Summary: Main Points on

Elasticity of Supply and Demand

Elasticity

Elasticity == responsiveness to a change in conditions.

Elasticity of Demand

Elasticity of demand = The (absolute value of the) percentage change in quantity demanded (when the price changes) divided by the percentage change in price.

Elasticity of supply = the percentage change in quantity supplied (when the price changes) divided by the percentage change in price.

perfectly elastic means elasticity -> infinity perfectly elastic -- HORIZONTAL -- demand curve

elastic          means    elasticity >1 elastic demand curve -- quantity demanded is highly responsive to a change in price
unit-elastic means     elasticity = 1 unit-elastic demand curve -- people spend the same amount on the good when the price rises or falls
inelastic      means      elasticity <1
perfectly inelastic        means    elasticity = 0

Note: Don't get confused -- the elasticity of demand is not the slope of the demand curve. EXPLANATION/EXAMPLE

CHANGES IN DEMAND OR SUPPLY

If demand is perfectly elastic, an increase in demand shifts the demand curve upward increase in demand -- demand curve shifts upward

and a decrease in demand shifts the curve downward. (Place mouse over pictures for summary.) decrease in demand -- demand curve shifts downward

If supply is perfectly elastic, an increase in supply shifts the supply curve downward increase in supply -- supply curve shifts downward

and a decrease in supply shifts the curve upward. (Place mouse over pictures for summary.) decrease in supply -- supply curve shifts upward

When the demand or supply curve is perfectly inelastic, changes in the other curve affect the price but do not affect the quantity traded. (Place mouse over picture for summary.)

increase in supply with perfectly INelastic demand -- the price falls

increase in demand with perfectly INelastic supply-- the price rises

When demand or supply is perfectly elastic, changes in the other curve affect the equilibrium quantity but do not affect the equilibrium price. (Place mouse over pictures for summary.)

increase in supply with perfectly elastic demand -- the equilibrium quantity rises

increase in demand with perfectly elastic supply -- the equilibrium quantity rises

Elasticities and Total Spending

A price increase raises spending on a good if its demand is inelastic and reduces spending if its demand is elastic. Similarly, a decrease in price lowers total spending on a good if demand is inelastic and raises total spending on the good if demand is elastic. (Place mouse over picture for summary.)
With elastic demand, an increase in supply raises total spending on the good.

With elastic demand, an increase in supply raises total spending on the good.

What Affects Elasticities?

More close substitutes for a good => demand tends to be more elastic.

And fewer close substitutes for a good => demand tends to be more inelastic.

EXAMPLE

When spending on a good is a higher fraction of people's incomes => their demands tend to be more elastic.

And when spending on a good is a smaller fraction of income => demands tend to be more inelastic.

EXAMPLE

Short-Run and Long-Run Elasticities

Demand curves are more elastic in the long run than in the short run.
Supply curves are also more elastic in the long run than in the short run.

EXPLANATION EXAMPLE MORE ADVANCED

Using Elasticities

When supply changes, the equilibrium quantity changes by the following amount:

percentage change in equilibrium quantity = (percentage change in equilibrium price) x (elasticity of demand).

When supply changes, the equilibrium price changes by the following amount:

percentage change in equilibrium price = (percentage change in equilibrium quantity) / (elasticity of demand).

When demand changes, the equilibrium quantity changes by the following amount:

percentage change in equilibrium quantity = (percentage change in equilibrium price) x (elasticity of supply).

When demand changes, the equilibrium price changes by the following amount:

percentage change in equilibrium price = (percentage change in equilibrium quantity) / (elasticity of supply).

For examples, see pages 116-17 of the textbook.

© 1999 Alan C. Stockman, except:
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