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Demand and Supply Elasticities

What is a demand elasticity?
A demand elasticity is the percentage change in Q that occurs from a 1%
change in another market variable, ceteris paribus
Elasticity is the sensitivity or responsiveness of your demand
Common elasticities
Price elasticity of demand
Income elasticity of demand
Cross-price elasticity of demand
These elasticities allow us to precisely quantify the changes in quantity
demanded or shifts in demand curves that we discussed before
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Price Elasticity of Demand
Price elasticity of demand: the percentage change in the quantity
demanded that results from a 1 percent change in the price
Quantify movements along the demand curve (i.e., changes in quantity
demanded)
Formula:

=
%
%
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Classifying Demand Elasticities
1. Perfectly inelastic demand: e
p
= 0
2. Inelastic demand: e
p
< 1
3. Unit elastic demand: e
p
= 1
4. Elastic demand: e
p
> 1
5. Perfectly elastic demand: e
p
= infinity
Rule of thumb:
Flatter curves are more elastic
Steeper curves are more inelastic
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Factors that Affect the Elasticity of Demand
1. Availability of close substitutes
Greater availability implies more elastic
2. Luxuries vs. necessities
Luxuries are more elastic
3. Time horizon
Longer horizon implies more elastic
4. Definition of the market
Narrower definition implies more elastic
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Total Revenue and Demand Elasticity
Total revenue: TR = P x Q
If e
p
< 1, then an increase (decrease) in P will increase (decrease) TR
If e
p
= 1, then a change in P will not change TR
If e
p
> 1, then an increase (decrease) in P will decrease (increase) TR
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Income Elasticity of Demand
Income elasticity of demand: percentage change in quantity demanded
given a 1 percent change in income
e
I
> 0 implies a normal good
e
I
< 0 implies an inferior good
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Cross-Price Elasticity of Demand
Cross price elasticity of demand: percentage change in quantity
demanded of good A given a 1 percent change in the price of good B
e
XP
> 0 implies substitutes
e
XP
< 0 implies complements
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Elasticity of Supply
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Classifying Supply Elasticities
1. Perfectly inelastic supply: e
s
= 0
2. Inelastic supply: e
s
< 1
3. Unit elastic supply: e
s
= 1
4. Elastic supply: e
s
> 1
5. Perfectly elastic supply: e
s
= infinity
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Factors that Affect the Elasticity of Supply
1. Flexibility of production
More flexible implies more elastic
2. Time horizon
Longer horizon implies more elastic
Calculating Elasticities
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Calculating Price Elasticity of Demand
Price elasticity of demand:

=
%
%
Note that % =

And that % =

Therefore:

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Calculating Price Elasticity of Demand, contd
Price elasticity of demand:

What is

is the (inverse of) the slope!

So

Elasticity is closely related to the slope of the demand curve

But it is not equivalent to the slope
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Why dont we use slope?
The slopes of the demand and supply curve tell us a lot about demand and
supply, so why use elasticities?
The slope depends upon the units that you use
Example: Cans of soda vs liters of soda
Different goods have different units, so slopes are hard to compare
Example: liters of soda vs. buckets of popcorn
Elasticities make it possible to compare across goods
% change in soda demand vs % change in popcorn demand
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Calculating elasticities
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The Midpoint Method
The midpoint method gives a good approximation of the elasticity:
) (
2
1
) (
2
1
1 2
1 2
1 2
1 2
P P
P P
Q Q
Q Q
e
p

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Total Revenue and Demand Elasticity, revisited
Total revenue: TR = P x Q
If e
p
< 1, then an increase (decrease) in P will increase (decrease) TR
If e
p
= 1, then a change in P will not change TR
If e
p
> 1, then an increase (decrease) in P will decrease (increase) TR