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```									               Elasticity
Claudia Garcia-Szekely

9/26/2011                            1
The Price Elasticity of
Demand
• Measures the response of the
quantity demanded to a change
in price.
• Compare how responsive to price
changes is the quantity
demanded of prescription drugs
and that of strawberries.
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Consumers barely notice

Consumers Overreact

110                              110

100                              100
Big change in Q

100              130         100 105

9/26/2011                                               3
Consumers barely notice

Consumers Overreact

110                              110

100                              100
Big change in Q

100              130         100 105

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Calculating the Elasticity
Price   Quantity Demanded   Point
0                  25       A         Midpoint Formula.
0.5                 22        B
The elasticity is
1                  19        C        measured between
1.5                16       D         two points along a
2                  13        E        given demand
2.36                11        F        curve.
2.5                 10       G
3                  7        H
The elasticity between B
3.5                 4         I
and C measures the
response to a \$0.50
4                  1        J
change in the price.
4.5                 0         K

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Midpoint Formula                    1.  Compute the
Price   Quantity Demanded   Point       difference
0               25          A          between the two
0.5              22           B         quantities: 22-19 =
1               19           C         3
2. Compute the
1.5             16          D         average of the two
2               13           E        quantities: (22 +
2.36             11           F        19)/2 = 41/2 = 20.5
2.5              10          G
3                   7       H         you got in (1) by the
3.5                  4        I        answer in (2). This is
4                   1       J         the Percentage
4.5                  0        K        change in the
quantity demanded:
3/20.5 = 0.146
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The Midpoint Formula
Price   Quantity Demanded   Point
0               25          A      4.   Compute the
0.5              22           B          difference between
1               19           C          the two prices: (1-
1.5             16          D
0.5) = 0.5
2               13           E     5. Compute the
2.36             11           F        average of the two
2.5              10          G         prices: (1+0.5)/2 =
3                   7       H         0.75
3.5                  4        I     6. Divide the answer in
4                   1       J
(5). This is the
4.5                  0        K
percentage change in
the price: 0.5/0.75
=0.667.
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The Midpoint Formula
8. Divide the percentage change in the
got in (3), by the percentage change
in the price: the answer you got in
(6).
The answer is the Price Elasticity of
Demand between B and C.
0.146 / 0.667 = 0.21

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The Midpoint Formula

Percentage Change Quantity Demanded
epd =
Percentage Change in price

Change in Quantity / Average Quantity
epd =
Change in Price / Average Price

9/26/2011                                9
The Price Elasticity of
Demand
• Measures the responsiveness of
the quantity demanded to a
change in price.
• There is a negative relationship
between the price and the
quantity demanded.
• The price elasticity of demand is
ALWAYS NEGATIVE.
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Price elasticity of
demand is ALWAYS
NEGATIVE

Always write a negative
Change in Quantity   /   Average Quantity
epd =
Change in Price / Average Price

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Three Types of
Elasticities
Consider only the absolute value of the
elasticity: |E|
The absolute value of the elasticity can
be
• |e|>1                   Elastic

• |e|=1               Unitarily Elastic

• |e|<1                  Inelastic

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Sensitive Demands are
Elastic Demands (e > 1)
Percentage Change in Quantity Demanded
epd =
Percentage Change in price

If the numerator (DQ%) is larger than the
denominator (DP%) then epd is greater than
one.
A relatively small change in price causes a
relatively large change in quantity demanded.

9/26/2011                               13
Insensitive Demands are
Inelastic Demands (e < 1)

Percentage Change in Quantity Demanded
epd =
Percentage Change in price
If the numerator (DQ%) is smaller than the
denominator (DP%), then epd is less than one.
A relatively large change in price causes a
relatively small change in quantity demanded.

9/26/2011                                14
Example
Elasticity
It has been observed that    20%
ahas no units!
decrease in the price of good X,
caused a 5% increase in the quantity
demanded of X.

epd      = 5% / -20% = - 0.25
Elasticity of Demand is less than one:
Inelastic

9/26/2011                               15
Example
It has been observed that a 5%
increase in the price, caused a 10%
reduction in the quantity
demanded.
epd = -10% / 5% = - 2
Elasticity of Demand is greater than
one: Elastic

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1. Compute price elasticity
PRICE              QUANTITY

3               4

1   e = -1      12

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1. Compute price elasticity
PRICE                  QUANTITY

5                   4

1   e = - 0.75      12

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1. Compute price elasticity
PRICE                QUANTITY

3                 3

1   e = -1.2      12

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At Midpoint

Calculate the elasticity of
demand between A and E
E

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A is the Midpoint

Calculate the elasticity AT A

E

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The Elasticity Changes Along the
Demand Curve         As you move along a
Quantity                                          demand curve -as price
Price Demanded Point Elasticity                                  changes- the elasticity
changes in absolute
value.
0                         25          A
Elasticity Increases
0.5                        22          B                -0.06
As Price Increases

1                         19          C                -0.22   For low prices (at the
1.5                        16          D                -0.43     At of the
bottomthe demand
2                         13          E                -0.72   midpoint, is
curve) demand
relatively inelastic
2.5                        10          G                -1.17
3                          7          H                -1.94
1
|e| =prices (at the top
For high
3.5                         4          I                -3.55   of the demand curve)
4                          1          J                -9.00   demand is relatively elastic
4.5                         0          K               -17.00
The Elasticity Changes Along
the Demand Curve
|e| > 1
|e| = 1

|e| < 1

0
0                    100
1000
100/2 == 500
1000/2 50
Midpoint
9/26/2011                             23
Without calculating the
elasticity:
a. Is the elasticity at A
> B? A < B? A=B?
b. Is the elasticity at F
F          > 1? F < 1? F=1?
c. Is the elasticity at E
E      = 1?

9/26/2011                              24
Perfectly Elastic Demand
• When the elasticity
is a very large                    |e| =
number (close to
infinity)              0.61
• A perfectly elastic     0.6
demand shows that at
the slightest increase
in the price, the
quantity demanded
would drop to zero.      0 Units           100 Units
Perfectly Inelastic Demand
• When the elasticity
is a very small
number (close to      1.20
zero)
• A perfectly inelastic
demand shows that            |e| = 0
even after a large
change in the price    0.6
the quantity
demanded would not
change at all.                     100 Units
The demand curve with the smallest elasticity is _______
The demand curve with the largest elasticity is _______
Demand curve _______ is perfectly elastic
Demand curve _______ is perfectly inelastic
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If the price elasticity of demand for
good X is 0.5. In order to induce a
10% reduction in consumption of this
good, the government would need to
tax this good until the price rises by
how much?
edp= % D Q / % D P
0.5= 10%/ % D P
10 /0.5 =% D P
20 =% D P                28
What Determines the
Elasticity?
• The number of substitutes available.
• The Definition of the market.
• The length of time consumers have to
react to a price change.
• Necessities tend to have inelastic
demands, whereas luxuries have elastic
demands.
– Example: Doctor visits, sailboats.
9/26/2011                              29
The number of
Substitutes Available.
The more
substitutes       The more
exist for a       sensitive
given good, the   (elastic)
easier it would   demand would
be for            be to price
consumers to      changes
switch.

9/26/2011                      30
Definition of              Common mistake: The more

the market.           +       +           =
specific the more inelastic
because only Ben and Jerry’s
chocolate ice cream “will do”
Narrowly defined
markets have
Ben and Jerry’s
more elastic               Chocolate
demands.                  Ice Cream

|epd | > 1

9/26/2011                                     31
Common mistake: The
The Definition of the   larger the set the more

market.         elastic because there are
lots of “choices”
HDz
Ice Cream
defined
markets have                   B&J
less elastic
demands
Food
Beverages

| epd | < 1
9/26/2011                                      32
2. Which product will
be more elastic? Why?

2. Which product has
more substitutes?
a)   All frozen desserts
b)   Ice cream
c)   Chocolate ice cream
d)   Ben and Jerry’s chocolate ice
cream

9/26/2011                                        33
The Amount of Time to
React
• The longer the time allowed, the
easier it is for consumers to find
an alternative or modify their
behavior.
• Goods have more elastic demands
over longer time horizons.
Example: Gasoline.
9/26/2011                           34
Two ways to increase
revenue
1. Increase price, in order to make
more per unit
2. Decrease price, in order to sell more
units.

9/26/2011                               35
Inelastic Demand
Increase Price              Decrease Price
• Quantity sold drops       • Quantity sold increase
• Decrease in Q is          • Increase in Q is
SMALLER than increase       SMALLER than
in price                    decrease in price
• Total Revenue increase.   • Total Revenue decrease

If demand is
Inelastic, increase
price to increase TR
9/26/2011                                    36
Elastic Demand
Increase Price              Decrease Price
• Quantity sold drops       • Quantity sold increase
• Decrease in Q is          • Increase in Q is
LARGER than increase in     LARGER than decrease
price                       in price
• Total Revenue decrease.   • Total Revenue increase

If demand is Elastic,
decrease price to
increase TR
9/26/2011                                      37
The Price Elasticity of
Demand and Revenues
• Total Revenues = Price x Quantity
• An increase in price will increase TR only if
the quantity demanded does not fall “too
much”.
• If the increase in price is larger than the
drop in quantities, TR will increase.
• This is precisely what happens if demand is
_____________
Inelastic

9/26/2011                                    38
When Demand is Inelastic
TR follow the change in P
If the drop in quantities is smaller than
the increase in price, total revenues will
increase.
TR = P x Q              epd = D%Q / D%P
epd = small/ Large
|epd | < 1
This is the case when |e| < 1.

9/26/2011                                39
When Demand is Elastic TR
If the drop in quantities sold is larger than
the increase in price, total revenues will fall
after a price increase.

TR =        Px   Q      epd = D%Q / D%P
epd = Large/ small
|epd | > 1
This is the case when |e| > 1
9/26/2011                               40
Elasticity and Total Revenues
TR = P x Q
This is the case when |e| > 1.

TR = P x   Q
This is the case when |e| < 1.

9/26/2011                     41
Price   Quantity   Total Revenue         elasticity
0      1,200               0
2      1,100             2200              0.0
4      1,000             4000
If total Revenues        -0.1
6       900              5400
increase with a         -0.3
Demand is
8       800         price increase
6400            Inelastic
-0.4
10       700              7000              -0.6
12       600              7200              -0.8
14       500              7000              -1.2
16       400              6400
If total Revenues        -1.7
18       300              5400
decrease with a         -2.4
Demand is elastic
20       200              4000
price increase         -3.8
22       100              2200              -7.0
24        0                 0              -23.0
If a company increases
prices and as a result:
• Total Revenues       • Total Revenues
Decrease.              Increase.
• Then the effect of   • Then the quantity
higher prices, was     sold did not drop
completely offset      enough to offset
by the drop in         the increase in
Demand is
quantities sold.
Elastic            price.
Demand is
Inelastic

9/26/2011                                 43
3. Is this demand elastic
or inelastic?
PRICE         TOTAL      ELASTICITY
REVENUE

1        1,950,000
Demand is
Inelastic
1.25        2,062,500

9/26/2011                             44
The Elasticity Changes Along
the Demand Curve
Decrease Price to Increase TR
|e| > 1
An increase/decrease in price
|e| = 1
would leave TR unchanged

Increase Price to Increase TR
|e| < 1

Midpoint

9/26/2011                                           45
When Demand is
Inelastic
S1
S0

P1

P0
Gain
L
Gain     >   L
o
s
o                     s
s
s       D0   TR increase
Q1 Q
0

9/26/2011                                         46
When Demand is
Inelastic
S0
S1

>
P0
Loss                 Loss

Gain
P1
Gain

D0

Q0 Q1

9/26/2011
TR decrease           47
When Demand is Elastic

>
S0

Gain
S1               Loss

P0
P1      Loss
Gain
D0

TR Increase
Q0      Q1

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When Demand is Elastic
S1

S0

>

Loss
Gain

P1
Gain

P0
Loss

D0

TR Decrease
Q1      Q0
9/26/2011                                            49
Elasticity and Price
Controls
• When supply and demand are both elastic, a price
floor will cause a larger surplus than when supply
and demand are inelastic
• When supply and demand are both elastic, a price
ceiling will cause a a larger shortage than when
supply and demand are inelastic.

50
Questions to prepare for the Quiz
1. Assume that currently, a book publisher charges one price
for a novel by author B.
An economist determines that the price elasticity of demand
for die hard fans of this author is – 0.4 and that the price
elasticity of demand for regular buyers is –3.

The advertising department comes up with the idea of
publishing the same book in a hard cover version to be
published first, and a soft cover version to be released two
months after the release of the hard cover version. This
would allow the publisher to charge different prices to
these two groups.

How would you advise them to set prices in order to increase
total revenues?
2. Assume that currently, all customers pay the
same price for a packet of cigarettes “Generic”
brand D.
An economist determines that the price elasticity
of demand by adults is –0.4 and that the price
elasticity of demand by teenagers is –3.

The advertising department comes up with the idea
of packaging cigarettes differently to target
different groups: Target teenagers with “Cool”
brand A and adults with “less tar” brand B.
How would you adjust prices in order to increase

You must provide a clear explanation for your
2.     Determine whether demand is elastic, inelastic,
unit elastic or can’t tell:
a. Chapped Hands Community College’s tuition
increased from \$20 per unit to \$25 per unit.
a.   Inelastic   Enrollment dropped from 8,000 to 7,200
0.47
students.
b.   Unit
elastic b. Washington apple growers sell a 10% larger crop
c.   Can’t tell  than last year’s , but the revenue they earned is
d.   Inelastic   unchanged.
e.   Elastic c. Honda offers a \$100 rebate on its largest rider
1.67        lawn mowers, and their sales rise 5%.
f.    Perfectly
d. The price of doctor services falls and your
Inelastic
E=0         family’s total expenditures are less on doctor
services and more on other things.
e. The price of carnations rises by 15%. Florists
substitute daisies and ferns ant the quantity
used of carnations drop by 25%.
f. The price of coffee drops by 25 cents per
pound, but you continue to drink the same
amount as before.
Tax Soda to Fight
Obesity?
• Reducing soda intake by a 100
calories a day results in a half a
pound of weight loss after 18 months.
• A 10% tax on sodas, sport sodas and
fruit juice cocktails would prompt
consumers to reduce consumption by
8%.

9/26/2011                              54
Demand    Supply  Demand Demand
Price of Quantity Quantity Demand    Demand
Point        X        X
good X     X
good X Complement Substitute
good N    good R

A          20          200           120         350          1050

B          40          180           140         340          1065

C          60          160           160         330          1080

D          80          140           180         320          1095

E         100          120           200         310          1110

F         120          100           220         300          1125
3.   Use the table above to answer the following questions:
a. Calculate the elasticity of demand and the elasticity of supply at point B
b. Should this producer increase, decrease or leave the price the same? Why?
Use a supply and demand
diagram to explain why…
• Oil producing countries enjoy increases in their
total revenues when they restrict supply.
• Farmers suffer declines in their total revenues
when they become more productive as a group.
• Fresh tomato farmers enjoy increases in their
total revenues when they become more productive
as a group.
• Oil producing countries would see their total
revenues decrease if they were to increase oil
production.
• Restaurant owners see an increase in total
revenues as competition from new restaurants
increases.
9/26/2011                                        56
Table 5. Estimated Price Elasticities of Demand for Various
Goods and Services
Goods                                Estimated Elasticity of Demand
Inelastic
Salt                                              0.1
Matches                                           0.1
Toothpicks                                        0.1
Airline travel, short-run                         0.1
Gasoline, short-run                               0.2
Gasoline, long-run                                0.7
Residential natural gas, short-run                0.1
Residential natural gas, long-run                 0.5
Coffee                                            0.25
Fish (cod) consumed at home                       0.5
Tobacco products, short-run                       0.45
Legal services, short-run                         0.4
Physician services                                0.6
Taxi, short-run                                   0.6
Automobiles, long-run                             0.2
Approximately Unitary
Elasticity
Movies                     0.9
Housing, owner occupied,
long-run                   1.2
Shellfish, consumed at
home                       0.9
Oysters, consumed at
home                       1.1
Private education          1.1
Tires, short-run           0.9
Tires, long-run            1.2

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Elastic
Restaurant meals              2.3
Foreign travel, long-run       4
Airline travel, long-run      2.4
Fresh green peas              2.8
Automobiles, short-run     1.2 - 1.5
Chevrolet automobiles          4
Fresh tomatoes                4.6

9/26/2011                                59
Types of Elasticity
• Price elasticity of demand.
• Price elasticity of supply.
• Income elasticity of
demand.
• Cross Price elasticity of
demand.
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The Price Elasticity of
Supply
• Measures the sensitivity of the
quantity supplied to changes in the
price.
• Since there is a direct relationship
between the price and the quantity
supplied
• The price elasticity of supply is
always positive.

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Price Elasticity of Supply:
eps

D in Quantity Supplied         /   Average Quantity
eps =
Change in Price   /   Average Price

Percentage Change in Quantity Supplied
epd =
Percentage Change in price

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Calculating the Price
Elasticity of Supply
• To calculate the price    Price   Q Supplied Elasticity
elasticity of supply,      40        140
follow the same steps      50        160        0.60
60        180        0.65
as for the price           70        200        0.68
elasticity of demand.      80        220        0.71
• The only difference is     90        240        0.74
100        260        0.76
that the price            110        280        0.78
elasticity of supply is   120        300        0.79
always POSITIVE.          130        320        0.81
140        340        0.82
150        360        0.83
160        380        0.84

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Extreme Cases                 eps = infinity
P D0      D1
Perfectly Elastic
Supply
suppliers can easily     Po                      Supply
increase or decrease
production
to match demand,
Q0     Q1            Qs
Perfectly Inelastic Supply P
Supply
suppliers cannot
increase production                   eps = 0
to match demand.
Supply is “fixed”.
D1
D0
Qs
9/26/2011                 Fixed Quantity         64
Perfectly Inelastic Supply
The quantity supplied of DaVinci
paintings doesn't change
regardless of what the price is.
The number of seats in a
regardless of price

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Elasticity changes along a
P    Supply Curve
eps = infinity   S   S

S

eps = 0
Q

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Calculate the Elasticity at point B.
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Refer to the graph above. When price rises by 20%,
Refer to the graph above. When price rises by 20%,
quantity supplied remains the Which curve best
quantity supplied rises by 20%.same. Which curve best
30%
demonstrates the elasticity of supply in this example?
demonstrates the elasticity of supply in this example?
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Without calculating
the elasticity:
a. Is the elasticity at
A > B? A < B? A=B?
b. Is the elasticity at
E          F > 1? F < 1? F=1?
F   c. Is the elasticity at
C > D? C < D? C =D?
d. Is the elasticity at
E > 1? E < 1? E=1?
e. Is the elasticity at
C > 1? C < 1? C =1?

9/26/2011                             69
Refer to the graph above. When price rises by 20%,
quantity supplied increases by 5%. Which curve best
demonstrates the elasticity of supply in this example?
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The Income Elasticity of
Demand
• Measures the sensitivity of
Demand to changes in INCOME.
• The relationship between Demand
and INCOME depends on whether
the good is normal or inferior.

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The Income Elasticity
Formula

Change in Quantity     /   Average Quantity
epd =
Change in Income   /   Average Income
Percentage Change in Demand
epd =
Percentage Change in Income

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Normal Goods
• The Demand for normal goods
INCREASES when income
INCREASES.
• There is a positive relationship
between income and demand for
normal goods.
• The sign of the income elasticity for
normal goods is positive.

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Calculating Average Quantity
Change in Quantity / the Income
ey =
d

Elasticity (Normal Goods)
Change in Income / Average Income
1. Find the Percentage     Income DemandedEdy
Q.
change in quantity
demanded = 100 /       1000   300
350 = 0.286            2000   400   0.43
2. Find the percentage
3000   500   0.56
change in income =
1000/1500 = 0.667        4000   600   0.64
3. The Income Elasticity =  5000   700   0.69
0.286/0.667 = 0.429      6000   800   0.73
7000   900   0.76
+                        8000   1000 0.79
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Inferior Goods
• Demand for inferior goods
DECREASES when income
INCRESES.
• There is a negative relationship
between income and demand for
inferior goods.
• The sign of the income elasticity for
inferior goods is negative.

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Inferior Good Income
Elasticity
Income Q. Demanded  Ed y
1000      1000
2000       900    -0.16
3000       800    -0.29
4000       700    -0.47
5000       600    -0.69
6000       500    -1.00
7000       400    -1.44
8000       300    -2.14

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The Cross Price Elasticity
• Measures the sensitivity of the
quantity demanded of one good to
changes in the price of ANOTHER
GOOD.
• Goods can be either Complements or
Substitutes.

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Cross Price Elasticity
Formula

% Change in Quantity demanded of Coke
X
epd =
%Change in price of Pepsi
Y.

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Cross Price Elasticity for
Complements
• The quantity demanded of a good
decreases when the price of a complement
increases,
Example: When the price of PRINTERS increases,
the quantity demanded of INK decreases.
• The price of one good and the Demand of
the other good move in opposite directions.
• The cross price elasticity between
complements is NEGATIVE.

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Cross Price Elasticity
Complements ( Negative)
Price X         Qua ntity Y   Cross Price
Elasticity x,y
100.00            600.00
130.00            580.00         -0.130
160.00      All Negative!
560.00        -0.170
190.00            540.00         -0.212
220.00            520.00         -0.258
250.00            500.00         -0.307
280.00            480.00         -0.361
310.00            460.00         -0.418
340.00            440.00         -0.481
370.00            420.00         -0.550

9/26/2011
400.00           400.00         -0.626        80
Cross Price Elasticity for
Substitutes
• When the price of a substitute INCREASES,
the quantity demanded of the good
INCREASES.
Example: When the price of movie tickets increases,
the quantity demanded of video tapes increases too.
• The price of one good and the Demand of the
other move in the SAME direction.
• The cross price elasticity between
substitutes is POSITIVE.

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Cross Price Elasticity
Substitutes (Positive)
Price X         Qua ntity Y   Cross Price
Elasticity x,z
100.00            600.00
130.00            620.00          0.126
160.00            640.00          0.153
190.00    All Positive!
660.00        0.179
220.00            680.00          0.204
250.00            700.00          0.227
280.00            720.00          0.249
310.00            740.00          0.269
340.00            760.00          0.289
370.00            780.00          0.307
400.00            800.00          0.325
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Use the information in table 1 above to calculate:
1. Price elasticity of demand for good X between points B and D.
2. Price elasticity of demand for good X at C.
3. Price elasticity of supply between A and B.
4. Cross Price elasticity between X and N between points E and F. Are X and N
substitutes? Or complements?
5. Cross Price elasticity between X and R between points E and F. Are X and R
substitutes? Or complements?
Solutions

9/26/2011               84
Solutions

9/26/2011               85
Solutions

9/26/2011               86
Solutions

9/26/2011               87
9/26/2011   88

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