1

Demand and Supply Elasticities

2

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

• The midpoint method:

12

12

12

12

PPPP

QQQQ

ep

3

Special Cases of Demand Elasticities

1. Perfectly inelastic demand: ep = 0

2. Inelastic demand: ep < 1

3. Unit elastic demand: ep = 1

4. Elastic demand: ep > 1

5. Perfectly elastic demand: ep = infinity

4

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. Budget share– Greater share implies more elastic

4. Time horizon– Longer horizon implies more elastic

5. Definition of the market– Narrower definition implies more elastic

5

Total Revenue and Demand Elasticity

• Total revenue: TR = P x Q

• If ep < 1, then an increase (decrease) in P will increase (decrease) TR

• If ep = 1, then a change in P will not change TR

• If ep > 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

12

12

12

12

II

II

QQ

QQeI

• eI > 0 implies a normal good

• eI < 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

BB

BB

AA

AA

XPPP

PP

QQ

QQe

12

12

12

12

• eXP > 0 implies substitutes

• eXP < 0 implies complements

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Elasticity of Supply

• Elasticity of supply: the percentage change in the quantity supplied that results from a 1 percent change in the price

• Calculate es using the same midpoint formula that we used for ep

9

Special Cases of Supply Elasticities

1. Perfectly inelastic supply: es = 0

2. Inelastic supply: es < 1

3. Unit elastic supply: es = 1

4. Elastic supply: es > 1

5. Perfectly elastic supply: es = infinity

10

Factors that Affect the Elasticity of Supply

1. Feasibility of production– More feasible implies more elastic

2. Time horizon– Longer horizon implies more elastic