1. Elasticity of Demand and Supply
 Calculating Percentage Change
 Significance of Price Elasticity of Demand (Ep)
 Determinants of Price Elasticity of Demand (Ep)
 Price Elasticity of Demand (Ep)
 For Next Time

2. Price Elasticity of Demand
 A measure of the extent to which the quantity demanded of
a good changes when the price of the good changes, ceteris
paribus.
 We know if we raise a price, the Qd will decline, but we
don’t know how much.
 Elasticity answers the “how much” question.
 In Business, we want to know the relationship between Qd
and Price
 Ep = % Change in Quantity Demanded
% Change in Price

3. Price of Latte
 Suppose a retail gourmet coffee outlet is selling its
premium “Latte” for $3/cup. The store generally is selling
15 cups of “Latte” per hour, and the store manager is
thinking seriously of raising the price to $5/cup. He
knows he will lose some sales but thinks that most of his
customers are willing to pay more. Help him quantify his
decision by determining how many fewer cups he can sell
and still generate more revenue per hour.

4. Calculating Percentage Change
 Percentage Change measures how much a value has
changed from one time period to another
 For Example, if a firm’s sales for the current month
amounted to $100 million and the previous month, the
same firm’s sales were $90 million. What was the
percentage change?
 There are two methods of calculating the percentage
change
• Simple Method
• Midpoint Method

5. Calculating Percentage Change
 Simple Method
Percentage Change = Current Value-Previous Value
Previous Value
 or, = $100m - $90 m = $10m = 11.1%
$90m $90m
 Very Common Usage, especially in the business world

6. Calculating Percentage Change
 Midpoint Method
Percentage Change = Current Value – Previous Value
(Current Value + Previous Value)/ 2
 Or, = $100m -$90m = $10m = 10.5%
($100m + $90m)/2 $95m
 The midpoint method is the better method because it gives
similar results whether we are measuring forward or
backward

7. Price Elasticity of Demand
 From Formula Ep = % Change in Qd
% Change in Price
 If Price Elasticity of Demand > 1, demand is elastic
 If Price Elasticity of Demand = 1, demand is unit elastic
 If Price Elasticity of Demand < 1, demand is
inelastic

8. Demand Elasticity
 Elastic Demand – When % Change in Quantity Demanded
> % Change in Price
 Unit Elastic Demand – When % Change in Quantity
Demanded = % Change in Price
 Inelastic Demand – When % Change in Quantity
Demanded < % Change in Price
 Perfectly Elastic Demand – When Quantity Demanded
Changes by a very large percentage in response to an
almost zero Change in Price
 Perfectly Inelastic Demand – When the Quantity
Demanded remains constant as Price changes

9. Perfectly Elastic Demand Curve
14
12
10
8 D
6
4
2
5 10 15 20 25 30
Quantity
The elasticity of a perfectly elastic demand curve is infinity
Copyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved. 18-10

10. Perfectly Inelastic Demand Curve
D
30
25
20
15
10
5
5 10 15 20 25
Quantity
The elasticity of a perfectly inelastic demand curve is 0
Copyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved. 18-11

11. Relativity Elasticity of Demand Curves
D1
D2
Quantity
Copyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved. 18-12

12. Elasticity of Straight Line Demand Curve
11
Very elastic
10
e = 6.33
9
8
Slightly elastic
7
Unit elastic
6 e = 1.0
Slightly inelastic
5
4
3 e = .29
Very
inelastic
2
1
D
0
0 1 2 3 4 5 6 7 8 9 10 11
Quantity
Copyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved. 18-14

13. Significance of Price Elasticity of Demand
 Profit maximization requires that business set a price that
will maximize the firm’s profit
 Elasticity tells the firm how much control it has over using
price to raise profit
 If Ep > 1, then the % Change in Qd > % Change is Price
and demand is said to be elastic
• An increase in price will reduce total revenue
• A decrease in price will increase total revenue

14. Significance of Price Elasticity of Demand
 If Ep < 1, then the % change in Qd < % change in price,
and demand is said to be inelastic
• An increase in price will increase total revenue
• A decrease in price will decrease total revenue
 If Ep = 1, then the % change in Qd = % change in Price,
and demand is said to be unit elastic
• An increase in price will have no impact on total revenue
• A decrease in price will have no impact on total revenue

15. Price Elasticity of Demand Influences
 Substitute Product Availability (key determinant)
-- Luxury or Necessity (Ep for luxury items is >)
-- How narrowly it is defined (coffee is inelastic but latte
may have more substitutes and therefore is more elastic)
-- Time elapsed since price change (>time, >elasticity;
more time to find substitutes or manage consumption)
 Income Effects
-- The greater the proportion of income spent
on the good, greater a price change impacts
Quantity Demanded

16. Advertising
 Purpose – Product Differentiation (Branding)
 To make the demand for a product greater
 To make the demand for a product more inelastic
D D
Copyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved. 18-18

17. Elasticity Thoughts
 Demand Curve Slope and Elasticity (Steeper the slope, lower the
elasticity)
 A Units-Free Measure (% Change – Absolute Value)
 Elasticity Along a Linear Demand Curve
-- Slope is constant but elasticity varies
 Elasticity and Total Revenue
-- Price and Total Revenue change in opposite directions, demand is elastic
-- Price Change leaves Total Revenue unchanged, demand is unit elastic
-- Price and Total Revenue change in same direction, demand is inelastic

18. Price Elasticity of Supply
 A measure of the extent to which the quantity
supplied of a good changes when the price of the
good changes, and all other influences on seller’s
plans remain the same (cateris paribus)

19. Price Elasticity of Supply
 Perfectly Elastic Supply – When the quantity supplied
changes by a very large percentage in response to an
almost zero increase in price
 Elastic Supply – When the % change in the quantity
supplied > the % change in the price
 Unit Elastic Supply – When the % change in the quantity
supplied = the % change in price
 Inelastic Supply – When the % change in the quantity
demanded is < the % change in price
 Perfectly Inelastic Supply – When the quantity supplied
remains the same as the price changes

20. Influences on Price Elasticity of Supply
 Production Possibilities – page 124
-- Opportunity Costs
constant or gently rising opportunity costs
= elastic price elasticity
-- Fixed Production = inelastic price elasticity
-- Time Elapse – longer time, > price
elasticity

21. Influences of Price Elasticity of Supply
 Storage Possibilities
The better the storability, the more elastic is the
price elasticity of supply

22. Computing Price Elasticity of Supply
 Percentage change in quantity supplied
Percentage change in price
• If Price Elasticity of Supply > 1, Supply is elastic
• If Price Elasticity of Supply = 1, Supply is unit
elastic
• If price elasticity of supply< 1, Supply is inelastic

23. Cross Elasticity of Demand
 A measure of the extent to which the demand for a good
changes when the price of a substitute or complement
changes, ceteris paribus
% Change in Quantity Demanded
% Change in Price of one of its
substitutes or complements

24. Income Elasticity of Demand
 A measure of the extent to which the demand for a good
changes when income changes, ceteris paribus
 % Change in Quantity Demanded
% Change in Income

25. Income Elasticity of Demand
 If income elasticity of demand > 1 the demand for
the good is income elastic
 If income elasticity of demand is between
0 and 1, the demand is income inelastic
 * If income elasticity of demand < 0 the demand
is negative income elastic