Mirco Soffritti

Microeconomics
The content of Topic 5

Elasticity Price elasticity PED: linear case

What it is and what it is
used for
of demand When the demand function
is linear
How the quantity demanded
responds to a price change

Elasticities of demand Price elasticity of

The demand is sensitive to supply
many things
Beyond demand
01 Elasticity
The ‘unit of measure’ problem
Assume the following demand function for chocolate ice cream
𝑞 = 𝐷 𝑝 = 200 − 20𝑝
where 𝑝 denotes the unit price ($) of ice creams and 𝑞 (lt) its quantity demanded.

If the price of one litre of ice cream were to increase from 3$ to 4$, the quantity
demanded (lt) would decrease by 20.
Now assume that we were to express the quantity demanded in deciliters (dl)
If the price of one litre of ice cream were to increase from 3$ to 4$, the quantity
demanded (dt) would decrease by 2.
Note: The answer about the response of quantity to a price change is unit-of-
measure sensitive (not ‘unit-of-measure’ free). And this is not a good feature!
Elasticity
We aim for a measure of ‘responsiveness’ of a variable Y to a change in a
variable X which is ‘unit-of-measure independent’, i.e., an index that is the
same regardless of the unit of measure we use to express our two
variables.
This is the elasticity of Y with respect to (wrt) X:

% change in 𝑌 ∆𝑌/𝑌 ∆𝑌 𝑋
𝜖𝑌,𝑋 = elasticity of 𝑌 wrt 𝑋 = = =
% change in 𝑋 ∆𝑋/𝑋 ∆𝑋 𝑌

This measure of responsiveness is ‘unit-of-measure’ independent.

 Price elasticity of
02 demand
Price elasticity of demand
The price elasticity of demand (PED) is the ratio of the percent
change in quantity demanded to the percent change in price as we
move along the demand curve, starting from 𝑝0 :
% change in 𝑞 ∆𝑞/𝑞0 ∆𝑞 𝑝0
𝜖𝑞,𝑝 = = =
% change in 𝑝 ∆𝑝/𝑝0 ∆𝑝 𝑞0

At any 𝑝0 where 𝜖𝑞𝐷,𝑝 is

• greater than 1, we say that the demand is elastic (or highly elastic)
• equal to 1, we say that the demand is unit elastic
• smaller than 1, we say that the demand is inelastic
PED for ambulance rides
With reference to the demand curve below, we calculate the PED
∆𝑞/𝑞0 ∆𝑞 𝑝0
𝜖𝑞,𝑝 = =
∆𝑝/𝑝0 ∆𝑝 𝑞0
assuming that we start from 𝑝0 = $200 and
we get to 𝑝1 = $210.
∆𝑝 = 210 − 200 = 10; ∆𝑞𝐷 = 9.9 − 10 = −0.1
Hence:
∆𝑞𝐷 𝑝0 −0.1 200
𝜖𝑞𝐷,𝑝 = = = −0.2 (inelastic)
∆𝑝 𝑞0 10 10

For a 1% increase in price starting from 𝑝0 = $200,

there is a 0.2% decrease in the quantity demanded.
PED and slope
slope
Again, the PED is
∆𝑞/𝑞0 ∆𝑞 𝑝0
𝜖𝑞𝐷 ,𝑝 = =
∆𝑝/𝑝0 ∆𝑝 𝑞0

∆𝑞
where ∆𝑝
is the slope of the demand curve in the interval 𝑝0 , 𝑝1 .

Hence, the elasticity is not the same as the slope. However:

• The slope enters the formula of the PED
• The PED, like the slope, is negative (Law of Demand)
• The PED may be different along the demand, even when the slope is constant.
• The demand tends to be inelastic where the slope is small (in abs. value)
• The demand tends to be elastic where the slope is big (in abs. value)
Unit-elastic demand

∆𝑞/𝑞0 ∆𝑞 𝑝0
𝜖𝑞𝐷 ,𝑝 = = = −1
∆𝑝/𝑝0 ∆𝑝 𝑞0

Starting from 𝑝0 = $0.9, a 20% increase in price leads to a 20% decrease in the
quantity demanded from 𝑞0 = 1.100
Inelastic demand

∆𝑞/𝑞0 ∆𝑞 𝑝0
𝜖𝑞𝐷 ,𝑝 = = > −1
∆𝑝/𝑝0 ∆𝑝 𝑞0

Starting from 𝑝0 = $0.9, a 20% increase in price leads to a 10% decrease in the
quantity demanded from 𝑞0 = 1.050
Elastic demand

∆𝑞/𝑞0 ∆𝑞 𝑝0
𝜖𝑞𝐷 ,𝑝 = = < −1
∆𝑝/𝑝0 ∆𝑝 𝑞0

Starting from 𝑝0 = $0.9, a 20% increase in price leads to a 40% decrease in the
quantity demanded from 𝑞0 = 1.200
To practice with PED
The Ministry of Transportation claims that “In the next week, if the price of oil
increases by 10% and the quantity demanded will fall by 15%”
What is the price elasticity of demand that is compatible with this claim?

This is just a blind application of the PED formula:

∆𝑞/𝑞0 0.15
𝜖𝑞𝐷 ,𝑝 = − = −1.5 (elastic)
∆𝑝/𝑝0 0.1
To practice with PED
The owner of the House of Pizza tells you that “At the initial price of $10, the quantity
demanded for pepperoni & basil pizzas is 100 ut. However, if the price rises to $15,
the quantity demanded becomes 90.” What is the price elasticity of demand that is
compatible with this claim?

This is again an application of the PED formula:

∆𝑞 𝑝0 90−100 10
𝜖𝑞,𝑝 = = = −0.2 (inelastic)
∆𝑝 𝑞0 15−10 100
PED for actual goods
The starting-point issue…
With reference to the demand curve below, when we calculate the PED
∆𝑞/𝑞0 ∆𝑞 𝑝0
𝜖𝑞𝐷 ,𝑝 = =
∆𝑝/𝑝0 ∆𝑝 𝑞0
there is a problem: our percent change calculation
depends on our choice of starting point, that is on 𝑝0
In practice, going from 𝑝0 = $200 to 𝑝1 = $210
produces a different elastacity than going from
𝑝0 = $210 to 𝑝1 = $200.
Which, if you think about it, makes no sense!
To solve this problem, we calculate the price elasticity
of demand using the midpoint formula for percentage changes.
… and the mid-point solution
Midpoint (or average) price elasticity of demand
MPED: instead of using 𝑝0 and 𝑞0 , for the price
elasticity we use the average (midpoint) between
the initial and the final values.

∆𝑞/(𝑞0 + 𝑞1 )/2 ∆𝑞 𝑝0 + 𝑝1
𝑚𝜖𝑞,𝑝 = =⋯=
∆𝑝/(𝑝0 + 𝑝1 )/2 ∆𝑝 𝑞0 + 𝑞1
Hence:
∆𝑞 𝑝 +𝑝 −0.1 410
𝑚𝜖𝑞,𝑝 = ∆𝑝 𝑞0+𝑞1 = = −0.20603 (inelast)
0 1 10 19.9

For a 1% increase in price in the interval 𝑝0 , 𝑝1 = $200, $210

there is an average 0.20603% decrease in the quantity demanded.
To practice with MPED
If the price of a sushi roll drops from $8 to $4 and sales rise from 20 to 40
units, what is the (absolute value) of the price elasticity of demand using
the midpoint formula (MPED)?
a) 0.5
b) 0.66
c) 1
d) 2
To practice with MPED
The owner of the House of Pizza tells you that “At the initial price of $10, the quantity
demanded for pepperoni & basil pizzas is 100 ut. However, if the price rises to $15,
the quantity demanded becomes 90.” What is the mid-point price elasticity of
demand that is compatible with this claim?

This is an application of the MPED formula:

∆𝑞 𝑝0 +𝑝1 90−100 25
𝑚𝜖𝑞,𝑝 = = = −0.2631
∆𝑝 𝑞0 +𝑞1 15−10 190

For a 1% increase in price in the interval $10, $15

there is an average 0.2631% decrease in the quantity
demanded for pepperoni & basil pizza.
03 PED. The linear case
The PED of a linear demand
In many application (and in this course) the demand function is often assumed
to be linear for simplicity (actual demand functions are typically not linear)

𝑞 𝑝 = 𝑚 − 𝑏𝑝, with 𝑚, 𝑏 > 0

where 𝑚 is the intercept on the 𝑝 axis, and −𝑏 is the slope.
With reference to PED:
∆𝑞 𝑝0 𝑝0
𝜖𝑞,𝑝 = = −𝑏
∆𝑝 𝑞0 𝑞0

Notice that, even though the slope of a linear demand is constant along the
curve, its elasticity changes based on the initial pair (𝑝0 , 𝑞0 ) we are working
with. Hence, PED is not constant along a linear demand function.
The PED of a linear demand
∆𝑞 𝑝0 𝑝0
𝑞 𝑝 = 𝑚 − 𝑏𝑝, with 𝑚, 𝑏 > 0 → 𝜖𝑞,𝑝 = = −𝑏
∆𝑝 𝑞0 𝑞0

Note that:
• when 𝑝0 = 0, then 𝜖𝑞,𝑝 = 0
𝑞0
• when = 𝑏 (half a way) , then 𝜖𝑞,𝑝 = −1
𝑝0

• when 𝑝0 → 0, then 𝜖𝑞,𝑝 → −∞

The further up we move along a linear demand

function the greater (in absolute value) the price
elasticity of demand along a línear demand function.
The PED of a linear demand. Extreme 1
Vertical demand curve
0 𝑝0
𝑞 𝑝 = 𝑞ത → 𝜖𝑞,𝑝 = =0
∆𝑝 𝑞ത

Since the quantity does not change

along a vertical demand curve, ∆𝑞 = 0
and the PED is zero everywhere.
Perfectly inelatsic demand
The PED of a linear demand. Extreme 2
Horizontal demand curve
∆𝑞 𝑝ҧ
𝑝 𝑞 = 𝑝ҧ → 𝜖𝑞,𝑝 = = −∞
0 𝑞

Since the price does not change along

a horixontal demand curve, ∆𝑝 = 0
and the PED is infinite everywhere.
Perfectly elastic demand
To practice with PED of a linear function
Which of the following statements is true for the price elasticity of demand
(PED) along a downward sloping linear demand curve?
a) It remains constant as the price changes.
b) It is high (in a.v.) at higher prices and low (in a.v.) at lower prices.
c) It is low (in a.v.) at higher prices and high (in a.v.) at lower prices.
d) It is unitary at all points.
To practice with PED of a linear function
Which of the following is true about the slope of a linear demand curve
and the price elasticity of demand?
a) The slope of the demand curve uniquely determines the price
elasticity of demand.
b) The price elasticity of demand does not depend on the slope of the
demand curve.
c) The slope of the demand curve is constant, but the price elasticity
of demand typically varies along the curve.
d) The price elasticity of demand is constant, but the slope of the
demand curve varies.
To practice with PED of a linear function
For the demand function 𝑞 = 90 − 4𝑝, find the price at which the price
elasticity of demand equals -2.
a) $10
b) $12
c) $15
d) $20
To practice with PED of a linear function
If the demand function is q = 50 − 2𝑝, what is the approximate value of
the price elasticity of demand when the price is $10?
a) -0.25
b) -0.66
c) -1
d) -2
04 Demand elasticities
Other elasticities
As we have seen, the quantity demanded for a good depends on the unit
price of that good but also on other factors, such as:
• People’s income
• Price of other (related) goods
• Number of demanders
• Etc.
We can calculate the elasticity of the quantity demanded wrt to all the
measurable factors (ceteris paribus in place) on which the quantity
demanded depends.
 Income elasticity of demand
The income elasticity of demand* (IED) measures how sensitive the
quantity demanded of a good is to changes in income (𝐼).
% change in 𝑞 ∆𝑞/𝑞0 ∆𝑞 𝐼0
𝜖𝑞,𝐼 = = =
% change in 𝐼 ∆𝐼/𝐼0 ∆𝐼 𝑞0

The IED can be used to distinguish normal from inferior goods.

• For inferior goods, income elasticity is negative, that is 𝜖𝑞,𝐼 < 0.
• For normal goods, income elasticity is positive, 𝜖𝑞,𝐼 > 0. For these goods:
i. income-elastic goods, 𝜖𝑞,𝐼 > 1.
ii.income-inelastic goods, 0 < 𝜖𝑞,𝐼 < 1.
* Make sure you know how to calculate also the mid-point income elasticity of demand (MIED)
To practice with IED
If the income elasticity of demand (𝜖𝑞,𝐼 ) for Coke is 0.5 and income decreases
by 8%, what is the expected percentage change in the quantity demanded?
a) 4% increase
b) 4% decrease
c) 8% increase
d) 8% decrease
To practice with IED
What type of good has a negative income elasticity of demand (𝜖𝑞,𝐼 < 0)?
a) Normal good
b) Inferior good
c) Luxury good
d) Giffen good
To practice with IED
Which of the following statements is true for income-elastic goods?
a) The income elasticity of demand is less than 0.
b) The income elasticity of demand is between 0 and 1.
c) The income elasticity of demand is equal to 1.
d) The income elasticity of demand is greater than 1
To practice with MIED
Tanya consumes 10 boxes of ramen noodles a year when her yearly income is
$40,000. After her income falls to $30,000 a year, she consumes 40 boxes of
ramen noodles a year. Calculate Tanya’s income elasticity of demand for ramen
noodles (use the midpoint method).
a) 4.2
b) –4.2
c) –2.25
d) 2.25
Cross-price elasticity of demand
The cross-price elasticity of demand* (CPED) measures how sensitive
the quantity demanded of a good 𝑌 is to changes in the price of another
good Y (𝑝𝑥 ).
0
% change in 𝑞𝑥 ∆𝑞𝑥 /𝑞𝑥0 ∆𝑞𝑥 𝑝𝑦
𝜖𝑞𝑥,𝑝𝑦 = = 0 =
% change in 𝑝𝑦 ∆𝑝𝑦 /𝑝𝑦 ∆𝑝𝑦 𝑞𝑥0

The CPED can be used to distinguish substitute goods from complement goods.
• For substitutes, 𝜖𝑞𝑥 ,𝑝𝑦 is positive
• For complements 𝜖𝑞𝑥 ,𝑝𝑦 is negative

* Make sure you know how to calculate also the mid-point cross-price elasticity of
demand (MCPED)
To practice with CPED
The price of milk increases by 4%, causing the quantity demanded Oreos to
decrease by 6%. The cross-price elasticity of demand is _____, and the two
goods are ______.
a) 1.5; substitutes
b) –1.5; complements
c) 0.67; complements
d) –2.4; substitutes
To practice with CPED (challenging)
The accompanying table lists the cross-price elasticities of demand for several
goods, where the percent quantity change is measured for the first good of the
pair, and the percent price change is measured for the second good.
To practice with CPED (challenging)
a. Explain the sign of each of the cross-price elasticities. What does it imply
about the relationship between the two goods in question?
b. Compare the absolute values of the cross-price elasticities and explain
their magnitudes. For example, why is the cross-price elasticity of
McDonald’s burgers and Burger King burgers less than the cross-price
elasticity of butter and margarine?
c. Use the information in the table to calculate how a 5% increase in the
price of Pepsi affects the quantity of Coke demanded.
d. Use the information in the table to calculate how a 10% decrease in the
price of gasoline affects the quantity of SUVs demanded.
 Price elasticity of
05 supply
Price elasticity of supply
The price elasticity of supply (PES) is a measure of the responsiveness of
the quantity of a good supplied to the price of that good. It is the ratio of the
percent change in the quantity supplied to the percent change in the price
as we move along the supply curve. Moving a long a supply curve,
% change in 𝑞 ∆𝑞/𝑞0 ∆𝑞 𝑝0
𝜖𝑞,𝑝 = = =
% change in 𝑝 ∆𝑝/𝑝0 ∆𝑝 𝑞0

Generally speaking, the PES is positive. Also:

• Where 𝜖𝑞,𝑝 > 1, we say that the supply is elastic
• Where 𝜖𝑞,𝑝 < 1, we say that the supply is inelastic
How would you calculate the mid-point price elasticity of supply (MPES)?
Price elasticity of supply. Extreme cases
To practice with PES
If the initial price of a given MP3 payer is $100 and the quantity
supplied is 500 units, and then the price increases to $120 and the
quantity supplied increases to 600 units, what is the price elasticity
of supply (PES)?
a) 0.75
b) 1.2
c) 1.0
d) 1.5
To practice with PES
What happens to the price elasticity of supply when the supply curve is
a horizontal line?
a) The supply is perfectly inelastic.
b) The supply is elastic.
c) The supply is unitary elastic.
d) The supply is perfectly elastic.
To practice with PES
Which of the following best describes an elastic supply?
a) The quantity supplied changes significantly with a small change in price.
b) The quantity supplied remains unchanged regardless of any change in
price.
c) The quantity supplied decreases as the price increases.
d) The quantity supplied is zero at any price.
To practice with elasticity
Which of the following best describes the relationship between the slope
of a linear demand curve and the price elasticity of demand (PED)?
a) The slope uniquely determines PED.
b) PED is constant along a linear demand curve.
c) The slope is constant, but PED varies along the curve.
d) PED is unaffected by the slope of the demand curve
To practice with elasticity
Given the demand function 𝑞(𝑝) = 200 − 20𝑝 , calculate the price at
which the price elasticity of demand (PED) equals -1.
a) $5
b) $8
c) $10
d) $15
To practice with elasticity
A laptop has an income elasticity of demand (IED) of 2. If consumer income
decreases by 10%, what will be the percentage change in the quantity
demanded?
a) 5% decrease
b) 10% decrease
c) 20% decrease
d) 20% increase
To practice with elasticity (challenging)
Which of the following best describes the relationship between the slope
of a linear demand curve and the price elasticity of demand (PED)?
a) The slope uniquely determines PED.
b) PED is constant along a linear demand curve.
c) The slope is constant, but PED varies along the curve.
d) PED is unaffected by the slope of the demand curve
To practice with elasticity (challenging)
What can you conclude about the price elasticity of demand in each of the
following statements?
a. “The pizza delivery business in this town is very competitive. I’d lose half
my customers if I raised the price by as little as 10%.”
b. “I owned both of the two Jerry Garcia autographed lithographs in
existence. I sold one on eBay for a high price. But when I sold the second
one, the price dropped by 80%.”
c. “My economics professor has chosen to use the Krugman/Wells textbook
for this class. I have no choice but to buy this book.”
d. “I always spend a total of exactly $10 per week on coffee.”
Elasticity – Summary table (I)
Elasticity – Summary table (II)
Summary of Topic 5
Key Elasticity Concepts
• Elasticity Overview: Elasticity is a fundamental concept in
microeconomics, measuring how demand and supply respond to
changes in price, income, and the prices of related goods.
• Price Elasticity of Demand (PED): The chapter focuses on PED,
which varies along a linear demand curve. It helps classify demand as
elastic (sensitive to price changes), inelastic (less sensitive), or
unitary elastic (proportional change).
Summary of Topic 5
Income and Cross-Price Elasticity
• Income Elasticity of Demand (IED): This measures how demand
changes with income levels, distinguishing between normal goods
(positive elasticity) and inferior goods (negative elasticity).
• Cross-Price Elasticity of Demand (CPED): CPED examines the
relationship between goods, identifying whether they are substitutes
(positive elasticity) or complements (negative elasticity).
Summary of Topic 5
Implications for Policy and Strategy
• Price Elasticity of Supply (PES): The chapter also covers PES, showing
how supply responds to price changes, which is vital for understanding
market adjustments.
• Application: These elasticity measures are crucial for informed
decision-making in policy and business, guiding pricing strategies, tax
policies, and market interventions to optimize economic outcomes.