Lecture 8
ELASTICITY

• Price elasticity of demand (and supply)
• Elastic and inelastic demand (and supply)
• Total revenue
• Cross elasticity of demand
• Income elasticity of demand

1. Price elasticity of demand

• Measures the responsiveness of quantity demanded to price

• Pure number; no units

• Definition:
  e = [% change in quantity demanded] / [% change in price]
  % change in P = Change in P/(Avg value of P)
  % change in Q = Change in Q/(Avg value of Q)

2. Shape of the demand curve

• Perfectly inelastic curve:
  e=0 (medicines, salt)

• Perfectly elastic curve:
  e is infinite

• Unit-elastic curve:
  e=1

• Elastic curve:
  e > 1 (Luxury goods; goods with close substitutes)

• Inelastic curve:
  e < 1 (Necessities; goods without substitutes)

• Straight-line demand curve:
  Show that e falls as Q increases.

3. Total expenditure (or Total revenue)

• If demand is elastic (e > 1):
  TR increases

• If demand is inelastic (e < 1):
  TR decreases

• If demand is unit-elastic (e=1):
  TR remains unchanged

4. Cross elasticity of demand

• Substitutes:
  Cross elasticity is positive

• Complements:
  Cross elasticity is negative

5. Income elasticity of demand

• Definition?

6. Price elasticity of supply

• Elastic supply:
  Flat supply curve

• Inelastic supply:
  Steep supply curve

7. The burden of a sales tax

Answer: Depends on the elasticity of demand and supply