ECO 151

ELASTICITY
Week 5
Topic “Elasticity”
5.0 ELASTICITY: Outline

Definition of Elasticity
•Different types of elasticity
1. Price elasticity of demand
•Calculating the price elasticity of demand: at a
point – point elasticity; or between two
points – arc or midpoint elasticity
 5.0 ELASTICITY: AN INTRODUCTORY OVERVIEW

 Elasticity – a measure of responsiveness or sensitivity

 Examples
 DV= Size of maize crop, IV= Rainfall
 DV=Investment, IV= Interest Rate
 DV=Qd of Rice, IV= Price of Rice
 DV=Q of labour supplied, IV= Wage
 Elasticity – the percentage change in a dependent variable if
the relevant independent variable changes by one per cent
 5.0 ELASTICITY: Types of elasticity

• The price elasticity of demand

• The income elasticity of demand

• The cross elasticity of demand

• The price elasticity of supply

 5.1 THE PRICE ELASTICITY OF DEMAND

The price elasticity of demand – the percentage change in

the quantity demanded if the price of the product changes by
one per cent, ceteris paribus

–Shows how responsive quantity demanded is to changes in

price
 5.1 THE PRICE ELASTICITY OF DEMAND
• The impact of different demand elasticities on the equilibrium
price and quantity
• Figure 5-1 The impact of different demand elasticities on the equilibrium price and
quantity.
(a) Relatively elastic demand curve (b) Relatively inelastic demand curve

• Note that such a comparison is valid only if the same scale, the same original
equilibrium and the same shift of supply are used in both cases.
 5.1 THE PRICE ELASTICITY OF DEMAND
Important aspects and implications:
 Units do not affect the result

o Important – it uses percentage changes and not

units, i.e. relative changes, not absolute.
o Absolute – price expressed in monetary terms (rands,
pounds, euros), quantity expressed in terms of
physical units (kilos, boxes, bags).

 Price elasticity of demand is the ratio of the percentage

change in quantity demanded to the percentage change in
price – this ratio is called the ELASTICITY
COEFFICIENT.
 5.1 THE PRICE ELASTICITY OF DEMAND
Important aspects and implications:
 Can compare different goods and services
ELASTICITY COEFFICIENT shows how people react to
changes in prices of different goods and services.

•Because it is in percentage terms, we can compare how

people react to price changes of meat, bread, petrol, cars,
pens….etc.

•Would not be possible if used ‘absolute numbers’ e.g. a R1

change in price of these products would have very different
effects on the quantity demanded.

•Can compare a 1 per cent change in the price of the

product.
 5.1 THE PRICE ELASTICITY OF DEMAND
Important aspects and implications:
 Can compare different goods and services
Example:
• Consider two products; cars and bread.

 If the price of cars and bread increased by R1, the effect on

quantity demanded would be very different.

 Because the price of a car of approximately R100,000 is far

greater compared to the price of a bread that is under R15.

 Percentage change in car price would be <1% (0.001 %),

percentage change in price of bread (R15 each) would be
6.67%.
 5.1 THE PRICE ELASTICITY OF DEMAND
Important aspects and implications:
 Consider the absolute value
Example:
 Consider a 6 % increase in the price of bread, ceteris
paribus, resulting in 18 % decrease in quantity demanded of
bread. The elasticity coefficient will be equal to
%∆Qd −18%
=ep =
%∆P 6%
= |−3|
= 3

 A 1 % increase in the price of bread, ceteris paribus, will lead to a

3% decrease in quantity demanded of bread.
 5.1 THE PRICE ELASTICITY OF DEMAND
• Calculating price elasticity of demand
Two formulas:
1. Point elasticity (use for small price changes)
%∆Qd
ep =
%∆P
∆Qd
x100
Qd
= (can cancel out 100s)
∆P
x100
P
∆Qd ∆P
= ÷
Qd P
∆Qd P
= x
∆P Qd
Derive this for yourself to check if you fully understand how we got to this final
equation!!!!
 5.1 THE PRICE ELASTICITY OF DEMAND
• Calculating price elasticity of demand
1. Point elasticity
∆Qd P
ep = x
∆P Qd
•The slope of the linear demand curve = ΔP/ ΔQ

•So the one part of the equation is ΔQ/ ΔP which is

the inverse of the slope of the linear demand
curve.

•Second part of the equation is P/Q which is the

ratio of price to quantity at any point on the line
(therefore known as POINT ELASTICITY…
ELASTICITY AT A POINT).
 5.1 Calculating point price elasticity of demand
 ep = ΔQ/ΔP x P/Q
ΔQ/ΔP is fixed = - 20/10
=-2
 At A, ep = ΔQ/ΔP x P/Q
= -2 x 10/0
(anything divided by 0 … infinity)
= -2 x ∞
=∞
 As we move downward and to the right,
the elasticity coefficient falls.

 In the middle of the line,

the elasticity coefficient = -1

 At C …- 2 x 5/10= - 2 x ½ = -1
 To the left of this, the coefficient is greater
than (-)1 and to the right the coefficient is
less than (-)1.

 At E… ep = -2 x 0/20 (zero divided by anything is

zero) = -2 x 0 = 0
 Calculating point price elasticity of demand
Example 2:
Section between:
A. P1=48,Q1=2 and B. P2=36,Q2=4.
Using our formula now, calculate.
ep = ΔQ/ΔP x P/Q
ΔQ/ΔP = - 2/12 = -1/6
P/Q = ?? Which point do we use?
1. -1/6 x 48/2 = -4
2. -1/6 x 36/4 = -1½

Two different answers for the same

question… the answer will depend
on the direction of the change -- to
calculate elasticity of this section
of the demand curve.
 5.1 THE PRICE ELASTICITY OF DEMAND

• Calculating arc price elasticity of demand

• The elasticity coefficient calculated by comparing two points
on a demand curve is called Arc elasticity (use for larger
price fluctuations).

%∆Qd
Arc e p =
%∆P
∆Qd P (Q2 − Q1 ) / (Q1 + Q2 )
= * or
∆P Qd ( P2 − P1 ) / ( P1 + P2 )
 Instead of just using P and Q values, now use the average of
the two P and Q value that is being looked at.
5.1 THE PRICE ELASTICITY OF DEMAND
Example
1. P1=10,Q1=17 and 2. P2=8,Q2=19

ep = (Q2-Q1)/(Q1+Q2)]
(P2-P1)/(P1+P2)

= 2/(17+19)
-2/ (10+8]

= 2/(36)
-2/(18)

= 2/18 x -9/2
= -1/2
ELASTICITY:

Price elasticity of demand

and revenue
 •5.1 Price elasticity of demand and total
revenue(or total expenditure)

 Can determine by how much total expenditure by

consumers on a product changes (as a result of the change
in quantity demanded) when the price of the product
changes.

 This is probably the most important reason why e.g. business

people or policy makers are interested in information
concerning the price elasticity of demand.

 Remember - Total expenditure by consumers on a product

equals total revenue of firms for that product.
 5.1 Price elasticity of demand and total
revenue(or total expenditure)
• The price elasticity of demand can be used to determine by how
much the total expenditure by consumers on a product changes
when the price of the product changes

 Price elasticity of demand > 1

– TR increases as Q increases

 Price elasticity of demand = 1

– TR reaches a maximum

 Price elasticity of demand < 1

– TR falls as Q increases
 5.1 Price elasticity of demand and total
revenue(or total expenditure)
TABLE 5-1 The demand for cappuccinos and total revenue from cappuccino sales
5.1 Price elasticity of demand and total
revenue(or total expenditure)
Figure 5-2 The relationship
between price elasticity of
demand and total revenue

• When ep is greater than one,

TR increases as the quantity of
cappuccinos increases.
• When ep is equal to one, TR is
at a maximum.
• When ep is less than one, TR
falls as the quantity of
cappuccinos increases.

• This relationship holds for all

downward-sloping linear
demand curves.
 5.1 THE PRICE ELASTICITY OF DEMAND

• Different categories of price elasticity of demand

Remember to
• Perfectly inelastic demand (ep = 0) Only consider
the absolute
• Inelastic demand (0 < ep < 1) value of the
elasticity
• Unitary elastic demand (ep = 1) coefficient when
identifying the
• Elastic demand (1 < ep < ∞) categories of
price elasticity
of demand.
• Perfectly elastic demand (ep = ∞)
 5.1 THE PRICE ELASTICITY OF DEMAND
• Different categories of price elasticity of demand

1. Price has no effect Qd.

2. Qd is independent of price.

3. Consumers plan to purchase

a fixed amount of the good
irrespective of the price.

4. Elasticity coefficient: ep = 0.

5. Vertical line parallel to the price axis.

Types of goods
• Insulin, very addictive substances.
 5.1 THE PRICE ELASTICITY OF DEMAND
• Different categories of price elasticity of demand
• Qd responds to price change
but not greatly.
% Δ P > % Δ Qd.

• 10% increase in P, 2%
decrease in Qd.

10 % > 2%.

•Elasticity coefficient: 0 < eP < 1.

Types of Goods:
•Examples, necessities: food, housing,
electricity, health care, education, petrol.
 5.1 THE PRICE ELASTICITY OF DEMAND
• Different categories of price elasticity of demand

 % Δ P = % Δ Qd

 Price increases by
10% then Qd
decreases by 10%.

Elasticity coefficient:
ep = 1
 5.1 THE PRICE ELASTICITY OF DEMAND
• Different categories of price elasticity of demand
 Elastic:Highly responsive
 When price changes; Qd
responds greater than
the change in price.

 P increase by 10%, Qd
decreases by 15%

15 % > 10%
% Δ Qd > % Δ P

1 < ep < ∞

Types of goods:
•Examples, luxury goods : Cars,
CDs, magazines, fast foods.
 5.1 THE PRICE ELASTICITY OF DEMAND
• Different categories of price elasticity of demand
 Perfectly responsive.

 Consumers are willing to purchase

any quantity at a certain price,
but if the price changes up only
slightly the Qd falls to zero.
 Elasticity coefficient: ep=∞

 Horizontal demand curve.

 Example, two vending machines

side by side. If the price of goods are
the same, people buy from any.
If the price of one machine’s goods is
higher than the other, only buy from
the cheaper one.
 5.1 THE PRICE ELASTICITY OF DEMAND
• Different categories of price elasticity of demand
TABLE 5-2 Price elasticity of demand: a summary
 5.1 THE PRICE ELASTICITY OF DEMAND
• Determinants of the price elasticity of demand
• Substitution possibilities
• The degree of complementarity of the product
• The type of want satisfied by the product
• The time period under consideration
• The proportion of income spent on the product
• The definition of the product
• Advertising
• Durability
• Number of uses of the product
• Addiction

The combined effect of the determinants

5.1 Determinants of the price elasticity of demand
 Substitution possibilities
• If there is a larger number of close substitutes; demand is
ELASTIC.
• Increase in Price – leads to Substitution Effect –
Consumers switch to relatively cheaper substitute goods.

• Example, if the price of train tickets go up, substitute by

now taking a taxi. The easier it is to swap, the more elastic
the demand for train tickets are.

 The broader the definition of the product,

• The less substitution possibilities there are – and the
less price elastic it becomes; e.g. meat and beef or in
branded products like Colgate vs toothpaste due to
advertising.
 5.1 Determinants of the price elasticity of demand

 The degree of complementarity of the product

• With highly complementary goods, the price elasticity of

demand tends to be low – demand is INELASTIC.

• Example, cars and tyres, petrol and cars, CDs and CD

players.

• Often argued that it is the lack of substitute rather than the

complementarity that is responsible for the inelasticity of
the product.

• You also have to consider the other product.

5.1 Determinants of the price elasticity
of demand

 The type of want satisfied by the product

• Necessities (e.g. basic food stuffs, medical care,

petrol, electricity) are inelastic – they don’t
respond much to changes in price.

• Luxuries (e.g. swimming pools, entertainment)

are elastic – they can respond to changes in
price.
5.1 Determinants of the price elasticity of demand

 The time period under consideration

• Demand tends to be more price elastic in the long run than
in the short run, ceteris paribus.
• More time to respond.
• Example, with the increase in price of crude oil in the 1970s,
people could do little in the short term. But in the longer term
could, for example, develop fuel efficient cars to decrease the
demand for petrol.

 Durability
• Also products that last longer (more durable) tend to be more
elastic since they can be used again – e.g. can put off buying
new products for longer period if the price of the product has
increased
5.1 Determinants of the price elasticity of demand
 The proportion of income spent on the product

• It is argued that the greater the proportion of income

spent on the product, the greater the price elasticity of
demand.

• For example, changes in prices of products like salt or

matches may not change the quantity demanded of these
products much, because they only constitute a small
proportion of the consumers’ income. But goods such as
rent or insurance payments that take up a larger proportion
of income may be more elastic.
5.1 Determinants of the price elasticity of demand

Other:

 Number of uses for the product – the more

uses (e.g. electricity for heating, lighting, cooking)
– the more price elastic the product; can always
eliminate some of the uses.

 Addiction – very addictive products will have low

price elasticities (inelastic). For completely
addicted consumers it may be perfectly price
inelastic.
 ELASTICITY:

Other demand elasticities

2. Income elasticity of demand
3. Cross elasticity of demand
4. The price elasticity of supply
 5.2 Income elasticity of demand

• The income elasticity of demand – measures the

responsiveness of the quantity demanded to changes in
income.
– 0 < ey < 1
» normal good, essential good
– 1 < ey
» normal good, luxury good
– ey < 0
» inferior good

Percentage change in the quantity demanded of a product ∆Qd Y

ey = x
Percentage change in consumers income ∆Y Qd
5.2 Cross elasticity of demand
• Cross elasticity of demand – measures the
responsiveness of the quantity demanded for a particular
good when the price of another good changes.
– 0 < ec
» substitutes
– ec < 0
» complements
– ec = 0
» unrelated goods
Percentage change in the quantity demanded of a product A ∆Qd A P
ec = = * B
Percentage change in Price of product B ∆PB Qd A

Box 5-3: Summary: cross elasticity of demand (page 130)

 5.3 THE PRICE ELASTICITY OF SUPPLY

• Price elasticity of supply – the ratio between the percentage

change in the quantity supplied of a product and the
percentage change in the price of the product

• By how much will the quantity supplied change if the price

changes by one per cent?

Percentage change in the quantity supplied ∆ Qs x P

es = =
Percentage change in Price of product ∆P Qs
 5.3 THE PRICE ELASTICITY OF SUPPLY

• Different categories of supply elasticity

• Perfectly inelastic supply (es = 0)

• Inelastic supply (0 < es < 1)
• Unitary elastic supply (es = 1)
• Elastic supply (1 < es < ∞)
• Perfectly elastic supply (es = ∞)
 5.3 THE PRICE ELASTICITY OF SUPPLY
The different categories of price elasticity of supply

 Price has no effect on Qs.

 Qs is independent of price.

 Suppliers plan to supply a

fixed amount of the good
irrespective of the price.

 Elasticity coefficient:
es = 0.

 Vertical line parallel to the price

axis.
 5.3 THE PRICE ELASTICITY OF SUPPLY

The different categories of price elasticity of supply

• Qs responds to price change

but not greatly.

% Δ P > % Δ Qs.

Elasticity coefficient: 0 < es < 1.

• The supply curve intersect the

horizontal axis
 5.3 THE PRICE ELASTICITY OF SUPPLY

The different categories of price elasticity of supply

% Δ P = % Δ Qs

Price increase
by 10% then Qs
increases by 10%.

Elasticity coefficient:
es = 1

The supply curve passes

through the origin
 5.3 THE PRICE ELASTICITY OF SUPPLY
The different categories of price elasticity of supply

 When price changes; Qs

responds greater than
the change in price.

 Example: P increases by 10%,

Qs increases by 20%

20 % > 10%

% Δ Qs > % Δ P

1 < es < ∞

• The supply curve intersect the

vertical axis
 5.3 THE PRICE ELASTICITY OF SUPPLY

The different categories of price elasticity of supply

 Perfectly responsive.

 Suppliers are willing to

supply any quantity at a
given price

Elasticity coefficient es = ∞

 Horizontal supply curve.

 5.3 THE PRICE ELASTICITY OF SUPPLY

• The determinants of the price elasticity of

supply

• Time
• Expectations
• Stockpiling
• Excess capacity
• Availability of inputs

Box 5-4: Summary: price elasticity of supply

 5.3 Determinants of price elasticity of supply

 Time that elapsed since price change –

Short run – inelastic… since suppliers don’t have sufficient time to
respond to price change
Long run – elastic… since suppliers have had the time to respond
to price changes.
 Price expectations – if expected price changes are seen as a
longer term phenomenon, suppliers will be more likely to adjust
production.
 Stockpiling or excess capacity – The supply of products that
can be stockpiled is more elastic than that of perishable goods.
If suppliers have excess capacity they can respond much faster
to changes e.g. price increases.
 Availability of inputs - If essential inputs are not available, firms
cannot increase their output in reaction to an increase in the
price of a product -- if they can’t respond, supply is inelastic.
5.3 THE PRICE ELASTICITY : A SUMMARY

TABLE 5-4 Different elasticities: a summary

5.3 THE PRICE ELASTICITY : A SUMMARY

TABLE 5-4 Different elasticities: a summary