Chapter 3

Elasticity and Consumer Behavior

Based on the law of demand, buyers are willing and able to purchase more goods and services
at lower price than at higher prices. These are natural reactions or inclinations of buyers. However,
such reactions vary depending on the importance and availability of the goods and services. These
varying reactions are known as demand elasticities.
In the increase of producers or sellers, they have also their reactions to price changes. Clearly,
they tend to sell more goods and services when prices are higher. Their reactions also vary depending
on their ability to produce in a given time. For instance, they cannot take advantage of higher prices if
they cannot produce the goods and services. Such varying reactions of producers are known as supply
elasticities.
Another consumer behavior is the nature of human satisfaction. It has been experienced that
consumption of more goods of the same king reduces the level of satisfaction. In addition, our desires
to satisfy our human wants are restricted by our purchasing power or budget.
This chapter discusses, with the support or response of the buyers to changes in price of goods
and services. As mentioned earlier, buyers tend to reduce their purchases as price increases, and tend
to increase their purchases whenever price falls. These are logical reactions to price changes. However,
such reactions vary in accordance with the nature of the products and the particular needs of the
buyers. For example, is a product is very important to the consumers, they have to buy it despite the
big increase in its price. On the other hand, there are products in which with just a slight increase in
their prices, many consumers are reluctant to buy such products. These products are not important to
them. They can still live without said products.
These are five types of demand elasticity or types of reactions of buyers to price changes of
goods and services:
1. Elastic demand. A change in price results to a greater change in quantity demanded. For
example, a 20 percent (decrease or increase) creates a 60 percent change in quantity
demanded (increase or decrease). This shows buyers are very sensitive to price change. They
are easily discouraged to buy the products if their prices increase. However, they are easily
encouraged to buy the same products if their decrease. Such products are not very important
to them, but they provide comforts and pleasures to the consumers. These are the luxury goods
like stereo, radio, camera, television set, etc.
2. Inelastic demand. A change in price results lesser change in quantity demanded. For example, a
50 percent change in price creates only a 5 percent change in quantity demanded. This means
buyers are not sensitive to price change. Products under this category are very essential to
buyers. They cannot live without them; it is hard to live without such products like rice,
medicine, or shelter. People have to buy said even if there is a big increase in their prices.
However, a big decrease in the prices of the aforementioned goods has a very little increase in
 quantity demanded. For example, a great decline in the prices of rice and medicine does not
encourage people to eat more rice or take more medicine. They only buy as much as the
requirement of their normal consumption. But if the price of rice is very high and many people
can not afford such price, they are forced to eat only twice a day, or mix rice with corn. Many
extremely poor people are doing this.
3. Unitary demand. A change in price results to an equal change in quantity demanded. For
example, a 25 percent change in quantity demanded. Goods or services under this category are
considered semi-luxury or semi-essential goods. Some types of clothing or shoes are either
luxury or essential goods.
4. Perfectly elastic demand. Without change in price, there is an infinite change in quantity
demanded. Such demand applies to a company which sells in a purely competitive market.
More details on this are explained in Chapter 5.
5. Perfectly inelastic demand. A change in price creates no change in quantity demanded. This is
an extreme situation which involves life or death to an individual. Regardless of price, he has to
buy the product like a medicine with no substitute.

Figure 3.1. Types of demand elasticity showing the various degrees of reactions of buyers brought
about by price change.

P P D P
D
D

O Q O Q O Q
Elastic Demand Inelastic Demand Unitary Demand

P P

O Q O Q
Perfectly Elastic Demand Perfectly Inelastic Demand

Determinants of Demand and Elasticity

1. Number of goods substitutes. Demand is elastic for a product with many good substitutes. An
increase in the price of such product induces buyers to look for good substitutes. On the other
 hand, products without good substitutes have an inelastic demand. Buyers have no or little
choice except to purchase them if they really need them. Example, electricity for factory.
2. Price increase in proportion to income. If the price increase has very little effect on the income
or budget of the buyers, demand is inelastic. For example, a 40 percent increase in the price of
a needle or candy means only a few centavos. Thus, the result is only a slight decrease in
quantity demanded. But if the price increase in tuition fees is likely to discourage many very
poor families from sending their children to college. In fact, in the Philippines, university
education has become a privilege of the few.
3. Importance of the product to the consumers. Luxury goods are not very important to many
Filipinos. So, these are elastic. Examples are diamond rings, sports car, expensive wines, elegant
clothing, etc. rice important to all consumers. Electricity is important to factory owners.
Gasoline is important to the transportation industry. All of these are inelastic.
Elasticity Formula
Q
Elasticity Q
P
P

Q = the difference between the original quantity and the new quantity. (Disregard negative sign)
Q = original quantity
Q = the difference between the original price and the new price. (Disregard negative sign)
P = original price
Example:
Year Quantity demanded Price
1998 100 4
1989 60 5
Solution:
Q = 40; Q = 100 while P = 1; P=4
40 2
100 5 = 2 = 8 = 1.6
=
1 5 5
1
4 4
If elasticity coefficient (answer) is:
More than 1= elastic demand
1= unitary demand
Less than 1= inelastic demand

Economic Significance of Demand Elasticity

The concept of elasticity of demand is not just a theoretical exercise which has no practical
applications in business and economic policies. On the contrary, it has several implications in both
private business and government planning. For instance, a good knowledge of demand elasticity helps
the businessmen in planning their pricing strategies. In the case of the government, it guides the
economic managers in formulating appropriate tax programs. Clearly, the market price of a product
influences wages, rents, interests, and profits. With the right pricing strategy, businessmen may attain
the following goals:
- Achieve target return on investment;
- Maintain or improve a share in the market;
- Meet or prevent competition; and
- Maximize profits.
Here are some practical examples of economic significance of elasticity of demand:
1. Wage determination. If the product has an elastic demand, a reduction in its price increases
quantity demanded. This means more sales and more profits. The company is in a position to
raise the wages of its workers. But if demand is inelastic, a reduction in its price has very little
effect on sales. Such price cut may even affect the availability of the company.
2. Farm production guide. Most agricultural products like rice, coconut and sugar are inelastic.
Quantity demanded does not change much even if there is a big decrease or increase in price.
Whenever there is an overproduction of farm crops due to good harvest, prices of said products
decrease. As a result, total revenue or income of the farmers also declines. Measures are
therefore prepared to control production to protect the interests of the farmers. For example,
areas of cultivation are being reduced. In some cases, the surplus products are burned or
dumped into the sea, just to maintain price stability.
3. Maximize profits. A reduction in price causes more quantity demanded. Businessmen can
estimate how far they can cut their prices to be able to generate their target sales. Even if the
profit per unit is only 5 centavos but millions of it are bought daily- this is in a better position to
attain profit maximization than another product which gets a profit of P5 per unit but only
hundreds are bought daily. Evidently, a substantial price reduction favors goods with highly
elastic demand.
4. Imposition of sales taxes. Government planners should exercise prudence in taxing goods and
services. Otherwise, instead of getting more money from the people, they get less. It is not
advisable to increase taxes on goods with high elastic demand. A tax is an additional price. So,
this greatly decreases quantity demand for the product. For example, a P1 tax is imposed on a
certain product. For example, a P1 tax is imposed on a certain product, and 1,000 units are sold;
so tax revenue is P, 1000. Supposing the tax has been increased to P2- because of the increase
in tax, the price of the product also increases. The result is that only 400 units have been sold.
So, tax revenue is only P800, which is P200 lower than the original tax revenue.

Elastic of Supply
Supply elasticity refers to the reaction or response of the sellers/ producers to price change of
goods. Based on the law of supply, producers are willing and able to offer more goods at a higher