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Seventh Edition
Microeconomics
Principles of
N. Gregory Mankiw
CHAPTER
5
Elasticity and its
Application
Part 1
WojciechGerson(1831-1901)

2. Imagine you design websites for local
businesses. You charge $200 per website, and
currently sell 12 websites per month.
Your costs are rising (including the opportunity
cost of your time), so you consider raising the
price to $250.
What do you think is going to happen to your
revenue? Why?
A scenario…
2Elasticity | Part 1

3. What determines price elasticity?
To learn the determinants of price elasticity, we look at a
series of examples. Each compares two common goods.
In each example:
• Suppose the prices of both goods rise by 20%.
• The good with the more elastic demand is the good for
which Qd (the Quantity demanded – or more simply, the
amount sold) falls the most (in percent).
• What lesson does the example teach us about what
determines how price elastic (or responsive) demand for a
good is?

4. EXAMPLE 1 | Breakfast Cereal vs. Sunscreen
• The prices of both of these goods rise by 20%.
For which good does Qd drop the most? Why?
• Breakfast cereal has close substitutes
(e.g., pancakes, Eggo waffles, leftover pizza),
so buyers can easily switch if the price rises.
• Sunscreen has no close substitutes,
so a price increase would not affect demand very much.
• Lesson: Price elasticity is higher when close
substitutes are available.

5. EXAMPLE 2 | “Blue Jeans” vs. “Clothing”
• The prices of both goods rise by 20%.
For which good does Qd drop the most? Why?
• For a narrowly defined good such as
blue jeans, there are many substitutes
(khakis, shorts, Speedos).
• There are fewer substitutes available for broadly defined
goods.
(Are there any substitutes for clothing?)
• Lesson: Price elasticity is higher for narrowly defined
goods than for broadly defined ones.

6. EXAMPLE 3 |Insulin vs. Caribbean Cruises
• The prices of both of these goods rise by 20%.
For which good does Qd drop the most? Why?
• To millions of diabetics, insulin is a necessity.
A rise in its price would cause little or no decrease in
demand.
• A cruise is a luxury. If the price rises,
some people will forego it.
• Lesson: Price elasticity is higher for luxuries than for
necessities.

7. Think about this…
• The price of gasoline rises 20%. Does Qd drop more in
the short run or the long run? Why?
• There’s not much people can do in the
short run, other than ride the bus or carpool.
• In the long run, people can buy smaller cars
or live closer to work.
• Lesson: Price elasticity is higher in the
long run than the short run.

8. The Determinants of Price Elasticity:
A Summary
The price elasticity of demand depends on:
• (B) how broadly or narrowly the good is defined
• (A) the extent to which close substitutes are
available (alternatives)
• (L) whether the good is a necessity or a luxury
• (L) the time horizon—elasticity is higher in the
long run than the short run

9. Elasticity |Graphically
(a) The flatter the curve, the
bigger the elasticity (as price
rises, demand drops a lot)
(b) The steeper the curve, the
smaller the elasticity.
P
Q
P
Q
(a) (b)
The price elasticity of demand is closely related to the
slope of the demand curve.

10. Elasticity | How consumers respond to price changes
KEY POINT
How much
consumers
respond to a
price increase
depends on the
characteristics
of the good. In
particular, the 4
characteristics
in the acronym
B-A-L-L.
Test Prep Question | Do you think your price increase is likely
to scare a lot of your customers away or not? Answer this
question in the following way: (1) Describe the demand for
the website services you sell in terms of each of the
determinants of elasticity (B-A-L-L). (2) Identify whether each
determinant(s) tends to make demand elastic or inelastic. (3)
Conclude whether the demand for your product is likely to
more elastic or inelastic.
Elasticity | Part 1 10
Whenever you see a Test Prep Question, you can click on it to enter
your answers [the questions will be repeated]. After you submit your
answer, you will see the correct answer and can revise your answer to
get more practice.

11. Good work! See you in the next presentation!