CH 20 Elasticity

Ch.
20: Elasticity
KANTI ANANTA NUZHAT

ECO101
Price Elasticity of Demand
 A measure of the responsiveness of quantity demanded to

changes in price.
 Measured by dividing the percentage change in the quantity
demanded of a good by the percentage change in its price.
 Economists compute price elasticity of demand using
midpoints as the base values of changes in prices and
quantities demanded.
Computing Elasticity of Demand
We divide the change in quantity

demanded by the average
quantity demanded, all of
which is then divided by the
change in price divided by the
average price.
Perfectly Elastic and Perfectly
Inelastic Demand
Perfectly Elastic and Perfectly Inelastic
Demand
 Unit Elastic Demand (Ed = 1): If the numerator and denominator are the same, the coefficient
is equal to one. The quantity demanded changes proportionally to a change in price.
Elastic and Inelastic Demand
 Perfectly Elastic Demand (Ed = ∞) If the quantity demanded is

extremely responsive to a change in price.
 Perfectly Inelastic Demand (Ed = 0) If quantity demanded is
completely unresponsive to changes in price, demand is
perfectly inelastic. A change in price causes no change in
quantity demanded.
Price Elasticity of Demand
Price Elasticity of Demand and Total
Revenue
 Total Revenue (TR) of a seller equals the price of a good times the quantity of the
good sold.
 Total revenue may increase, decrease or remain constant.
 If demand is elastic, a price rise decreases total revenue.
 If demand is elastic, a price fall increases total revenue.
 If demand is inelastic, a price fall decreases total revenue.
 If demand is unit elastic, a price fall will sell more goods while total revenue
remains constant.
Elasticities, Price
Changes and Total
Revenue
Price Elasticity of Demand Along a
Straight Line Demand Curve
Q&A
 On Tuesday, price and quantity demanded are $7 and 120 units, respectively.
Ten days later, price and quantity are $6 and 150 units, respectively. What is the
price elasticity of demand between the price of $6 and $7?
 What does a price elasticity of demand of 0.39 mean?
 Identify what happens to total revenue as a result of each of the following: price
rises and demand is elastic; price falls and demand is inelastic; price rises and
demand is unit elastic; price rises and demand is inelastic; price falls and demand
is elastic.
 Alexi says, “When a seller raises his price, his total revenue rises.” What is
Alexi implicitly saying?
Determinants of Price Elasticity
on Demand
 Number of Substitutes: The more substitutes for a good, the

higher the price elasticity of demand; the fewer substitutes for
a good, the lower the price elasticity of demand. The more
broadly defined the good, the fewer the substitutes; the more
narrowly defined the good, the greater the substitutes.
 Necessities Versus Luxuries: The more that a good is
considered a luxury rather than a necessity, the higher the price
elasticity of demand.
Determinants of Price Elasticity
on Demand
 Percentage of One’s Budget Spent on the Good: The greater the

percentage of one’s budget that goes to purchase a good, the higher the price
elasticity of demand; the smaller the percentage of one’s budget that goes to
purchase a good, the lower the elasticity of demand.
 Time: The more time that passes, the higher the price elasticity of demand
for the good; the less time that passes, the lower the price elasticity of
demand for the good.
Q&A
 If there are 7 substitutes for good X and demand is inelastic, does it follow
that if there are 9 substitutes for good X demand will be elastic? Explain
your answer.
 Price elasticity of demand is predicted to be higher for which good of the
following combinations of goods: Compaq computers or computers; Heinz
ketchup or ketchup; Perrier water or water? Explain your answers.
Cross Elasticity of Demand
 Measures the responsiveness in the quantity demanded of one

good to changes in the price of another good.
 Defined as the percentage change in the quantity demanded of
one good divided by the percentage change in the price of
another good.
 This concept is often used to determine whether two goods are
substitutes or complements and the degree to which one good
is a complement to or substitute for another.
Income Elasticity of Demand
 Measures the responsiveness of quantity demanded to changes

in income.
 Define as the percentage change in quantity demanded of a
good divided by the percentage change in income.
 Income elasticity of demand is positive (Ey > 0) for a normal
good.
 The demand for an inferior good decreases as income
increases.
Income Elasticity of Demand
 If Ey >1,
demand is considered to be income
elastic.
 If Ey <1,
demand is considered to be income
inelastic.
 If Ey =1,
demand is considered to be unit
elastic.
Price Elasticity of Supply
 Measures the responsiveness of quantity supplied to changes in

price.
 Defined as the percentage change in quantity supplied of a
good divided by the percentage change in the price of the
good.
 Supply can be classified as elastic, inelastic, unit elastic,
perfectly elastic, or perfectly inelastic.
Price Elasticity of Supply
Price Elasticity of Supply and Time
 The longer the period of

adjustment to a change in price, the
higher the price elasticity of
supply.
 Additional production takes time.
 Reducing production takes time.
Summary of the Four Elasticity
Concepts
Who Pays the Tax?
 A tax placed on the sellers of VCR

tapes shifts the supply curve from
S1 to S2 and raises the equilibrium
price from $8 to $8.50. Part of the
tax is paid by buyers through a
higher price paid, and part of the
tax is paid by sellers through a
lower price kept.
 Tax revenues are maximized by
placing the tax on the seller who
faces the more inelastic demand
curve.
Different Elasticities and Who Pays the Tax
Q&A
 What does an income elasticity of demand of 1.33 mean?

 If supply is perfectly inelastic, what does this signify?
 Why will government raise more tax revenue if it applies a tax
to a good with inelastic demand than if it applies the tax to a
good with elastic demand?
 Under what condition would a per-unit tax placed on the
sellers of computers be fully paid by the buyers of computers?
Examples:
Let us assume, a student has two options when coming to NSU: Bus and Pathao
(Uber Moto). If the bus fare increases and Pathao fare decreases then the student
will consume less bus rides and more Pathao rides.
If the bus fare increases by 10% and the number of bus rides the student takes
decreases by 2%, the price elasticity of demand can be calculated as: | 𝐸𝑑|=%Δ 𝑄𝑑
%Δ𝑃=−2/10=|−0.2 |=0.2
Interpretation: If the bus fare increases by 1% then the quantity demanded of bus
rides decrease by 0.5%.
Examples
 Due to the increase in bus fare (X), if the number of Pathao rides (Y) the
student takes increase by 10%, then we may calculate the cross price elasticity
as: 𝐸𝑐=%Δ𝑄𝑑𝑌/%Δ𝑃𝑋=10/10=1
 Interpretation: If the bus fare increases by 1% then Pathao rides increase by
1%. Hence, bus rides and Pathao rides are substitutes of each other. 4
Examples
Now, if the income (pocket money) of the student increases, let’s assume
by 20%, then it is likely the student will take less bus rides and more
Pathao rides. If the bus rides decrease by 10% and the Pathao rides
increase by 40%, then we may calculate the income elasticities as follows:
Income elasticity of bus ride: 𝐸𝑌=%Δ𝑄/𝑑%Δ𝑌=−10/20=−0.5
Interpretation: If income increases by 1% then the bus rides decrease by
0.5%. This shows bus rides are an inferior good.
Income elasticity of Pathao ride: 𝐸𝑌=%Δ𝑄𝑑/%Δ𝑌=40/20=2
Interpretation: If income increases by 1% then the Pathao rides increase
by 2%. This shows Pathao rides are normal goods.
Examples
Another Perspective:
Once the Dhaka Metro Rail is completed, a third option will be available to the
students (i.e. number of substitutes available to the student increases). Therefore,
the price elasticity of demand of bus rides and Pathao rides is likely to increase in
the future once the Dhaka Metro Rail is completed.
Why? Think about it. If the bus fare increases, the student now has the option of
Metro Rail as well as Pathao, so the number of bus rides (percentage of bus rides)
is likely to decrease more (as compared to the last scenario), and hence the 𝐸𝑑 is
likely to be greater.

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Ch.

KANTI ANANTA NUZHAT

 A measure of the responsiveness of quantity demanded to

We divide the change in quantity

 Perfectly Elastic Demand (Ed = ∞) If the quantity demanded is

 Number of Substitutes: The more substitutes for a good, the

 Percentage of One’s Budget Spent on the Good: The greater the

 Measures the responsiveness in the quantity demanded of one

 Measures the responsiveness of quantity demanded to changes

 Measures the responsiveness of quantity supplied to changes in

 The longer the period of

 A tax placed on the sellers of VCR

 What does an income elasticity of demand of 1.33 mean?

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