elastic) firms can

increase production !ithout a rise in cost
or time delay
+hen supply is inelastic) firms find hard

to change their production le'el in a
gi'en time period
Computing Price Elasticity of Supply
Percentage change in 2uantity supplied

Percentage change in price
O
1f Price Elasticity of Supply ; $) Supply is
elastic
O
1f Price Elasticity of Supply 7 $) Supply is unit
elastic
O
1f Price Elasticity of Supply 5 $) Supply is
inelastic
=easurement
Es ; $ price elastic of supply
Es 5 $ price inelastic of supply
Es 7 $ unit elastic of supply
Es 7 % perfectly inelastic of supply
Es 7 infinity perfectly elastic of supply

Digure I (he Price Elasticity of Supply
3a4 Perfect" Inea!tic S'pp"5 Ea!ticit" E6'a! 0
F9
<
Supply
7'antit" $%%
%
$. ?n
increase
in price . . .
2. . . . lea'es the 2uantity supplied unchanged.
Price
3#4 Inea!tic S'pp"5 Ea!ticit" I! Le!! Than 8
$$%
F9
$%%
<
7'antit"
%
$. ? 228
increase
in price . . .
Price
2. . . . leads to a $%8 increase in 2uantity supplied.
Supply
3c4 Unit Ea!tic S'pp"5 Ea!ticit" E6'a! 8
$29
F9
$%%
<
7'antit" %
Price
2. . . . leads to a 228 increase in 2uantity supplied.
$. ? 228
increase
in price . . .
Supply
3%4 Ea!tic S'pp"5 Ea!ticit" I! *reater Than 8
7'antit"
%
Price
$. ? 228
increase
in price . . .
2. . . . leads to a IJ8 increase in 2uantity supplied.
<
$%%
F9
2%%
Supply
3e4 Perfect" Ea!tic S'pp"5 Ea!ticit" E6'a! Infinit"
7'antit" %
Price
F< Supply
&. ?t a price belo! F<)
2uantity supplied is "ero.
2. ?t exactly F<)
producers !ill
supply any 2uantity.
$. ?t any price
abo'e F<) 2uantity
supplied is infinite.
-sing the idea of elasticity of
supply
What will determine
the elasticity of
supply of iPods and
iPod nanos?
What about the
elasticity of supply
of tunes downloaded
from iTunes?
Need to think
from the business
perspective!
+hat Determines Supply
Elasticity,
Dactor substitution possibilities
Can labour or capital inputs be s!itched easily !hen

there is a change in demand,
+hen factor substitution is possible and can be

achie'ed at lo! cost) supply !ill be elastic
+hen factors are highly speciali"ed) substitution may

be harder and thus supply !ill be inelastic
Spare production capacity a'ailable
+hen there is spare capacity) businesses can expand

output easily to meet rising demand !ithout up!ard
pressure on costs
+hat Determines Supply
Elasticity 426
Stoc#s 4in'entories6 a'ailable to meet demand
? lo! le'el of stoc#s ma#es supply inelastic in the short

term
+hen stoc#s can be released onto the mar#et) supply is

elastic
(he time frame allo!ed
=omentary period 4fixed supply6
Short run 4inelastic supply6
@ong run 4elastic supply6
?rtificial limits on supply
E.g. the impact of patents that limit !hich firms can

supply a product
Decide on the PeS
Dootball stadium
Dresh salmon
oil
Dlu 0abs
Ee! houses
Remin%er5
PeS !ho$! $hether
firm! can re!pon% to a
ri!e in price #"
increa!in- their !'pp"
Elastic 7 easy to increase
Supply !ithout cost and
time issues.
1nelastic 7 harder to
change supply
-se
your
!hite
boards
?pplying (he Concept
Seats in a football stadium / theatre / cinema
Short run capacity of any stadium is more or less

fixed
@ong run * allo!s for the expansion of stadium

capacity / de'elopment of a ne! ground
?n increase in demand for fresh salmon
(ime lags in the production process * e.g. a fixed

supply a'ailable to the mar#et in momentary
period 4i.e. the daily fish catch6
@onger termP change in the number of 'essels)

length of time at sea
Cil and elasticity of supply
+orld supply of oil follo!ing

a large rise in !orld
demand
Kariable amount of
spare capacity among
the ma0or oil producers
Can oil stoc#s be put

onto the mar#et to meet
the rise in demand,
Cil supply might be

inelastic if current output
is close to capacity
Elasticity of supply of ne!
housing
(he supply of ne!

housing
Planning permission
Q a'ailability of land
to de'elop Q
shortages of s#illed
labour
(ime lags in the

production process
* ne! housing
de'elopments ta#e
months to complete
Elasticity of supply of
drugs
Short term supply is dependent on stoc#s of

product a'ailable
1f stoc#s are lo!) supply cannot increase in the

short term to meet demand
Debate o'er the use of patents and ho! this

limits production in the long run
Supply elasticity
Migrant workers can help to
relieve shortages of labour and
improve the elasticity of supply
n many agricultural markets!
the delay between planting and
harvesting makes supply very
inelastic in the momentary
period
?PP@1C?(1CE of E@?S(1C1(B
Can good ne!s for farming be bad ne!s

for farmers,
+hat happens to !heat farmers and the

mar#et for !heat !hen uni'ersity
agronomists disco'er a ne! !heat
hybrid that is more producti'e than
existing 'arieties,
(/E ?PP@1C?(1CE CD S-PP@B)
DE=?ED) ?ED E@?S(1C1(B
Examine !hether the supply or demand

cur'e shifts.
Determine the direction of the shift of the

cur'e.
-se the supply-and-demand diagram to

see ho! the mar#et e2uilibrium changes.
Digure H ?n 1ncrease in Supply in the =ar#et for +heat
7'antit" of
+heat
%
Price of
+heat
&. . . . and a proportionately smaller
increase in 2uantity sold. ?s a result)
re'enue falls from F&%% to F22%.
Demand
S
$
S
2
2. . . . leads
to a large fall
in price . . .

$. +hen demand is inelastic)
an increase in supply . . .
2
$$%
F&
$%%

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CHAPTER 4

Elasticity is a measure of the

(he greater the elasticity) the greater the

(he responsi'eness of ho! responsi'e

+hen price rises) !hat happens

/o! much does demand fall,

(he responsi'eness of ho! responsi'e

+hen price rises) !hat happens

/o! much does supply rises,

Economists !ant to compare apples and

1s oil mar#et demand more price

1s the labor supply of !omen more !age

1f you are a #'!ine!!per!on and

(ells suppliers ho! their tota re&en'e

(he ans!er is the concept of elasticity

+hen an elasticity is small 4E5$6) !e call

1nelastic demand means that the

1nelastic supply means that the 2uantity

Changes in 2uantity demanded is less

+hen an elasticity is large 4E;$6) !e call

Elastic demand means that the

Elastic supply means that the 2uantity

Changes in 2uantity demanded is

Example Ed 7 < means

Price elasticity of demand 4Ed6

1ncome elasticity of demand 4Ey6

Cross elasticity of demand 4Ec6

=easure the sensiti'ity/responsi'eness

/o! sensiti'e is the 2uantity demanded

=easure of the sensiti'ity /

Ey;% 4positi'e > elastic6 * luxury goods

Ey;% 4positi'e > inelastic6 * normal

Ey5% * inferior goods

Elastic for goods/ser'ices !ith close

Example Cars and buses

1nelastic for goods/ser'ices !ith no close

Share of budget spent on the product

Elastic * if the budget is spending large on

Example College fees

1nelastic * if only small budget ta#en into

Example price of salt

?d0ustment to a price change o'er time

=easure of the sensiti'ity /

Price and total re'enue mo'e in opposite

Price discrimination occurs !hen a

Dirms charge more to the indi'iduals !ith

Examples of price discrimination include

?ir ?siaNs =ad-mad Deals specials.

(he phenomenon of selling ne! cars.

(he almost-continual-sale phenomenon.

=o'ie tic#ets for ladies night only

=easure the sensiti'ity / responsi'eness

+hen supply is elastic) firms can

+hen supply is inelastic) firms find hard

Percentage change in 2uantity supplied

Es ; $ price elastic of supply

Es 5 $ price inelastic of supply

Es 7 $ unit elastic of supply