1LECTURE 5
Topic 3.
Elasticity
1
ECON1010
Introductory Microeconomics
2Q1. Which of the following is true?
a. An increase in population will see an increase in demand.
b. An increase in the cost of inputs will reduce supply.
c. Improved technology will increase supply.
d. Increasing taxes shifts supply to the left.
Last lecture feedback
2
e. All of the above are true.
Lecture 5 ECON1010
3Q2. If supply is fixed and demand increases, then
a. Both price and quantity demanded will decrease.
b. Price will increase and quantity demanded decrease.
c. Price will increase but it is not possible to state a conclusion
about quantity demanded.
d. More information is needed to make any comments.
Last lecture feedback
3
e. Both price and quantity demanded will increase.
Lecture 5 ECON1010
4Plan of Lecture 5.
Price Elasticity of Demand and Supply
- implications and applications.
4Lecture 5 ECON1010
5Consider this.
5
As price rises, we know quantity demanded falls.
Question:
As a supplier of a product or service, how far can you
raise your price without losing too many customers
and impacting profits?
Profit = Revenue ─ Expense
Revenue ($) = price ($/unit) * quantity demanded (units)
BUT
as price , quantity , and revenue?, profit?
Lecture 5 ECON1010
66Lecture 5 ECON1010
Elasticity.
An economic term used to measure the sensitivity
of one variable (eg. quantity demanded) to a change in
another variable (eg. price).
Economists use various measures of elasticity.
ECON1010 will only consider:
1. Price elasticity of demand, ed
2. Price elasticity of supply, es
7Definition of Elasticity.
A measure of how much one economic variable
responds to the change in another economic variable.
7
Price Elasticity of Demand.
▪ the percentage change in quantity demanded
divided by the percentage change in price.
▪ is a number less than 1, equal to 1, or larger than 1.
▪ is a dimensionless number (no units).
P
Q
e dd


=
%
%

8Applying the Elasticity Definition
P
Q
e dd


=
%
%

1.0
1.0
1.0
0.01-
%
%

=
−==


=
P
Q
e dd
 
 
 
   
)(10
10
0.01
0.1-
2/200
1/10-
%100*200)/200-(202
%100*0110)/-(9

valueabsolute=
−===
=
Quantity Demanded
(packets of chips)
Price
($/packet)
10
$2.02
$0.22
100
$0.20
99
$2.00
9
9Interpreting the “number” for elasticity.
9
Pricein change %
DemandedQuantity in change %
=ed
Observations:
▪ ed will be a negative number since “demand”
is a downward sloping relationship.
▪ for convenience we drop the negative sign
and use the absolute value when talking
about elasticity of demand, ed .
10
Point Price Elasticity of Demand, ed
(a graphical interpretation)
Q
P
run
rise
slope


==
iQ
Quantity demanded
(units)
Price
($/unit)
iP
A ),( ii PQ
PPi +
QQi −
P
Q
B
11
Point Price Elasticity of Demand, ed
ed =
11curvedemandofslopeQ
P
e
i
i
d
1
* =
12
12
Point Price Elasticity of Demand, ed
2. Varies depending on the price at a point on
the demand curve (Pi)
3. Varies depending on the quantity at a point
on the demand curve (Qi)
4. Varies depending on the slope at a point on
the demand curve.
1. Measures the percentage change in quantity
demanded in response to a one percent change
in price.
13
Interpreting the “number” for elasticity.
13
Define elasticity of demand as:
pricein change %
demandedquantity in change %
=ed
1. Inelastic if < 1ed
2. Unit elastic if = 1ed
3. Elastic if > 1ed
14
An analogy.
14
1. A piece of concrete is not able to be
stretched. It can be described as being
inelastic. In other words, as a force is applied,
there is little change in length (quantity).
2. A rubber band is stretched by applying a
force. The rubber is described as elastic. In
other words, as a force is applied, there is an
observable change in length (quantity).
Lecture 5 ECON1010
15
Price elasticity estimates for some products
Good or service Price elasticity of demand
Peas 2.80
Restaurant meals 1.63
Cars 1.35
Electricity 1.20
Beer 1.19
Movies 0.87
Air travel (international) 0.77
Shoes 0.70
Coffee 0.25
Theatre, opera 0.18
15
16
Point Price Elasticity of Demand
16
Example 1.
The price of a can of Coke was $2 midway through
the season at a Bronco’s home game at Lang Park.
8000 cans were sold.
Calculate the point price elasticity of demand for
Coke at Lang Park for this Bronco’s game. Assume
demand for Coke is linear as shown in the following
graph.
Lecture 5 ECON1010
17
Point Price Elasticity of Demand
Example 1:
curvedemandofslopeQ
P
e
i
i
d
1
* =
Quantity demanded
(1000’s cans)
Price
($/can)
0
8
2
6
12
A (8, 2)
inelastic
ed
=
== 5.0
)12/6(
1
*
8
2

18
Point Price Elasticity of Demand
18
Example 2.
Knowing something about elasticity of demand, the
food catering manager decides to increase the price
of a can of Coke to $3 at the Bronco’s second last
home game. 6000 cans were sold.
Calculate the point elasticity of demand for Coke
at Lang Park for the Bronco’s second last game.
Assume demand is linear as before.
Lecture 5 ECON1010
19
Point Price Elasticity of Demand
Example 2:
Quantity demanded
(1000’s cans)
Price
($/can)
0
6
3
6
12
curvedemandofslopeQ
P
e
i
i
d
1
* =
A (6, 3)
elasticunit
ed
=
== 1
)12/6(
1
*
6
3

20
Point Price Elasticity of Demand
20
Example 3.
The Bronco’s are having a great season, and the
food catering manager believes Lang Park will be
sold out for the last home game. The price of a can
of Coke is increased to $4 as it is believed that fans
just love Coke! 4000 cans were sold at the game.
Calculate the point elasticity of demand for Coke
at this last home game. Assume demand is linear as
at the previous games.
Lecture 5 ECON1010
21
Point Price Elasticity of Demand
Example 3:
Quantity demanded
(1000’s cans)
Price
($/can)
4
0
4
6
12
A (4, 4)
elastic
ed
=
== 2
)12/6(
1
*
4
4

curvedemandofslopeQ
P
e
i
i
d
1
* =
22
0
1
2
3
4
5
6
7
0 2 4 6 8 10 12 14
P
r
ic
e
(
$
/c
a
n
)
Quantity demanded ('000s of cans)
demand is price
elastic
>1ed
demand is price
inelastic
<1
ed
ed
demand is
unit elastic
= 1
Summary of Coke Examples
ed = 2
ed = 1
ed = 0.5
23
Elastic, Unit Elastic, and Inelastic Demand
3 Elasticity value
Inelastic
Unit
Elastic
Elastic
210
24
Note:
How can you realistically find the slope of the demand
curve at a particular price and quantity demanded?
Is demand really linear?
Calculating Midpoint Elasticity.
24
An approximation to the point price elasticity is called
the midpoint price elasticity.
Lecture 5 ECON1010
25
Calculating Elasticity using Midpoint Formula.
Price
($/unit)
Quantity Demanded (units)Q
B
A
P
),( AA PQ
),( BB PQ Midpoint between
A and B
BA QQQ −=
BA PPP −=
26
( ) 
( ) 2/
2/

BA
BA
d
PPP
QQQ
e
+
+
=
=
Midpoint Price Elasticity of Demand
AVERAGE
AVERAGE
de
PP
QQ



=
( ) 
( ) BA
BA
d
PPP
QQQ
e
+
+
=
=
27
Midpoint Price Elasticity of Demand
27
Example 4.
The price of a can of Coke was $3 at the second last
Bronco’s home game. 6000 cans were sold. For the
last home game, the food catering manager believed
the fans loved Coke so much they would pay an even
higher price. The price increased to $4 per can, and
4000 cans are sold. Roughly the same crowd number
of fans turned up for the last home game. The manager
does NOT know if demand is linear.
Estimate the midpoint elasticity of demand for Coke
at Lang Park.
28
Midpoint Price Elasticity of Demand
Example 4:
P
Q
Quantity demanded
(1000’s cans)
Price
($/can)
40
4
6
B
A
3
??
??
( ) 
( ) 
 
 
)(4.1
40.1
1/7
2/10-
343)/-(4
646)/-(4

valueabs=
−=
=
+
+
=
( ) 
( ) BA
BA
d
PPP
QQQ
e
+
+
=
29
The elasticity of demand for a can of Coke at Lang
Park was 1.40. This means demand is elastic.
Interpreting the “number” for elasticity.
29
But what does elastic demand tell us?
Based on the definition, it means the % change in
the quantity demanded of Coke is larger compared
to the % change in the price of Coke.
BIG Deal? So what are the implications of this???
30
Recall the analogy.
30
Elasticity shows an inverse relationship to the
slope of the demand curve.
Conclusions:
The steeper the demand curve at a particular
point on it, the more inelastic is demand.
The flatter the demand curve, the more elastic
is demand.
Lecture 5 ECON1010
31
D1
D2
12
4 6 12
6
4
Price Elasticity and Steepness of Demand Curve
Quantity demanded (‘000s cans)
P
ri
ce
(
$
/c
a
n
)
What is the Point Price Elasticity of Demand when Price = $4/can?
(4, 4)
2
1
6
12
1
4
4
1
=














=De (inelastic)
2
12
6
1
4
4
2
=














=De
(elastic)
32
Diagrammatic Summary.
Price
($/unit)
Quantity demanded (units)
ed = 0
perfectly inelastic
(slope = infinite)
ed
perfectly elastic
= infinite (slope = 0)
0
The steeper the demand curve slope, the relatively
more inelastic is demand.
33
Revisit Coke example again where = 1.4
33
Initially, price = $3 per can, Q = 6000 cans
Price rises to $4 per can for last game, and the
observed sales were Q = 4000 cans.
Conclusion:
Initially, revenue = $3/can * 6000 cans = $18 000
Price , revenue = $4/can * 4000 cans = $16 000
When > 1 (elastic), an increase in price results
in decrease in revenue.
ed
ed
Demand Elasticity and Consumer Expenditure
34
0
1
2
3
4
5
6
7
0 2 4 6 8 10 12 14
P
r
ic
e
(
$
/c
a
n
)
Quantity demanded ('000s of cans)
demand is price
elastic
>1ed
demand is price
inelastic
<1
ed
ed
demand is
unit elastic
=1
Summary of Coke Example
Revenue = $18,000
35
0
1
2
3
4
5
6
7
0 2 4 6 8 10 12 14
P
r
ic
e
(
$
/c
a
n
)
Quantity demanded ('000s of cans)
demand is price
elastic
>1ed
demand is price
inelastic
<1
ed
ed
demand is
unit elastic
=1
Summary of Coke Example
Revenue
= $16,000
36
0
1
2
3
4
5
6
7
0 2 4 6 8 10 12 14
P
r
ic
e
(
$
/c
a
n
)
Quantity demanded ('000s of cans)
demand is price
elastic
>1ed
demand is price
inelastic
<1
ed
ed
demand is
unit elastic
=1
Summary of Coke Example
Revenue = $16,000
37
Summary of analysis.
1. If demand is inelastic, price , revenue
2. If demand is unit elastic, revenue is maximised.
3. If demand is elastic, price , revenue
4. Elasticity is NOT constant along the demand curve.
5. As price rises, demand becomes relatively more
elastic (or referred to as becoming less inelastic).
37
38
The importance of Elasticity.
38
Consider the following questions for discussion
during the lecture.
1. Everyone needs to use oil, so oil is inelastic.
Lecture 5 ECON1010
2. Advertising cosmetics for women will only
enable an organisation to increase its
revenues as a result of shifting the demand.
39
The importance of Elasticity.
39
Comments on 1.
Lecture 5 ECON1010
40
The importance of Elasticity.
40
Comments on 2.
Lecture 5 ECON1010
41
The importance of Elasticity.
41
Factors affecting elasticity of demand.
1. Availability of close substitutes.
2. Time involved from the time of the price
change.
3. Essentials verses luxuries.
4. The percentage of a consumer’s budget spent
on the product (or service).
42
42
Factors affecting elasticity of demand.
1. Availability of close substitutes.
▪ The more substitutes available for a product, the
easier it is for consumers to switch when there is a
price increase.
▪ Ability of consumers to switch easily implies
there is intense competition.
▪ The more competition, the more elastic will be
demand.
Lecture 5 ECON1010
43
43
Factors affecting elasticity of demand.
2. Time involved from the time of the price
change.
▪ When prices change, consumers take time to
adjust their spending habits.
▪ The more time that passes after a price rise, the
more options consumers might be able to find to
switch to another product.
▪ The more time involved, the more elastic will be
demand.
Lecture 5 ECON1010
44
44
Factors affecting elasticity of demand.
3. Essentials verses luxuries.
▪ The more essential it is for consumers to have an
item, the less likely they are to switch to another
product (eg: razor blades for shaving).
▪ A luxury item is non–essential, and so consumers
are more easily able to choose not to purchase it
(eg: tickets to a day at the cricket).
▪ The more essential a product, the more inelastic
will be demand.
45
45
Factors affecting elasticity of demand.
4. The proportion of a consumer’s budget spent
on the product.
▪ The larger the proportion spent on an item, the
more careful a consumer will be before making
the purchase. The smaller the proportion, the less
worried they will be about the purchase.
▪ The more a product takes from a consumer’s
budget, the more elastic will be demand.
Lecture 5 ECON1010
46
In 2008, oil prices were surging above US$150 per
barrel. Prices at the petrol pump around Australia
were going above $2 a litre. Not only were
consumers starting to “scream” at such prices, but
some OPEC member countries were equally
becoming alarmed at the higher prices.
Using the theory of elasticity of demand and
diagrams, explain why OPEC members were
becoming concerned.
46
Applying the Concepts.
Lecture 5 ECON1010
47
Point Price Elasticity of Supply, es
es =
47
curvesupply theof slope
1
*
i
i
s
Q
P
e =
48
48
Price Elasticity of Supply, es
Important conclusions to note about price
elasticity of supply are:
1. It varies depending on the price at a point
on the supply curve (Pi)
2. It varies depending on the quantity at a
point on the supply curve (Qi)
3. It varies depending on the slope at a point
on the supply curve.
49
Applying the Point Elasticity Definition
Quantity Supplied
(packets of chips)
Price
($/packet)
11
2.05
1.05
100
1.00
101
2.00
10
50
Diagrammatic Summary.
es
perfectly inelastic
= 0 (slope = infinite)
perfectly elastic supply
= infinite (slope = 0)es
Price
($/unit)
Quantity supplied (units)0
The steeper the supply curve slope, the relatively
more inelastic is supply.
51
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52
Lecture 5 ECON1010 52
http://www.google.com.au/imgres?q=dalmatian+sheep
53
Conclusions.
▪ Elasticity is an economic tool that can help in making
choices.
▪ Demand and supply elasticity are used to assess
impacts on revenues from possible changes in prices
(of products and services).
53Lecture 5 ECON1010
54
Next Lecture
▪ Lecture 6.
Perfectly Competitive Supply.
- the cost side of the market.
54Lecture 5 ECON1010