Chapter 04 – Elasticity
CHAPTER 4
ELASTICITY
Chapter Overview
Supply and demand may be the most common words in economics, but
applying these concepts to the real world requires a bit of elaboration.
Elasticity is the first of several concepts we will study that will help you to
apply the concepts of supply and demand to business and policy questions.
In this chapter we saw how elasticity can be used to predict how price
changes will influence revenue. In the coming chapters we will use elasticity
to predict the e ects of government intervention in the market, and we will
dig deeper into the consumer and producer choices that drive elasticity.
Learning Objectives
LO 4.1: Calculate price elasticity of demand using the mid-point method.
LO 4.2: Explain how the determinants of price elasticity of demand a ect the
degree of elasticity.
LO 4.3: Calculate price elasticity of supply using the mid-point method.
LO 4.4: Explain how the determinants of price elasticity of supply a ect the
degree of elasticity.
LO 4.5: Calculate cross-price elasticity of demand, and interpret the sign of
the elasticity.
LO 4.6: Calculate income elasticity of demand, and interpret the sign of the
elasticity.
Chapter Outline
OPENING STORY: COFFEE BECOMES CHIC
What Is Elasticity?
Price Elasticity of Demand
Calculating Price Elasticity of Demand (LO 4.1)
Determinants of Price Elasticity of Demand (LO 4.2)
Using Price Elasticity of Demand
BOX FEATURE: REAL LIFE – DOES CHARGING FOR BEDNETS DECREASE
MALARIA?
BOX FEATURE: WHAT DO YOU THINK? – SHOULD ENTRANCE FEES AT
NATIONAL PARKS BE RAISED?
Price Elasticity of Supply
Calculating Price Elasticity of Supply (LO 4.3)
Determinants of Price Elasticity of Supply (LO 4.4)
Other Elasticities
Cross-Price Elasticity of Demand (LO 4.5)
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Chapter 04 – Elasticity
Income Elasticity of Demand (LO 4.6)
BOX FEATURE: WHERE CAN IT TAKE YOU? – PRICING ANALYST
Beyond the Lecture
Class Activity: Calculating Price Elasticity of Demand (LO 4.1)
Netflix enacted a large percentage price increase in 2016 (read an article
about this price increase here). Using the original estimates in the article,
have students consider the price elasticity of demand for Netflix. This works
well with small groups.
1. If the price increases from $8 to $10 and subscriptions fall by 480,000,
what economic phenomena are we seeing? (the answer is the first law
of demand)
2. Given that analysts expected higher revenues as a result of the higher
prices, what can we say about the elasticity of demand for Netflix?
Class Discussion: Determinants of Price Elasticity of Demand (LO
4.2)
Ask students to consider the price elasticity of demand for cigarettes. The
article here discusses a recent proposal to increase the federal cigarette tax.
This is also a nice topic for a small group discussion or in an online
environment.
1. How do smokers respond to a change in the price of cigarettes? Are
they relatively elastic or relatively inelastic?
2. What are the factors that drive the price elasticity of demand for
cigarettes?
3. Are there any substitutes for cigarettes? It is interesting to consider a
federal tax, state tax, or local tax here as the answers are slightly
di erent.
4. Does the other things constant assumption hold when taxes on
cigarettes rise?
Writing Assignment: Determinants of Price Elasticity of Demand (LO
4.2)
Have students listen to this EconTalk podcast by Russell Roberts featuring
Richard McKenzie on prices.
1. Why do prices fall after a major gift-giving season?
2. Why does popcorn at the movie theatre generally seem to be so
expensive?
Clicker Questions
There are three main purposes to clicker questions. First, they are a great
way to do a quick and instant “on demand” test of student understanding of
the material. You can cover material, and instantly get feedback on student
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Education.
Chapter 04 – Elasticity
comprehension. You can see whether you need to explain certain topics
again, or move on to the next subject. Second, they are a great method to
break up the class and take a moment away from lecture. It gets the
students actively involved. Finally, certain clicker questions can be framed in
a “discussion” manner, in which you can invite students to talk about the
possible right answer with their peers. You can instruct students to convince
their classmate of a right or wrong answer.
1. Which of the following will likely have the most elastic demand? [LO 4.2]
D. electricity
Feedback: A specific brand of cereal will likely have many substitutes. The
closeness and availability of substitutes plays a large role in the
determination of elasticity. More substitutes will mean that a good is more
elastic.
2. Which is the most likely to have a perfectly inelastic demand? [LO 4.2]
A. Your favorite fast food burrito that you like to eat once a week
Feedback: Gas may not have a lot of substitutes in the short run, but if
prices get very high, we will still choose to drive less when we can. If we
need a life-saving surgery, we’ll get it no matter the price.
3. Why do we use the midpoint method in calculating demand elasticity
instead of just a simple percent change formula? [LO 4.1]
D. To make our demand elasticity value turn into a positive number
Feedback: Using a percent change can cause a “directionality” issue in
which switching your new and old measurement point can change your
answer, even though you’re using the same two points. The midpoint
method eliminates this problem.
4. The sign (positive or negative) of a cross-price elasticity value can tell us
[LO 4.5]
A. if a good is normal or inferior
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Chapter 04 – Elasticity
5. Suppose milk has an income elasticity that is positive, but less than 1.
What does this mean? [LO 4.6]
A. Milk is an inferior good
Feedback: Remind your students that in this case, “necessity” doesn’t
mean something we “need”. It’s just a category label based on numerical
results of income elasticity. You can tell them to think about their income
tripling. They may buy a little more milk each week, but certainly not 3
times as much.
Solutions to End-of–Chapter Questions and Problems
Review Questions
1. You are advising a coffee shop manager who wants to estimate how much sales will change
if the price of a latte rises. You tell him that he should measure the change in sales using the
percentage change in quantity of coffee sold rather than the number of cups of coffee or the total
ounces of coffee sold. Similarly, you tell him that he should measure the price increase in
percentage terms rather than in terms of absolute dollars. Explain why he should measure
elasticity in percentage terms rather than in terms of dollars and cups. [LO 4.1]
Answer: If the coffee shop manager measures elasticity in percentage changes, he will have
an understanding of the price sensitivity of demand for lattes that will be consistent
2. Explain why the coffee shop manager should calculate elasticity using the mid-point
method. [LO 4.1]
Answer: Using the mid-point method to calculate elasticity is useful because the coffee shop
manager will have a single measure of the price sensitivity of demand over a particular range
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Education.
Chapter 04 – Elasticity
3. You are working as a private math tutor to raise money for a trip during spring break. First
explain why the price elasticity of demand for math tutoring might be elastic. Then explain why
the price elasticity of demand for math tutoring might be inelastic. [LO 4.2]
Answer: This would depend on the availability of other tutors who might charge prices
lower than you and how desperate your students are for tutoring. If your students can easily
4. You are working as a private math tutor to raise money for a trip during spring break. You
want to raise as much money as possible. Should you should increase or decrease the price you
charge? Explain. [LO 4.2]
Answer: Whether you should raise or lower your prices depends on the price elasticity of
demand. If demand is elastic, you will increase your revenue by lowering prices. With elastic
5. You have been hired by the government of Kenya, which produces a lot of
co ee, to examine the supply of gourmet co ee beans. Suppose you
discover that the price elasticity of supply is 0.85. Explain this figure to the
Kenyan government. [LO 4.3]
Answer: A price elasticity of supply of .85 would mean that supply of
gourmet co ee beans is inelastic, or not very responsive to prices. For
6. You have noticed that the price of tickets to your university’s basketball
games keeps increasing but the supply of tickets remains the same. Why
might supply be unresponsive to changes in price? [LO 4.3]
Answer: It may not be possible to increase the supply of tickets. The
number of tickets is likely fixed in the short run. There are usually a
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Chapter 04 – Elasticity
7. Which will have a more price-elastic supply over six months: real estate in downtown
Manhattan or real estate in rural Oklahoma? Explain your reasoning. [LO 4.4]
Answer: Real estate in rural Oklahoma will be more price-elastic in the short run than real
estate in Manhattan. Land is scarce in Manhattan, making it difficult to increase real estate.
8. Certain skilled labor, such as hair cutting, requires licensing or certification, which is costly
and takes a long time to acquire. Explain what would happen to the price elasticity of supply for
haircuts if this licensing requirement were removed. [LO 4.4]
Answer: The price elasticity of supply would increase (become more elastic). If the
9. Although we could describe both the cross-price elasticity of demand between paper coffee
cups and plastic coffee lids and the cross-price elasticity of demand between sugar and artificial
sweeteners as highly elastic, the first cross-price elasticity is negative and the second is positive.
What is the reason for this? [LO 4.5]
Answer: Goods that are strong complements like coffee cups and coffee lids will have a
more elastic cross-price elasticity. Likewise, goods that are strong substitutes like sugar and
artificial sweeteners will also have a more elastic cross-price elasticity. In both cases the
10. Name two related goods you consume that would have a positive cross-price elasticity. What
happens to your consumption of the second good if the price of the first good increases?
[LO 4.5]
Answer: When I am craving something sweet, I like cookies and donuts. These treats are
11. Name two related goods you consume which would have a negative
cross-price elasticity. What happens to your consumption of the second good
if the price of the first good increases? [LO 4.5]
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Chapter 04 – Elasticity
Answer: One of my favorite snacks is chips and guacamole. These goods are complements
12. In France, where cheese is an important and traditional part of people’s meals, people eat
about six times as much cheese per person as in the United States. In which country do you think
the demand for cheese will be more income-elastic? Why? [LO 4.6]
Answer: Demand for cheese will be more income-elastic in the United States. While people
in the United States also enjoy cheese, it is not as culturally important as it is in France.
13. Name a good you consume for which your income elasticity of demand
is positive. What happens when your income increases? [LO 4.6]
Answer: Most goods are normal and behave this way. I love dining out at nice restaurants
14. Name a good you consume for which your income elasticity of demand is negative. What
happens when your income increases? [LO 4.6]
Answer: I have always loved to travel. When I was a student, I would stay at youth hostels
4-7
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Education.