Chapter 4: Elasticity
Definition of Elasticity: how responsive one factor is to other factors
Independent of units of measurement and is based on ratios, so easily applied
Price Elasticity of Demand
Slope Formula: (ΔQ/Qaverage)/( ΔP/Paverage) or (% change in quantity demanded)/(% change in price)
What does the price elasticity mean and what does it look like?
● |Ed| = 0 denotes a perfectly inelastic demand → quantity demanded does not react to price (ex. Insulin)
● 0 < |Ed| < 1 denotes inelastic demand→ quantity demanded changes slower than price (ex. Food, shelter)
● |Ed| = 1 denotes unit elastic demand → quantity demanded changes at the same rate as price
● 1 < |Ed| < ∞ denotes elastic demand → quantity demanded changes faster than price (ex. Automobiles)
● |Ed| = ∞ denotes a perfectly elastic good → quantity demanded reacts radically to price (ex. Soft drink from 2 campus machines
located side by side)
What makes a good’s demand elastic or inelastic?
Closeness of substitutes The more substitutes a good has and the closer these substitutes are, the more elastic a good is
Proportion of income The larger of a share an income’s price takes up, the more elastic a good is (for example,
vacations take up a large % of a person’s income, meaning vacations are elastic)
Importance of goods The less essential a good is, the more elastic it is (for example, jewelry is non-essential, so it’s
elastic)
Time elapsed since price change The more time customers have to react to a price change, the more elastic the good is
Revenue and elasticity
● Price changes atfect revenue in ditferent ways depending on elasticity
● If the good is elastic, revenue increases as you decrease price
● If the good is inelastic, revenue increases as you increase price
● You can observe the revenue change to determine elasticity
Your demand and elasticity
● If your demand is elastic, your purchase amount will increase by more than 1% with a 1% price cut
● If your demand is inelastic, your purchase amount will increase by less than 1% with a 1% price cut
Income Elasticity of Demand: Measure of how quantity of good responds to change in income
Formula: (ΔQ/Qaverage)/( ΔI/Iaverage) or (% change in quantity demanded)/(% change in income)
● If your income elasticity is greater than 0, the good is income elastic (greater than 1) or income inelastic (less than 1) →
increasing income also increases quantity purchased
, ● If your income elasticity is less than 0, the good is inferior meaning that decreasing income increases quantity (i.e: fast food)
Cross elasticity of demand: Measure of how quantity of good demanded changes based on the price of another good
Formula: (ΔQ/Qaverage)/( ΔP/Paverage) or (% change in quantity demanded)/(% change in other good’s price)
● If cross elasticity is greater than 0, the two goods are substitutes; increase in the price of other good increases demand
● If cross elasticity is less than 0, the two goods are complements; increase in the price of other good decreases demand
Elasticity of supply: Measures how quantity supplied responds to price change:
Formula: (ΔQ/Qaverage)/( ΔP/Paverage) or (% change in quantity supplied)/(% change in good’s price)
● Vertical line is non-elastic; supply is not atfected by price change
● Any slanted line is unit-elastic; supply is atfected by price change
● Horizontal line is infinitely elastic; decrease in price could cause cessation of supply
Factors in supply elasticity
● Resource substitution → the easier it is to use the resources for the product in other products, the more supply elastic
● Time frame → the more time passes after a change in price, the more elastic the quantity supplied of a good is.
, Chapter 4 Practice Questions
1. If a good’s demand curve is a horizontal line, then the good has
a. Infinite price elasticity of demand
b. Price elasticity of demand equal to zero
c. Zero income elasticity
d. Price elasticity likely to fall in short run
2. Which one of the following has the most inelastic demand?
a. Apples
b. Peanut butter
c. Gasoline
d. Insulin for a diabetic
3. The price of beef increases by 20%. Beef producers are able to increase productivity of their herds by 15%. What’s the elasticity
coefficient for beef?
a. 1.95
b. 0.8
c. 0.75
d. 1.44
4. Which of the following factors influences the elasticity of demand?
a. Income
b. Preferences
c. The closeness of substitutes
d. The closeness of complements
5. If a rise in price leads to a decrease in total revenue, the price elasticity of demand is
a. Negative
b. Zero
c. Greater than zero but less than 1
d. Equal to 1
e. Greater than 1
6. When the price of good X goes up, the quantity demanded for Y goes down. Which of the following is true?
a. The two goods are complementary
b. The two goods are normal goods
c. The cross-price elasticity coefficient is positive
d. The cross-price elasticity coefficient is zero
7. An increase in demand with a highly inelastic supply will result in:
a. Price falling by a lot and quantity rising by a small degree
, b. Price rising by a small degree and quantity rising by a lot
c. Price falling by a small degree and quantity falling by a lot
d. Price rising by a lot and quantity rising by a small degree
8. A shift in demand would not atfect price when supply is
a. Perfectly inelastic
b. Unit elastic
c. Perfectly elastic
d. Of zero elasticity
9. When the price elasticity of demand is____ , demand for the good is perfectly inelastic.
a. Equal to infinity
b. Greater than 1
c. Equal to 1
d. Between 1 and zero
e. Equal to zero
10. When the price elasticity of demand is____ , demand for the good is elastic.
a. Equal to infinity
b. Greater than 1
c. Equal to 1
d. Between zero and 1
e. Equal to zero
11. ________ indicates when the demands for two or more goods are related.
a. The cross elasticity of demand
b. The income elasticity of demand
c. The price elasticity of demand
d. The normal elasticity of demand
12. The price of product A falls from $22 to $15. During this time, product B’s quantity demanded rises from 42 to 65. Product C’s
quantity demanded rises from 68 to 95. Which good is a greater compliment to product A?
a. Product B
b. Product C
13. Luxury goods tend to have income elasticities of demand that are
a. Greater than 1
b. Greater than zero but less than 1
c. Negative
d. Less than the income elasticity of demand for normal goods
14. If good X is a complement of good Y, then the cross elasticity of demand is
Definition of Elasticity: how responsive one factor is to other factors
Independent of units of measurement and is based on ratios, so easily applied
Price Elasticity of Demand
Slope Formula: (ΔQ/Qaverage)/( ΔP/Paverage) or (% change in quantity demanded)/(% change in price)
What does the price elasticity mean and what does it look like?
● |Ed| = 0 denotes a perfectly inelastic demand → quantity demanded does not react to price (ex. Insulin)
● 0 < |Ed| < 1 denotes inelastic demand→ quantity demanded changes slower than price (ex. Food, shelter)
● |Ed| = 1 denotes unit elastic demand → quantity demanded changes at the same rate as price
● 1 < |Ed| < ∞ denotes elastic demand → quantity demanded changes faster than price (ex. Automobiles)
● |Ed| = ∞ denotes a perfectly elastic good → quantity demanded reacts radically to price (ex. Soft drink from 2 campus machines
located side by side)
What makes a good’s demand elastic or inelastic?
Closeness of substitutes The more substitutes a good has and the closer these substitutes are, the more elastic a good is
Proportion of income The larger of a share an income’s price takes up, the more elastic a good is (for example,
vacations take up a large % of a person’s income, meaning vacations are elastic)
Importance of goods The less essential a good is, the more elastic it is (for example, jewelry is non-essential, so it’s
elastic)
Time elapsed since price change The more time customers have to react to a price change, the more elastic the good is
Revenue and elasticity
● Price changes atfect revenue in ditferent ways depending on elasticity
● If the good is elastic, revenue increases as you decrease price
● If the good is inelastic, revenue increases as you increase price
● You can observe the revenue change to determine elasticity
Your demand and elasticity
● If your demand is elastic, your purchase amount will increase by more than 1% with a 1% price cut
● If your demand is inelastic, your purchase amount will increase by less than 1% with a 1% price cut
Income Elasticity of Demand: Measure of how quantity of good responds to change in income
Formula: (ΔQ/Qaverage)/( ΔI/Iaverage) or (% change in quantity demanded)/(% change in income)
● If your income elasticity is greater than 0, the good is income elastic (greater than 1) or income inelastic (less than 1) →
increasing income also increases quantity purchased
, ● If your income elasticity is less than 0, the good is inferior meaning that decreasing income increases quantity (i.e: fast food)
Cross elasticity of demand: Measure of how quantity of good demanded changes based on the price of another good
Formula: (ΔQ/Qaverage)/( ΔP/Paverage) or (% change in quantity demanded)/(% change in other good’s price)
● If cross elasticity is greater than 0, the two goods are substitutes; increase in the price of other good increases demand
● If cross elasticity is less than 0, the two goods are complements; increase in the price of other good decreases demand
Elasticity of supply: Measures how quantity supplied responds to price change:
Formula: (ΔQ/Qaverage)/( ΔP/Paverage) or (% change in quantity supplied)/(% change in good’s price)
● Vertical line is non-elastic; supply is not atfected by price change
● Any slanted line is unit-elastic; supply is atfected by price change
● Horizontal line is infinitely elastic; decrease in price could cause cessation of supply
Factors in supply elasticity
● Resource substitution → the easier it is to use the resources for the product in other products, the more supply elastic
● Time frame → the more time passes after a change in price, the more elastic the quantity supplied of a good is.
, Chapter 4 Practice Questions
1. If a good’s demand curve is a horizontal line, then the good has
a. Infinite price elasticity of demand
b. Price elasticity of demand equal to zero
c. Zero income elasticity
d. Price elasticity likely to fall in short run
2. Which one of the following has the most inelastic demand?
a. Apples
b. Peanut butter
c. Gasoline
d. Insulin for a diabetic
3. The price of beef increases by 20%. Beef producers are able to increase productivity of their herds by 15%. What’s the elasticity
coefficient for beef?
a. 1.95
b. 0.8
c. 0.75
d. 1.44
4. Which of the following factors influences the elasticity of demand?
a. Income
b. Preferences
c. The closeness of substitutes
d. The closeness of complements
5. If a rise in price leads to a decrease in total revenue, the price elasticity of demand is
a. Negative
b. Zero
c. Greater than zero but less than 1
d. Equal to 1
e. Greater than 1
6. When the price of good X goes up, the quantity demanded for Y goes down. Which of the following is true?
a. The two goods are complementary
b. The two goods are normal goods
c. The cross-price elasticity coefficient is positive
d. The cross-price elasticity coefficient is zero
7. An increase in demand with a highly inelastic supply will result in:
a. Price falling by a lot and quantity rising by a small degree
, b. Price rising by a small degree and quantity rising by a lot
c. Price falling by a small degree and quantity falling by a lot
d. Price rising by a lot and quantity rising by a small degree
8. A shift in demand would not atfect price when supply is
a. Perfectly inelastic
b. Unit elastic
c. Perfectly elastic
d. Of zero elasticity
9. When the price elasticity of demand is____ , demand for the good is perfectly inelastic.
a. Equal to infinity
b. Greater than 1
c. Equal to 1
d. Between 1 and zero
e. Equal to zero
10. When the price elasticity of demand is____ , demand for the good is elastic.
a. Equal to infinity
b. Greater than 1
c. Equal to 1
d. Between zero and 1
e. Equal to zero
11. ________ indicates when the demands for two or more goods are related.
a. The cross elasticity of demand
b. The income elasticity of demand
c. The price elasticity of demand
d. The normal elasticity of demand
12. The price of product A falls from $22 to $15. During this time, product B’s quantity demanded rises from 42 to 65. Product C’s
quantity demanded rises from 68 to 95. Which good is a greater compliment to product A?
a. Product B
b. Product C
13. Luxury goods tend to have income elasticities of demand that are
a. Greater than 1
b. Greater than zero but less than 1
c. Negative
d. Less than the income elasticity of demand for normal goods
14. If good X is a complement of good Y, then the cross elasticity of demand is
