CHAPTER 5
ELASTICITY OF DEMAND AND SUPPLY
In this chapter, you will find:
Learning Outcomes
Chapter Outline with PowerPoint Script
Chapter Summary
Teaching Points (as on Prep Card)
Solutions to Problems Appendix
Experiential Assignments
INTRODUCTION
The ability to calculate and comprehend the concept of elasticity is important to both businesses engaged
in price setting and government officials involved in policy making. This chapter focuses on the price
elasticity of demand, but supply elasticity, income elasticity, and cross-price elasticity of demand are
covered also.
LEARNING OUTCOMES
5-1 Define and graph the price elasticity of demand
The price elasticities of demand and supply show how responsive buyers and sellers are to changes in
the price of a good. More elastic means more responsive. When the percentage change in quantity
5-2 Identify the determinants of the price elasticity of demand
5-3 Define and graph the price elasticity of supply
The price elasticity of supply measures the responsiveness of quantity supplied to price changes. Price
5-4 Describe other measures of elasticity
Income elasticity of demand measures the responsiveness of demand to changes in consumer income.
Income elasticity is positive for normal goods and negative for inferior goods. The cross-price
Chapter 5 Elasticity of Demand and Supply 68
CHAPTER OUTLINE WITH POWERPOINT SCRIPT
USE POWERPOINT SLIDES 2-5 FOR THE FOLLOWING SECTION
Price Elasticity of Demand
• A tool used to measure how responsive consumers are to price changes.
USE POWERPOINT SLIDES 6-7 FOR THE FOLLOWING SECTION
Categories of Price Elasticity of Demand
• Inelastic: Percentage change in price has relatively little effect on quantity demanded; elasticity value
USE POWERPOINT SLIDES 8-10 FOR THE FOLLOWING SECTION
Elasticity and Total Revenue: A price decline causes total revenue to:
• Increase if demand is elastic.
• Remain the same if demand is unit elastic.
USE POWERPOINT SLIDES 11-15 FOR THE FOLLOWING SECTION
Constant-Elasticity Demand: Occurs along demand curves that are:
USE POWERPOINT SLIDES 16-19 FOR THE FOLLOWING SECTION
Determinants of Price Elasticity of Demand
Availability of Substitutes: The greater the availability of substitutes and the more similar these
USE POWERPOINT SLIDES 20-24 FOR THE FOLLOWING SECTION
Price Elasticity of Supply: Measures how responsive producers are to a price change.
USE POWERPOINT SLIDES 25-27 FOR THE FOLLOWING SECTION
Constant Elasticity Supply Curves
USE POWERPOINT SLIDES 28-29 FOR THE FOLLOWING SECTION
Determinants of Supply Elasticity: the longer the adjustment period under consideration, the more able
producers are to adapt to a price change, thus Es is greater.
USE POWERPOINT SLIDES 30-32 FOR THE FOLLOWING SECTION
Other Elasticity Measures
Income Elasticity of Demand: How responsive demand is to a change in consumer income. (% in
USE POWERPOINT SLIDE 33 FOR THE FOLLOWING SECTION
Cross-Price Elasticity of Demand: Responsiveness of the demand for one good to changes in the price of
another good. Cross-price elasticity of demand is:
CHAPTER SUMMARY
The price elasticities of demand and supply show how responsive buyers and sellers are to changes in the
price of a good. More elastic means more responsive.
When the percentage change in quantity demanded exceeds the percentage change in price, demand is
price elastic. If demand is price elastic, a price increase reduces total revenue and a price decrease
Chapter 5 Elasticity of Demand and Supply 70
The price elasticity of supply measures the responsiveness of quantity supplied to price changes. Price
elasticity of supply depends on how much the marginal cost of production changes as output changes. If
marginal cost rises sharply as output expands, quantity supplied is less responsive to price increases and is
thus less elastic. Also, the longer the time period producers have to adjust to price changes, the more
elastic the supply.
TEACHING POINTS
1. After establishing how to calculate price elasticity, it is easy to illustrate the relationship between
elasticity and total revenue. Try the following steps using a numerical example:
a. Assume a small rise in the price of the good.
b. Note that this causes the quantity demanded to fall.
2. The elasticity formula is very useful. Consider a grocery store that sells, among other things, peanut
3. Remind students that this chapter focuses on revenues only—costs are not yet considered. Thus,
maximizing total revenue by selling at the unitary elastic price will almost never be an optimum. The
unitary elasticity problem forms a good basis for a question for students to ponder.
4. Aside from the obvious need for business owners to understand elasticity in their revenue
SOLUTIONS TO PROBLEMS APPENDIX
1. (Calculating Price Elasticity of Demand) Suppose that 50 units of a good are demanded at a price of
$1 per unit. A reduction in price to $0.20 results in an increase in quantity demanded to 70 units.
Show that these data yield a price elasticity of 0.25. By what percentage would a 10 percent rise in
Chapter 5 Elasticity of Demand and Supply 71
the price reduce the quantity demanded, assuming price elasticity remains constant along the demand
curve?
ED = A/B, where A = (70 – 50)/[(70 + 50)/2] = 0.0833 and B = (0.20 – 1.0)/[(0.20 + 1.0)/2] =0.333
2. (Price Elasticity and Total Revenue) Fill in the blanks for each price-quantity combination listed in
the following table. What relationship have you depicted?
Price
P Q Elasticity Total Revenue
$9 1
$8 2 ________ ___________
$7 3 ________ ___________
$6 4 ________ ___________
$5 5 ________ ___________
$4 6 ________ ___________
$3 7 ________ ___________
$2 8 ________ ___________
This example shows the relationship between price elasticity of demand and total revenue.
Price
P Q Elasticity Total Revenue
3. (Categories of Price Elasticity of Demand) For each of the following absolute values of price
elasticity of demand, indicate whether demand is elastic, inelastic, perfectly elastic, perfectly
inelastic, or unit elastic. In addition, determine what would happen to total revenue if a firm raised its
price in each elasticity range identified.
a. ED = 2.5
b. ED = 1.0
c. ED = ∞
d. ED = 0.8
Chapter 5 Elasticity of Demand and Supply 72
a. Elastic; total revenue would fall.
4. (Determinants of Price Elasticity) Why is the price elasticity of demand for Coca-Cola greater than
price elasticity of demand for soft drinks generally?
A major determinant of the price elasticity of demand for a product is the number of available
5. (Determinants of Price Elasticity) Would the price elasticity of demand for electricity be more elastic
over a shorter or a longer period of time?
6. (Price Elasticity of Supply) Calculate the price elasticity of supply for each of the following
combinations of price and quantity supplied. In each case, determine whether supply is elastic,
inelastic, perfectly elastic, perfectly inelastic, or unit elastic in each case.
a. Price falls from $2.25 to $1.75; quantity supplied falls from 600 units to 400 units.
b. Price falls from $2.25 to $1.75; quantity supplied falls from 600 units to 500 units.
c. Price falls from $2.25 to $1.75; quantity supplied remains at 600 units.
d. Price increases from $1.75 to $2.25; quantity supplied increases from 466.67 units to 600 units.
a. ES = 1.6; elastic.
7. (Cross-Price Elasticity) Rank the following in order of increasing (from negative to positive) cross-
price elasticity of demand with coffee. Explain your reasoning:
Bleach____Tea____Cream____Cola
First, cream: the cross-price elasticity is negative because coffee and cream are complements.
8. (Income Elasticity of Demand) Calculate the income elasticity of demand for each of the following
goods:
Quantity Demanded Quantity Demanded
When Income = $10,000 When Income = $20,000
Chapter 5 Elasticity of Demand and Supply 73
Good 1 10 25
Good 2 4 5
Good 3 3 2
The income elasticities for Goods 1, 2, and 3 are 1.29, 0.33, and –0.6, respectively, calculating the
9. (Other Elasticity Measures) Complete each of the following sentences:
a. The income elasticity of demand measures, for a given price, the __________ _____________
in quantity demanded divided by the __________________________ in income from which it
resulted.
b. If a decrease in the price of one good causes a decrease in demand for another good, the two
goods are ______________.
c. If the value of the cross-price elasticity of demand between two goods is approximately zero,
they are considered _________________.
a. Percent change; percent change
Experiential Assignments
1. The Campaign for Tobacco-Free Kids maintains a Web site with articles on the economics of
2. Farm problems are not unique to the United States. Send students to the Web page for “Policy
Coherence” concerning trade and agriculture. at http://www.tcd.ie/iiis/policycoherence/index.php/iiis
3. In the computer industry, cross-elasticities of demand are quite important. For example, we know
that computers and computer software are complements, and the cross-elasticity of demand would tell
us how strong that relationship is. Ask students to read the “Personal Technology” column in a
Chapter 5 Elasticity of Demand and Supply 74
effects of the price change. Ask them how the change will affect the quantity demanded of the item
described and how it will affect the demand for substitutes and complements to that item.