Micro Econ

© 2012 Pearson Addison-Wesley


Q1: The price elasticity of demand equals magnitude of the _________.

A change in the price divided by the change in quantity demanded

B change in the quantity demanded divided by the change in price

C percentage change in the price divided by the percentage change in the quantity demanded

D percentage change in the quantity demanded divided by the percentage change in the price



Q2: “Last October, due to an early frost, the price of a pumpkin increased by 10 percent compared to the previous year’s price. As a result, the quantity demanded decreased from 2 million to 1.5 million.” Based on this statement, the _______.

A demand for pumpkins is elastic

B demand for pumpkins is inelastic

C demand for pumpkins is unit elastic

D demand for pumpkins increased


Elasticity Along a Linear Demand Curve

First calculate the elasticity at the mid-point.

We first choose a small range where the point we want to calculate is in the middle.

The change in price is $5 and the average price is $12.50.

Price Elasticity of Demand


The quantity demanded increases from 20 to 30 pizzas an hour.

So the average quantity is 25 pizzas.

The price elasticity is (10/25)/(5/12.5), which equals 1.

How much is the elasticity at a price of $20? At a price of $5?



For example, if the price falls from $25 to $15, the quantity demanded increases from 0 to 20 pizzas an hour.

The average price is $20 and the average quantity is 10 pizzas.

The price elasticity of demand is (20/10)/(10/20), which equals 4.



If the price falls from $10 to $0, the quantity demanded increases from 30 to 50 pizzas an hour.

The average price is $5 and the average quantity is 40 pizzas.

The price elasticity is (20/40)/(10/5), which equals 1/4.



For any linear demand curve:

At prices above the mid-point of the demand curve, demand is elastic.At prices below the mid-point of the demand curve, demand is inelastic.

At the mid-point of the demand curve, demand is unit elastic.


The elasticity is always decreasing as we move down along the demand curve!


If the percentage change in the quantity demanded equals the percentage change in price, …

Then the price elasticity of demand equals 1 and the good has unit elastic demand.

Figure 4.3(b) illustrates this case—a demand curve with ever declining slope.



Total Revenue and Elasticity

Elasticity can help firms to decide whether they should increase or cut the price.

The total revenue from the sale of good or service equals the price of the good multiplied by the quantity sold.

When the price changes, total revenue also changes.

But a rise in price doesn’t always increase total revenue.

The key determination here is elasticity!



The change in total revenue due to a change in price depends on the elasticity of demand:

If demand is elastic, a 1 percent price cut increases the quantity sold by more than 1 percent, and total revenue increases.

EX ： the elasticity of pizza is 4 when price is $20 and quantity demanded is 10 per hour. The total revenue is $20* 10 = $200 per hour.

Now the firm cut the price by 10% to $18 , the quantity would increase by 40% (10%*4) to 14 per hour, therefore the total revenue is $18 * 14 =$252.



If demand is inelastic, a 1 percent price cut increases the quantity sold by less than 1 percent, and total revenues decreases.

If demand is unit elastic, a 1 percent price cut increases the quantity sold by 1 percent, and total revenue remains unchanged.

Decrease in revenue caused by price cut is exactly offset by increase in revenue caused by rise in sale.



The relationship between elasticity of demand and the total revenue:

As the price falls from $25 to $12.50, the quantity demanded increases from 0 to 25 pizzas.

Total revenue is 0 at a price of $25 and $312.50($12.50*25) at a price of $12.50.

Between these two points, demand is elastic, and total revenue increases as price falls.



In part (b), as the quantity increases from 0 to 25 pizzas, demand is elastic, and total revenue increases.



At $12.50, demand is unit elastic and total revenue stops increasing.



When price is $12.50 and quantity demanded is 25, demand is unit elastic, and total revenue is at its maximum.



As the price falls from $12.50 to zero, the quantity demanded increases from 25 to 50 pizzas.

But total revenue would decrease from $312.50 to 0.

Between the two points, demand is inelastic, and total revenue decreases.



As the quantity increases from 25 to 50 pizzas, demand is inelastic, and total revenue decreases.



When we know the change in total revenue that results from a price change, we can estimate the elasticity.

This method is called the total revenue test;

•If a price cut increases total revenue, demand is elastic.

If a price cut decreases total revenue, demand is inelastic.

If a price cut leaves total revenue unchanged, demand is unit elastic.



The Factors That Influence the Elasticity of Demand

The elasticity of demand for a good depends on:

The closeness of substitutes

The proportion of income spent on the good

The time elapsed since a price change



Closeness of Substitutes

The closer the substitutes for a good or service, the more elastic are the demand for the good or service.

Necessities, such as food or housing, generally have inelastic demand, while luxuries, such as super bowl tickets, generally have elastic demand.

Is the demand for gasoline elastic?

What about the demand for the gasoline in a Shell gas station, where an Exxon gas station is located nearby?



Proportion of Income Spent on the Good

The greater the proportion of income consumers spend on a good, the larger is the elasticity of demand for that good.

EX: think of your demand for gums and the demand for housing, suppose the price of both double at the same time…

Time Elapsed Since Price Change

The more time consumers have to adjust to a price change, or the longer that a good can be stored without losing its value, the more elastic is the demand for that good.

EX: think of a price increase in air ticket happened one week before your vacation, or one month…


Micro Econ

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