T h e B i g P i c t u r e
Where we have been:
The student can now use the demand and supply model to generate predictions and can supplement
this knowledge with the ability to provide richer predictions based on the elasticities of demand and
supply.
Where we are going:
Demand, supply, and de...
ACCESS Test Bank for Microeconomics 14th Edition Parkin
C h a p t e r
4 ELASTICITY
The Big Picture
Where we have been:
The student can now use the demand and supply model to generate predictions and can supplement
this knowledge with the ability to provide richer predictions based on the elasticities of demand and
supply.
Where we are going:
Demand, supply, and demand elasticity get an extensive workout in Chapter 6, where we use them to
explain the division of a tax burden between buyer and seller and the impact of price controls and
quotas. However, before doing that analysis, we study the efficiency and fairness of markets in
Chapter 5. Students will also apply elasticity in Chapter 12 to describe demand in perfect
competition. In Chapter 13, we study the relationship between total revenue and the price elasticity
of demand to show that a monopoly never operates on the inelastic part of the demand curve.
New in the Fourteenth Edition
There are only a few minor changes to this chapter. The chapter opening example and the Economics in
the News case study focus on using elasticity to determine quantitative effects—how much the price or
quantity change—due to changes caused by the Covid-19 pandemic.
, ACCESS Test Bank for Microeconomics 14th Edition Parkin
36 CHAPTER 4
Lecture Notes
Elasticity
The price elasticity of demand measures how strongly buyers respond to a change in the price of a good.
The price elasticity of demand can be used to make quantitative predictions of how changes affect the price
and quantity demanded of a good.
The income elasticity of demand measures how strongly demanders respond to a change in income, and the
cross elasticity of demand measures how strongly demanders respond to the change in the price of another good.
The price elasticity of supply measures how strongly producers respond to a change in the price of a good.
I. Price Elasticity of Demand
In general, elasticity measures responsiveness. The price elasticity of demand measures how responsive
demanders are to a change in the price of the good. This information is often useful for both businesses and
governments because it can predict the impact of a price change on total revenue or total expenditure.
Calculating Price Elasticity of Demand
The price elasticity of demand is a units-free measure of the responsiveness of the quantity demanded of
a good to a change in its price when all other influences on a buyer’s plans remain unchanged. The price
elasticity of demand is equal to the absolute value of:
The formulas for calculating all of the elasticities in the text are based on the arc elasticity or mid-point formula,
meaning the percentage changes are always calculated based on the average price (or income in the case of income
elasticity) and average quantity over the range of change. If you ask students to calculate elasticities, it is important to
practice calculating the percentage change using the average as the basis as it is not likely to be familiar Don’t be
afraid to start with this pre-elasticity warm up to assess the sharpness of your class. Ask: “Suppose that the campus
bookstore increases the price of an economics text from $75 to $100. What is the percentage increase in price?” Many
will say 25 percent. But using the midpoint formula the percentage change is ($25/$87.50) × 100, which is 28.6
percent.
Devise a mnemonic for elasticity calculations. Many students have a hard time remembering whether quantity or
price goes in the numerator of the elasticity formulas. Have the students create their own mnemonic. Suggest
McDonald’s Quarter Pounder™ hamburgers. It’s silly, but it works, reminding the student that Q (quantity) appears
before P (price) in the ratio of percentage changes.
The demand elasticity formula yields a negative value because price and quantity move in opposite
directions. However, it is the magnitude, or absolute value, of the measure that reveals how responsive the
quantity change has been to a price change. So, we use the magnitude or the absolute value of the price
elasticity of demand.
The table to the right has two points on the demand
curve for pizza from a particular pizza parlor. Price Quantity demanded
(dollars per pizza) (pizzas per week)
The absolute value of the percent change in
14 500
quantity demanded is [(500 400) 450] 100 = 16 400
22.2 percent.
The absolute value of the percentage change in
price is [($14 $16) $15] 100 = 13.3 percent.
Between these two points on the demand curve, the price elasticity of demand is 22.2% 13.3% = 1.67.
Elasticity is not the same as slope. Students sometimes wonder why we don’t just measure the slope of the demand
curve to measure responsiveness. Point out to the students that the slope will change when the units change. For
instance, you can compute the slope of a demand curve when the price is measured in dollars and then the slope of
the exact same demand curve when the price is measured in cents. The slope with the price measured in cents is 100
,ACCESS Test Bank for Microeconomics 14th Edition Parkin
ELASTICITY 37
times as large as the initial slope. Tell the students that it is not acceptable for the measure of responsiveness to change
whenever the units of the price (or of the quantity) change.
Inelastic and Elastic Demand
If the price elasticity of demand is less than 1.0, the good is said to have an inelastic demand. In this case,
the percentage change in the quantity demanded is less than the percentage change in price.
If the quantity demanded remains constant when the price changes, then the good is said to have
perfectly inelastic demand. The price elasticity of demand is 0 and the good’s demand curve is a
vertical line.
If the price elasticity of demand is equal to 1.0, the good is said to have a unit elastic demand. In this
case, the percentage change in the quantity demanded equals the percentage change in price.
If the price elasticity of demand is greater than 1.0, the good is said to have an elastic demand. In this
case, the percentage change in the quantity demanded exceeds the percentage change in price.
If the quantity demanded changes by an infinitely large percentage in response to a tiny price change,
then the good is said to have perfectly elastic demand. Furniture 1.26
The price elasticity of demand is infinite. Motor Vehicles 1.14
The table has some “real-life” elasticities from the book. Clothing 0.64
Oil 0.05
Economics in Action” Elastic and Inelastic Demand
This application shows real-world price elasticities of demand for a variety of goods and services as well as a table with
various food elasticities. This data can be a base for discussion of the factors that might lead one item to be more
elastic than the other and allow students in real-time to try to explain and apply price elasticity of demand.
Economics in the News: The Elasticity of Demand for Peanut Butter
The price elasticity of demand for peanut butter is the basis for this application. Further discussion of other demand
elasticities for peanut butter will be explored after those elasticities are introduced.
Elasticity Along a Linear Demand Curve
With the exception of a vertical demand curve and a
horizontal demand curve (along which the elasticity is
0 and infinite, respectively) the price elasticity of demand
changes when moving along a linear demand curve.
As the figure illustrates, at points on the demand
curve above the midpoint, the price elasticity of
demand is elastic while at points below the midpoint,
the price elasticity of demand is inelastic. At the
midpoint, the price elasticity of demand is unit elastic.
Total Revenue and Elasticity
The total revenue from the sale of a good equals
the price of the good multiplied by the quantity sold.
If demand is elastic, a 1 percent price cut increases the quantity
sold by more than 1 percent and total revenue increases.
If demand is unit elastic, a 1 percent price cut increases the
quantity sold by 1 percent and total revenue does not change.
If demand is inelastic, a 1 percent price cut increases the
quantity sold by less than 1 percent and total revenue decreases.
The total revenue test is a method of estimating the price elasticity of demand by observing the change
in total revenue that results from a change in price when all other influences on the quantity sold remain the
same.
If a price cut increases total revenue, demand is elastic. And if a price hike decreases total revenue,
demand is elastic.
, ACCESS Test Bank for Microeconomics 14th Edition Parkin
38 CHAPTER 4
If a price cut does not change total revenue, demand is unit elastic. And if a price hike does not change
total revenue, demand is unit elastic.
If a price cut decreases total revenue, demand is inelastic. And if a price hike increases total revenue,
demand is inelastic.
Similarly, when a price changes, a consumer’s change in expenditure depends on the consumer’s elasticity of
demand.
If demand is elastic, then a price cut means that expenditure on the item increases.
If demand is inelastic, then a price cut means that expenditure on the item decreases.
If demand is unit elastic, then a price cut means that expenditure on the item does not change.
How do changes in revenue relate to elasticity mathematically? When demand is elastic, the absolute value of the
ratio of the percentage change in quantity demanded to percentage change in price must be greater than one. This
point implies that the numerator of the formula for the price elasticity of demand must be greater than the
denominator. In that case, the percentage change in quantity demanded is stronger than the percentage change in
price, so revenues will change in the same direction as the quantity demanded. On the other hand, if demand is
inelastic, the denominator of the formula for the price elasticity of demand must be greater than the numerator. In
that case, changes in revenue will change in the same direction as the price because the percentage change in price is
stronger than the percentage change in quantity. Reviewing these results also helps students understand the logic for
why 1 is the significant value for the coefficient and that the elasticity being farther away from 1 means the reaction is
stronger, whether elastic or inelastic.
The Factors that Influence the Elasticity of Demand
The magnitude of the price elasticity of demand depends on:
The closeness of substitutes: The closer and more numerous the substitutes for a good or service, the more
elastic the demand. This is critical for understanding demand in the market structure section later in the book.
The proportion of income spent on the good: The greater the proportion of income spent on a good or
service, the more elastic the demand.
The amount of time elapsed since the price change: The longer the time elapsed since the price change,
the more elastic the demand.
Price elasticity of needs versus wants: Necessities, such as food or housing, generally have inelastic demand because
there are few substitutes for food and shelter. Luxuries, such as exotic vacations, generally have elastic demand.
Example: Most people’s demand for salt is inelastic, largely because most people spend a miniscule amount of their
income on salt. However large Northern cities’ demand for salt is significantly more elastic. These cities use salt to
treat their roads after a snow storm. Salt is a significant fraction of their budgets. Because the proportion of their
income they spend on salt is large, the price elasticity of demand for these cities is much larger than that of “ordinary”
consumers.
How do gasoline purchases respond to changes in price over time? When gas prices rise from $2 to $4, consumers
initially have few options available. At first, with a given car with a given gas mileage, higher gas prices do not reduce
the quantity of gas consumers purchase by very much. As time passes and gasoline prices continue to remain high,
some consumers eventually find ways to adjust their gas purchases by purchasing more fuel efficient cars, taking new
jobs that are closer to their homes, or by taking fewer road trips or car pooling.
II. More Elasticities of Demand
Income Elasticity of Demand
The income elasticity of demand is a measure of the responsiveness of the demand for a good to a
change in the income, other things remaining the same.
The income elasticity of demand is equal to:
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