Ison and Wall, Economics, 4

th
Edition Pearson Education Limited 2007
Slide 3.1
CHAPTER 3
Elasticity
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.2
Price elasticity of demand (PED)
Measures the responsiveness of the quantity
demanded (QD) of a product to a change in its
own price.

PED =


% change in QD of X
% change in price of X
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.3
PED terminology
Elasticity values (ignoring sign)
0 perfectly inelastic
0 1 relatively inelastic
1 unit elastic
1 infinity relatively elastic
Infinity perfectly elastic
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.4
Factors affecting price elasticity of
demand
Availability of close substitutes
Whether the product is a necessity or a luxury
Whether the product is habit forming
The time period under consideration.
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.5
PED and revenue
Relatively elastic demand if PED >I
(ignoring sign)
Fall in price: Total revenue rises
Rise in price: Total revenue falls
Relatively inelastic demand if PED < I
(ignoring sign)
Rise in price: Total revenue rises
Fall in price: Total revenue falls.
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.6
PED and revenue (Continued)
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.7
PED and tax incidence
Lump-sum tax: incidence of tax on consumer when demand is relatively inelastic
and relatively elastic
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.8
Tax and government revenue
Price elasticities of demand and government revenue from a lump-sum tax
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.9
Income elasticity of demand (IED)
Measures the responsiveness of the quantity
demanded (QD) of X to a change in real
household or national income.

IED =
% change in QD of X
% change in real income
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.10
Income elasticity of demand (IED) (Continued)
Some goods and especially services (e.g.
education, health, leisure) have high positive
IEDs.
IED may be negative over certain ranges of
income for inferior goods and services.
IED is useful in forecasting the likely shift in
demand when GDP is rising/falling.
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.11
IED (Continued)
Figure 3.6 The figure illustrates three situations relating to income elasticity of
demand. Up to an income level Y
1
the quantity demanded of the product increases
as income rises, indicating a positive income elasticity of demand and thus a
normal good. As income rises between Y
1
and Y
2
the quantity demanded of the
product remains unchanged; the income elasticity of demand is thus zero. Finally,
as income rises above Y
2
the quantity demanded decreases, thus illustrating
negative income elasticity of demand and an inferior good
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.12
Cross elasticity of demand (CED)
Measures the responsiveness of the quantity
demanded (QD) of A to a change in the price of B.
CED = % change in QD of A
% change in price of B
Where A and B are substitutes in consumption,
CED is positive
Where A and B are complements in consumption,
CED is negative.

Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.13
CED (Continued)
CED involves a shift in the demand curve
(here for product A)
Where A and B are substitutes in consumption
fall in price of B results in a decrease in
demand for A
Where A and B are complements in
consumption, fall in price of B results in an
increase in demand for A.
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.14
CED diagram
Figure 3.7 Line (1) illustrates a positive cross elasticity of demand with respect
to a substitute in that as the price of product B rises the demand for product A
increases. Line (2) illustrates a negative cross elasticity of demand with respect
to a complement, in that as the price of product B rises the demand for product A
decreases. Finally, line (3) illustrates a situation where the cross elasticity of
demand is zero, in that as the price of product B rises there is no effect on the
demand for product A
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.15
CED diagram (Continued)
In the diagram
Line 1 represents substitutes in consumption
CED positive
Line 2 represents complements in
consumption; CED negative
Line 3 represents CED zero.
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.16
Price elasticity of supply (PES)
Measures the responsiveness of supply of
product X to a change in its own price.

PES =


% change in quantity supplied of X
% change in price of X
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.17
Factors determining PES
Mobility of the factors of production.
The time period under consideration
Momentary period
Short run period
Long run period.
The existence of spare capacity.
The availability of stocks.
The willingness of the supplier to take risks.
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.18
Factors determining PES (Continued)
PES will be greater (more elastic)
The more mobile are factors of production
The longer the time period
The less risk-averse the producer
The fewer the natural constraints on
production.
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.19
PES and time
Figure 3.9 The figure illustrates momentary, short- and long-run supply curves.
The long-run supply curve S
2
is more elastic than the short-run supply curve S
1
,
over the price range P
0
to P
1
. The momentary supply curve S
0
is perfectly
inelastic
Ison and Wall, Economics, 4
th
Edition Pearson Education Limited 2007
Slide 3.20
PES and time (Continued)
In the diagram, the greater the time period, the
more elastic the supply curve is likely to be.