4-1

Copyright 2009 McGraw-Hill Australia Pty Ltd

PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Chapter 4
Elasticity
4-2
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Learning Objectives
Define price elasticity of demand and describe factors
that influence it
Explain the link between price elasticity of demand
and spending on goods
Define cross price elasticity of demand
Define income elasticity of demand
Define price elasticity of supply and describe factors
that influence it
4-3
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Outline
Defining price elasticity of demand
Measuring price elasticity of demand
Determinants of price elasticity of demand
Graphical interpretation of price elasticity
Calculating the price elasticity of demand
Cross-price elasticity and income elasticity
Price elasticity of supply
Determinants of supply elasticity



4-4
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Price elasticity
A measure of the responsiveness of the quantity
demanded of a good to a change in the price of
that good.

4-5
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Price elasticity defined
The percentage change in the quantity demanded
that results from a 1 per cent change in its price
4-6
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Measuring price elasticity of
demand
Price in Change Percentage
Demanded Quantity in Change Percentage
4-7
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Price elasticity defined
Elastic demand
Demand is elastic with respect to price if price elasticity of
demand is greater than 1
Inelastic demand
Demand is inelastic with respect to price if price elasticity of
demand is less than 1
Unit elastic demand
Demand is unit elastic with respect to price if price elasticity
of demand equals 1
4-8
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Elastic and inelastic demand
4-9
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Price elasticity of demand for
sushi
Suppose:
Price of sushi = $2/piece
Quantity demanded = 400 pieces/day
When price falls:
New price of sushi = $1.94/piece
Quantity demanded = 404 pieces/day
What is the price elasticity of demand for sushi?
4-10
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Price elasticity of demand for
sushi
% change in quantity demanded = 1
% change in price = 3

Inelastic :
3
1
Price in Change %
Quantity in Change %
=
4-11
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Determinants of price elasticity of
demand
Substitution possibilities
- Products that have no close substitutes tend to have highly
inelastic demand (e.g. table salt and snake anti-venom)
Budget share
- Big ticket items tend to have high price elasticity of demand
(e.g. hot tubs)
Time
- Replacing an inefficient air conditioner with an energy-efficient
one

4-12
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Price elasticity estimates for
selected products
4-13
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Price elasticity demand at work
How effective will a fat tax be in solving
the growing problem of obesity?
4-14
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
A Graphical interpretation of price
elasticity
For small changes in price

P P
Q Q
elasticity Price = e =
Where Q is the original quantity and P is the
original price.
4-15
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
A Graphical interpretation of price
elasticity
Example
Originally
Price (P) = $100
Quantity (Q) = 20
New
Price (P) = $105
Quantity (Q) = 15

Elastic : 5
5
25
100 5
20 5
= = = e
4-16
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
A Graphical interpretation of price
elasticity
|
|
.
|

\
|
|
.
|

\
|
=
slope Q
P
A
1
at elasticity ice Pr
4-17
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Calculating price elasticity of
demand
4
5
20
intercept horizontal
intercept vertical
slope = = =
3
2
12
8
4
1
x
3
8
= = = e
A
4-18
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Calculating price elasticity of
demand Question:
What is the price elasticity of demand
at the point B on the demand curve?
4-19
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Price elasticity and the steepness
of the demand curve
2
1
6
12
1
4
4
1
D
=
|
|
|
.
|

\
|
|
.
|

\
|
= e
2
12
6
1
4
4
2
D
=
|
|
|
.
|

\
|
|
.
|

\
|
= e
4-20
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Price elasticity and the steepness
of the demand curve
Insert Fig 4.4
1-20
For D
2
when P = $1
5
1
12
6
1
10
1
2
D
=
|
|
.
|

\
|
|
.
|

\
|
= e
4-21
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Price elasticity and the steepness
of the demand curve
Observation
If two demand curves have a point in common, the steeper
curve must be less elastic with respect to price at that point.
4-22
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Price elasticity at the midpoint of a
straight-line demand curve
Observation:
The price elasticity of demand at the midpoint of any straight-
line demand curve always takes the value of 1.
4-23
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Price elasticity regions along a
straight-line demand curve
Observation
Demand is elasticity on the top half, unit elastic at the midpoint,
and inelastic on the bottom half of a straight-line demand curve.
4-24
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Perfectly elastic demand
Demand is perfectly elastic with respect to
price if price elasticity of demand is infinite.
This occurs when the demand curve is
horizontal.
4-25
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Perfectly elastic demand curve
) y (elasticit demand
elastic Perfectly
=
4-26
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Perfectly inelastic demand
Demand is perfectly inelastic with
respect to price if price elasticity of
demand is zero. This occurs when
the demand curve is vertical.

1-26
Copyright 2008 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
4-27
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Perfectly inelastic demand curve
) 0 y (elasticit demand
inelastic Perfectly
=
4-28
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Elasticity and total expenditure
Total expenditure = P x Q
Market demand measures the quantity (Q) at
each price (P).
Total expenditure = Total revenue

4-29
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Elasticity and total expenditure
How much do moviegoers spend on
movie tickets?
Original price = $2
Quantity sold = 500 tickets/day
Total expenditure = $2 x 500 = $1000/day
New price = $4
Quantity sold = 400 tickets/day
Total expenditure = $4 x 400 = $1600/day

1-29
4-30
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Effect of an increase in price on total
expenditure when price is low
Observation:
An increase in price from $2 to $4 per ticket increases total
expenditure on tickets from $1000/day to $1600/day.
4-31
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Effect of an increase in price on total
expenditure when price is high
Observation:
An increase in price from $8 to $10 per ticket results in a fall in
total expenditure on tickets from $1600/day to $1000/day.

4-32
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Constructing a total expenditure
curve for movie tickets
Steps:
1. Calculate total expenditure for a sample of points
on the demand curve
2. Plot total expenditure at each of the price points
on a graph
3. Sketch the curve by joining these points
4-33
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Demand curve for movie tickets
1-33
Copyright 2008 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
4-34
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Total expenditure as a function of
price
1-34
Copyright 2008 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
4-35
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Total expenditure as a function of
price
Observation:
For goods whose demand curve is a straight line, total expenditure
reaches a maximum at the price corresponding to the midpoint of
the demand curve.
4-36
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Effect of elastic demand on total
expenditure
Rock band example
If the price elasticity of demand is more than 1, should a
rock band raise or lower its price to increase total
revenue?


4-37
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Effect of elastic demand on total
expenditure
Then
Total revenue = $20 x 5000 =
$100 000/week
If P is increased 10%, Q will decrease 30%
Total revenue = $22 x 3500 = $77 000/week
If P is lowered 10%, Q will increase 30%
Total revenue = $18 x 6500 = $177 000/week

4-38
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Effect of elastic demand on total
expenditure
Rules:
1. When price elasticity is greater than 1, changes in
price and changes in total expenditure always
move in opposite directions
2. When price elasticity is less than 1, changes in
price and changes in total expenditures always
move in the same direction.


4-39
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Effect of elastic demand on total
expenditure
4-40
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Cross-price elasticity of demand
Percentage by which the quantity
demanded of a good changes in
response to a 1 per cent change in
the price of the second good
E.g. Percentage by which the quantity of peanuts
demanded changes in response to a 1% change in the
price of cashews
4-41
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Income elasticity of demand
Percentage by which the quantity
demanded of a good changes in
response to a 1 per cent change in
income
Percentage by which the quantity of peanut
demanded changes in response to a 1% change in
income

4-42
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Cross-price elasticity of demand
Suppose that the demand for hamburgers
depends on the level of advertising. Define the
advertising expenditure elasticity of demand for
hamburgers.
4-43
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Substitute and complimentary
goods
When the cross-price elasticity of demand is
positive, the two goods are substitutes
When the cross-price elasticity of demand is
negative, the two goods are compliments

4-44
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Normal and inferior goods
A normal good has positive income elasticity of
demand
An inferior good has negative income elasticity of
demand
4-45
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Price elasticity of supply
The percentage change in quantity supplied that
occurs in response to a 1 per cent change in price

P P
Q Q
supply of elasticity Price
A
A
=
|
|
.
|

\
|
|
.
|

\
|
=
slope
1
Q
P
supply of elasticity Price
4-46
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Supply curve for which price
elasticity declines as quantity rises
( )( ) 2 1 2 4 A = =
( )( ) 3 5 1 3 5 B = =
4-47
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Supply curve for which price
elasticity is constant
( )( ) 1 4 12 12 4 = = A
( )( ) 1 5 15 15 5 = = B
4-48
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
A perfectly inelastic supply curve
Elasticity is zero at every single point along a vertical supply curve
What is the price elasticity of supply of lakefront land in
Taupo, New Zealand?
4-49
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
A perfectly elastic supply curve
Insert Fig 4.15
What is the price elasticity of supply of lemonade?
The elasticity of supply is infinite at every point along a horizontal
supply curve
4-50
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Determinants of supply elasticity
Flexibility of inputs
Mobility of inputs
Ability to produce substitute inputs
Time

4-51
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Elasticity in action
Why are petrol prices so much more volatile than
car prices?
Differences in markets
Demand for petrol is more inelastic.
Petrol market has larger and more frequent supply shifts
4-52
Copyright 2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Principles of Microeconomics 2e by Frank, Jennings and Olekalns
Slides prepared by Jayanath Ananda, La Trobe University
Elasticity in action