▪LECTURE 4 ECON1211

▪Elasticity and Its Applications INTRODUCTIO

▪from MANKIW & TAYLOR 2014; Ch. 4 N TO
ECONOMICS

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 Elasticity . . .

▪ … allows us to analyze supply and demand

with greater precision.
▪… is a measure of how much buyers or sellers
respond to changes in market conditions
▪ What is the effect of additional taxes on cigarette
consumption?
▪ Price elasticity of demand
▪ What is the effect of an increse in oil price on
production?
▪ Price elasticity of supply
▪ What is the effect of an increse in income on
demand?
▪ Income elasticity of demand

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 The elasticity of demand

▪Price elasticity of demand is a measure of how much the quantity

demanded of a good responds to a change in the price of that
good.
▪The Price Elasticity of Demand and Its Determinants
▪Availability of Close Substitutes
▪Necessities versus Luxuries
▪Definition of the Market
▪Time Horizon

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Computing the Price Elasticity of
Demand
▪ Example: If the price of a product
increases from $2.00 to $2.20 and
the amount you buy falls from 10 to
8, then your elasticity of demand
would be calculated as:
▪ % change in Q= -20
▪ % change in P= 10
▪ Price elasticity of demand (Ed) = -
20 / 10 = -2
▪ Generally treated in absolute terms:
|Ed | 🡺 |-2 | = 2

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Price elasticities of different
goods/services
Market Own Price Elasticity
Transportation -0,6
Motor vehicles -1,4
Motorcycles & -2,3
bicycles
Food -0,7
Cereal -1,5
Clothing -0,9
Women’s clothing
Source: Baye et al. 1992
-1,2 5
Using the Midpoint Method

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The Variety of
Demand Curves
▪ Inelastic Demand
▪ Quantity demanded does
not respond strongly to price
changes.
▪ Price elasticity of demand is
less than one.

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> The Variety of
Demand Curves
▪ Elastic Demand
▪ Quantity demanded
responds strongly to changes
in price.
▪ Price elasticity of demand is
greater than one.

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 ▪ Perfectly Inelastic
▪ Quantity demanded does not
respond to price changes.
▪ Perfectly Elastic
▪ Quantity demanded changes
infinitely with any change in
>> The price.
Variety of ▪ Unit Elastic
Demand ▪ Quantity demanded changes
Curves by the same percentage as the
price.

▪ Because the price elasticity of

demand measures how much
quantity demanded responds to
the price, it is closely related to
the slope of the demand curve.
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 The Price Elasticity of Demand
(a) Perfectly Inelastic Demand: Elasticity Equals 0

Price
Demand

$5

4
1. An
increas
e
in price . . .

0 100 Quantity

2. . . . leaves the quantity demanded unchanged.

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 > The Price Elasticity of Demand

(b) Inelastic Demand: Elasticity Is Less Than 1

Price

$5

4
1. A 25% Deman
increas d
e
in price . . .

0 90 100 Quantity

2. . . . leads to an 10% decrease in quantity demanded.

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>> The Price Elasticity of Demand
(c) Unit Elastic Demand: Elasticity Equals 1
Price

$5

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1. A 25% Deman
increas d
e
in price . . .

0 75 100 Quantity

2. . . . leads to a 25% decrease in quantity demanded.

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>>> The Price Elasticity of Demand
(d) Elastic Demand: Elasticity Is Greater Than 1
Price

$5

4 Deman
1. A 25% d
increas
e
in price . . .

0 50 100 Quantity

2. . . . leads to a 50% decrease in quantity demanded.

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 >>>> The Price Elasticity of Demand

(e) Perfectly Elastic Demand: Elasticity Equals Infinity

Price

1. At any price
above $4, quantity
demanded is zero.
$4 Deman
d
2. At exactly $4,
consumers
will
buy any quantity.

0 Quantity
3. At a price below $4,
quantity demanded is infinite.
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Total Revenue and
the Price Elasticity
of Demand
▪Total revenue is the
amount paid by buyers
and received by sellers of
a good.
▪Computed as the price of
the good times the
quantity sold.

TR = P x Q

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Total Revenue
Price

$4

P × Q = $400
P
(revenue) Demand

0 100 Quantity
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Q
Elasticity and Total Revenue along a Linear Demand Curve

▪With an inelastic demand curve, an increase in price leads to a

decrease in quantity that is proportionately smaller. Thus, total
revenue increases.
▪ Mona Lisa & Louvre Museum

▪With an elastic demand curve, an increase in the price leads to

a decrease in quantity demanded that is proportionately larger.
Thus, total revenue decreases.
▪ a standard sedan car producer
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How Total Revenue Changes When Price Changes: Inelastic
demand
Price
Price
An Increase in price from $1 … leads to an Increase in
to $3 … total revenue from $100 to
$240

$3

Revenue = $240
$1
Revenue = $100 Demand Demand

0 10 Quantity 0 80 Quantity
0

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How Total Revenue Changes When Price Changes: Elastic
demand
Price
Price

An Increase in price from $4 … leads to an decrease in

to $5 … total revenue from $200 to
$100

$5

$4

Demand
Demand

Revenue = $200 Revenue = $100

0 50 Quantity 0 20 Quantity

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 Income Elasticity of Demand

▪Income elasticity of demand measures how

much the quantity demanded of a good
responds to a change in consumers’ income.
▪It is computed as the percentage change in
the quantity demanded divided by the
percentage change in income.

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Income
Elasticity
▪ Types of Goods
▪ Normal Goods
▪ Inferior Goods

▪ Higher income raises the

quantity demanded for
normal goods but lowers the
quantity demanded for
inferior goods.
▪ Goods consumers regard as
necessities tend to be income
inelastic
▪ Examples include food, fuel,
clothing, utilities, and 21
medical services.
Exercise
▪When a couple has a monthly income
of 4.000 TL, they would usually
consume 10 kg of apple. Now that
the couple makes 6.000 TL a month,
they consume 8 kg of apple.
a) Compute, by defining the formula,
the couple’s income elasticity of
demand for apple.
b) Explain your answer. (Is apple, a
normal or an inferior good to the
couple?)
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 The elasticity of supply

▪Price elasticity of supply is a measure

of how much the quantity supplied of
a good responds to a change in the
price of that good.

▪Price elasticity of supply is the

percentage change in quantity
supplied resulting from a percent
change in price.

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The Price Elasticity of Supply
(a) Perfectly Inelastic Supply: Elasticity Equals 0

Price
Supply

$5

4
1. An
increas
e
in price . . .

0 100 Quantity

2. . . . leaves the quantity supplied unchanged.

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> The Price Elasticity of Supply
(b) Inelastic Supply: Elasticity Is Less Than 1

Price

Suppl
y
$5

4
1. A 25%
increas
e
in price . . .

0 100 110 Quantity

2. . . . leads to a 10% increase in quantity supplied.

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>> The Price Elasticity of Supply
(c) Unit Elastic Supply: Elasticity Equals 1
Price

Suppl
$5 y

4
1. A 25%
increas
e
in price . . .

0 100 125 Quantity

2. . . . leads to a 25% increase in quantity supplied.

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>>> The Price Elasticity of Supply
(d) Elastic Supply: Elasticity Is Greater Than 1
Price

Suppl
y
$5

4
1. A 25%
increas
e
in price . . .

0 100 200 Quantity

2. . . . leads to a 100% increase in quantity supplied.

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>>>> The Price Elasticity of Supply
(e) Perfectly Elastic Supply: Elasticity Equals Infinity
Price

1. At any price
above $4, quantity
supplied is
infinite.
$4 Suppl
y
2. At exactly $4,
producers
will
supply any quantity.

0 Quantity
3. At a price below $4,
quantity supplied is zero.
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 Determinants of Elasticity of Supply

▪Ability of sellers to change the amount of the good they

produce.
▪ Beach-front land is inelastic.
▪ Books, cars, or manufactured goods are elastic.
▪Time period.
▪ Supply is more elastic in the long run.

▪An example: peak and off peak airline travel

▪ Peak: Demand is price inelastic, so tickets are expensive.
▪ Off peak: Demand is price elastic, so to maximise revenues ticket prices
are lowered.

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Can good news for farming be bad news for farmers?
▪What happens to wheat farmers and the market for wheat when
university agronomists discover a new wheat hybrid that is more
productive than existing varieties?
▪ Examine whether the supply or demand curve shifts.
▪ What about the elasticity of the demand of wheat?
▪ How the market equilibrium and farmers’ income changes?

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> Can good news for farming be bad news for farmers?

Price of
Wheat 1. When demand is inelastic,
2. . . . leads an increase in supply . . .
to a large fall S1
in price . . . S2

$3

Demand

0 100 110 Quantity of

Wheat
3. . . . and a proportionately smaller
increase in quantity sold. As a result,
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revenue falls from $300 to $220.
Key concepts of the lecture
▪elasticity
▪price elasticity of demand
▪total revenue
▪income elasticity of demand
▪cross-price elasticity of demand
▪price elasticity of supply

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 Exercise
▪According to the study of the Ministry of
Health the price elasticity of demand of
cigarettes is -0,2. And people purchase about 500 million cigarettes
each year.
a. If the tax on cigarettes were increased enough to raise the
price of cigarettes by 50 percent, what would be the effect
on the quantity cigarettes demanded? Show your work
explicitly.
b. Is raising the tax on cigarettes a more effective way to reduce
smoking, if the demand of cigarettes is elastic or if it is
inelastic? Briefly explain and justify your answer with
diagrams.

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