ECO 151

ELASTICITY
Week 6
Topic “Elasticity Application”
 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
• Calculating price elasticity of demand
Two formulas:
1. Point elasticity (use for small price changes)
%Δ𝑄𝑄𝑄𝑄
𝑒𝑒𝑝𝑝 =
%Δ𝑃𝑃
Δ𝑄𝑄𝑄𝑄
× 100
𝑄𝑄𝑄𝑄
= (can cancel out 100s)
Δ𝑃𝑃
× 100
𝑃𝑃
Δ𝑄𝑄𝑄𝑄 Δ𝑃𝑃
= ÷
𝑄𝑄𝑄𝑄 𝑃𝑃
Δ𝑄𝑄𝑄𝑄 𝑃𝑃
= ×
Δ𝑃𝑃 𝑄𝑄𝑄𝑄

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
Two formulas:
1. Point elasticity (use for small price changes)
Δ𝑄𝑄𝑄𝑄 𝑃𝑃
𝑒𝑒𝑝𝑝 = ×
Δ𝑃𝑃 𝑄𝑄𝑄𝑄
Δ𝑄𝑄𝑄𝑄
𝑜𝑜𝑜𝑜 Since is the inverse of the slope of the demand curve,
Δ𝑃𝑃
then we can also calculate elasticity as
1 𝑃𝑃
𝑒𝑒𝑝𝑝 = ×
𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑄𝑄𝑄𝑄

Interpretation

Ep = 0 0 < Ep < 1 Ep = 1 1 < Ep < ∞ Ep = ∞

Perfectly Inelastic Unitary Elastic Perfectly
inelastic elastic elastic
5.1 THE POINT PRICE ELASTICITY OF DEMAND

• Worked Question 1

Given the demand curve P = 10 - 0.5Qd

Calculate the point price elasticity of demand :-

(a) At P = 4. Interpret the answer.

(b) At P = 8. Interpret the answer.

5.1 THE POINT PRICE ELASTICITY OF DEMAND
• Worked Question 1
Given the demand curve P = 10 - 0.5Qd
Calculate the point price elasticity of demand :-

(a) At P = 4. Interpret the answer.

When P = 4, Qd = 12
1 𝑃𝑃
𝑒𝑒𝑝𝑝 = ×
𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑄𝑄𝑄𝑄
1 4
= ×
−0.5 12
= −0.6667
= −0,6667
= 0,6667
Inelastic Demand
5.1 THE POINT PRICE ELASTICITY OF DEMAND
• Worked Question 1
Given the demand curve P = 10 - 0.5Qd
Calculate the point price elasticity of demand :-

(b) At P = 8. Interpret the answer.

When P = 8, Qd = 4
1 𝑃𝑃
𝑒𝑒𝑝𝑝 = ×
𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑄𝑄𝑄𝑄
1 8
= ×
−0.5 4
= −4
= −4
=4

Elastic Demand
 5.1 THE PRICE ELASTICITY OF DEMAND

• Try this Question

 Calculate the price elasticity of demand for the demand curve

Q = 300 – 5P using the point method, where price is:
– R0
– R10
– R20
– R30
– R40
Interpret the answers.
5.1 THE ARC PRICE ELASTICITY OF DEMAND

• Calculating price elasticity of demand

Two formulas:
2. Arc elasticity or mid-point elasticity

%Δ𝑄𝑄𝑄𝑄
𝐴𝐴𝐴𝐴𝐴𝐴 𝑒𝑒𝑝𝑝 =
%Δ𝑃𝑃
Δ𝑄𝑄𝑄𝑄 𝑃𝑃 (𝑄𝑄2 − 𝑄𝑄1 )/(𝑄𝑄1 + 𝑄𝑄2 )
= × 𝑜𝑜𝑜𝑜
Δ𝑃𝑃 𝑄𝑄𝑄𝑄 (𝑃𝑃2 − 𝑃𝑃1 )/(𝑃𝑃1 + 𝑃𝑃2 )
 5.1 THE ARC PRICE ELASTICITY OF DEMAND

• Worked Question

Given the demand curve P = 10 - 0.5Qd

Calculate the mid-point price elasticity of demand :-

(a) When the price increases from 4 to 5. Interpret the answer.

(b) When the price increases from 8 to 9. Interpret the answer.

 5.1 THE ARC PRICE ELASTICITY OF DEMAND
• Worked Question

Given the demand curve P = 10 - 0.5Qd

Calculate the mid-point price elasticity of demand :-

(a) When the price increases from 4 to 5. Interpret the answer

When P = 4; Qd = 12 and P = 5; Qd=10
(𝑄𝑄2 − 𝑄𝑄1 )/(𝑄𝑄1 + 𝑄𝑄2 )
𝐴𝐴𝐴𝐴𝐴𝐴 𝑒𝑒𝑝𝑝 =
(𝑃𝑃2 − 𝑃𝑃1 )/(𝑃𝑃1 + 𝑃𝑃2 )
(10 − 12)/(12 + 10)
=
(5 − 4)/(4 + 5)
= −0.8182
= −0,8182
= 0,8182
Demand is Inelastic
 5.1 THE ARC PRICE ELASTICITY OF DEMAND
• Worked Question

Given the demand curve P = 10 - 0.5Qd

Calculate the mid-point price elasticity of demand :-
(b) When the price increases from 8 to 9. Interpret the answer.

When P = 8; Qd = 4 and P = 9; Qd = 2
(𝑄𝑄2 − 𝑄𝑄1 )/(𝑄𝑄1 + 𝑄𝑄2 )
𝐴𝐴𝐴𝐴𝐴𝐴 𝑒𝑒𝑝𝑝 =
(𝑃𝑃2 − 𝑃𝑃1 )/(𝑃𝑃1 + 𝑃𝑃2 )
(2 − 4)/(4 + 2)
=
(9 − 8)/(8 + 9)
= −5.6667
= −5,6667
= 5,6667

Demand is Elastic
 5.1 THE ARC PRICE ELASTICITY OF DEMAND

• Try this Question

Calculate the price elasticity of demand for the demand curve

Qd = 300 – 5P. Using the arc method, solve where price:

–Increases from R10 to R20. Interpret the answers.

–Increases from R40 to R50. Interpret the answers.

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

Use the demand curve

P = 10 - 0.5Q
To draw the demand
and a revenue curve

(The same way as was

done for cappuccino)
5.1 Price elasticity of demand and total
revenue(or total expenditure)
P = 10 - 0.5P
5.1 Price elasticity of demand and total
revenue(or total expenditure)
P = 10 - 0.5Qd
 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
» income-inferior good
%ΔQd Δ𝑄𝑄𝑄𝑄 𝑌𝑌
𝑒𝑒𝑦𝑦 (point) = = ×
%Δ𝑌𝑌 Δ𝑌𝑌 𝑄𝑄𝑄𝑄
%ΔQd (𝑄𝑄𝑄 − 𝑄𝑄𝑄)/(𝑄𝑄𝑄 + 𝑄𝑄𝑄)
𝑒𝑒𝑦𝑦 (arc) = =
%Δ𝑌𝑌 (𝑌𝑌𝑌 − 𝑌𝑌𝑌)/(𝑌𝑌𝑌 + 𝑌𝑌𝑌)
 5.2 Income elasticity of demand

The average monthly income of households in Cape Town increases from R2 000 to
R2 500. As a result, the quantity demanded of white bread increases from 1 000
to 1 100 units per day, the quantity demanded of brown bread decreases from 2
000 to 1 900 units per day, and the quantity demanded of KFC fried chicken
increase from 300 to 500 pieces per day.
(a) Use the arc method to calculate the income elasticity of demand for each good.
(b) Classify each of these three products as normal or income-inferior. Explain your
answers in each case.
(c) Classify each of these three products as a necessity or a luxury. Explain your
answer in each case.
 5.2 Income elasticity of demand
The average monthly income of households in Cape Town increases from R2 000 to R2 500. As a result, the
quantity demanded of white bread increases from 1 000 to 1 100 units per day, the quantity demanded of
brown bread decreases from 2 000 to 1 900 units per day, and the quantity demanded of KFC fried
chicken increase from 300 to 500 pieces per day.

(a) Use the arc method to calculate the income elasticity of demand for each good.
(𝑄𝑄𝑄 − 𝑄𝑄𝑄)/(𝑄𝑄𝑄 + 𝑄𝑄𝑄)
𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 𝑒𝑒𝑦𝑦 (arc) =
(𝑌𝑌𝑌 − 𝑌𝑌𝑌)/(𝑌𝑌𝑌 + 𝑌𝑌𝑌)
(1100 − 1000)/(1000 + 1100)
=
(2500 − 2000)/(2000 + 2500)
(100)/(2100) 450 000
= =
(500)/(4500) 1 050 000
=0.4286

(b) Classify each of these three products as normal or income-inferior. Explain? White
bread is a normal good since the income elasticity coefficient is positive.
(c) Classify each of these three products as a necessity or a luxury. White bread is a
necessity good simply because the income elasticity is positive and less than 1.
 5.2 Income elasticity of demand
The average monthly income of households in Cape Town increases from R2 000 to R2 500. As a result, the
quantity demanded of white bread increases from 1 000 to 1 100 units per day, the quantity demanded of
brown bread decreases from 2 000 to 1 900 units per day, and the quantity demanded of KFC fried
chicken increase from 300 to 500 pieces per day.

(a) Use the arc method to calculate the income elasticity of demand for each good.
(𝑄𝑄𝑄 − 𝑄𝑄𝑄)/(𝑄𝑄𝑄 + 𝑄𝑄𝑄)
𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 𝑒𝑒𝑦𝑦 (arc) =
(𝑌𝑌𝑌 − 𝑌𝑌𝑌)/(𝑌𝑌𝑌 + 𝑌𝑌𝑌)
(1900 − 2000)/(2000 + 1900)
=
(2500 − 2000)/(2000 + 2500)
(−100)/(3900) −450 000
= =
(500)/(4500) 1 950 000
=−0.2308

(b) Classify each of these three products as normal or income-inferior. Explain? Brown
bread is an income-inferior good since the income elasticity coefficient is negative.
 5.2 Income elasticity of demand
The average monthly income of households in Cape Town increases from R2 000 to R2 500. As a result, the
quantity demanded of white bread increases from 1 000 to 1 100 units per day, the quantity demanded of
brown bread decreases from 2 000 to 1 900 units per day, and the quantity demanded of KFC fried
chicken increase from 300 to 500 pieces per day.

(a) Use the arc method to calculate the income elasticity of demand for each good.
(Q 2 − Q1) / (Q1 + Q 2)
Fried Chicken e y (arc) =
(Y 2 − Y 1) / (Y 1 + Y 2)
(500 − 300) / (300 + 500)
=
(2500 − 2000) / (2000 + 2500)
(200) / (800) 900 000
= =
(500) / (4500) 400 000
=2.25
(b) Classify each of these three products as normal or income-inferior. Explain? Fried
Chicken is a normal good since the income elasticity coefficient is positive.
(c) Classify each of these three products as a necessity or a luxury. Fried Chicken is a
luxury good since its the income elasticity is positive and greater than 1.
 5.2 Income elasticity of demand

Try this Question

The average monthly income of households in the Limpopo province increases
from R1 200 to R1 500. As a result, the quantity demanded of beef burgers
increases from 300 to 600 units per day, the quantity demanded of radios
decreases from 350 to 250 units per day, and the quantity demanded of
smartphones increase from 100 to 250 units per day.
2.1 Use the arc method to calculate the income elasticity of demand for each good.
2.2 Classify each of these three products as normal or income-inferior. Explain your
answers in each case.
2.3 Classify each of these three products as a necessity or a luxury. Explain your
answer in each case.
5.2 Cross-price elasticity of demand
• Cross-price 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
%Δ𝑄𝑄𝑑𝑑𝐴𝐴 Δ𝑄𝑄𝑑𝑑𝐴𝐴 𝑃𝑃𝐵𝐵
𝑒𝑒𝑐𝑐 (point) = = ×
%Δ𝑃𝑃𝐵𝐵 Δ𝑃𝑃𝐵𝐵 𝑄𝑄𝑑𝑑𝐴𝐴
%Δ𝑄𝑄𝑑𝑑𝐴𝐴 (𝑄𝑄𝐴𝐴 2 − 𝑄𝑄𝐴𝐴1 )/(𝑄𝑄𝐴𝐴1 + 𝑄𝑄𝐴𝐴 2 )
𝑒𝑒𝑐𝑐 (arc) = =
%Δ𝑃𝑃𝐵𝐵 (𝑃𝑃𝐵𝐵 2 − 𝑃𝑃𝐵𝐵 1 )/(𝑃𝑃𝐵𝐵 1 + 𝑃𝑃𝐵𝐵 2 )
 5.3 CROSS-PRICE elasticity of demand

The per-unit price of MP3 decreases from R10 to R8. As a result, the
quantity demanded of CDs in Cape Town decreases from 500 to 300
units per day, while the quantity demanded of iPods increases from
100 to 150 units per day.

(a) Use the arc method to calculate the cross-price elasticity of

demand for CDs. Interpret the answer.

(b) Use the arc method to calculate the cross-price elasticity of

demand for iPods. Interpret the answer.
 5.3 CROSS-PRICE elasticity of demand
The per-unit price of MP3 decreases from R10 to R8. As a result, the quantity
demanded of CDs in Cape Town decreases from 500 to 300 units per day, while
the quantity demanded of iPods increases from 100 to 150 units per day.
(a) Use the arc method to calculate the cross elasticity of demand
for CDs. Interpret the answer.
(QA 2 − QA1 ) / (QA1 + QA 2 )
ec (arc) =
( PB 2 − PB1 ) / ( PB1 + PB 2 )
(300 − 500) / (500 + 300)
=
(8 − 10) / (10 + 8)
( −200) / (800)
=
( −2) / (18)
−3600
=
−1600
= 2.25

As the cross elasticity of demand is positive, it means the CDs and

MP3s are Substitute goods
 5.3 CROSS-PRICE elasticity of demand
The per-unit price of MP3 decreases from R10 to R8. As a result, the quantity
demanded of CDs in Cape Town decreases from 500 to 300 units per day, while
the quantity demanded of iPods increases from 100 to 150 units per day.
(b) Use the arc method to calculate the cross elasticity of demand
for iPods. Interpret the answer.
(QA 2 − QA1 ) / (QA1 + QA 2 )
ec (arc) =
( PB 2 − PB1 ) / ( PB1 + PB 2 )
(150 − 100) / (100 + 150)
=
(8 − 10) / (10 + 8)
(50) / (250)
=
( −2) / (18)
900
=
−500
= −1.80

As the cross elasticity of demand is negative, it means the iPods

and MP3s are Complements goods
 5.3 CROSS-PRICE elasticity of demand

Try this Question

Suppose the price of Doritos fall from R12.50 to R8.50. As a result,

the quantity of peanuts increases from 50 to 200.

Calculate the cross-price elasticity using the arc formula and

interpret your answer.
 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

%Δ𝑄𝑄𝑄𝑄 Δ𝑄𝑄𝑄𝑄 𝑃𝑃
𝑒𝑒𝑠𝑠 (point) = = ×
%Δ𝑃𝑃 Δ𝑃𝑃 𝑄𝑄𝑄𝑄
%Δ𝑄𝑄𝑄𝑄 (𝑄𝑄2 − 𝑄𝑄1 )/(𝑄𝑄2 + 𝑄𝑄1 )
𝑒𝑒𝑠𝑠 (𝑎𝑎𝑎𝑎𝑎𝑎) = =
%Δ𝑃𝑃 (𝑃𝑃2 − 𝑃𝑃1 )/(𝑃𝑃2 + 𝑃𝑃1 )
 5.3 THE PRICE ELASTICITY OF SUPPLY

Given the supply equation P = 7 + 2Qs , calculate the price elasticity

of supply.

(a) At P = 9. Interpret the answer.

(b) When the price increases from 21 to 25, using the arc method.

Interpret your answer.

 5.3 THE PRICE ELASTICITY OF SUPPLY

Given the supply equation P = 7 + 2Qs , calculate the price

elasticity of supply.

(a) At P = 9; Qs = 1. Interpret the answer.

1 𝑃𝑃
𝑒𝑒𝑠𝑠 (point) = ×
𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑄𝑄𝑄𝑄
1 9
= ×
2 1
=4.5
Supply is elastic
 5.3 THE PRICE ELASTICITY OF SUPPLY
Given the supply equation P = 7 + 2 Qs , calculate the price elasticity of supply.
(b)When the price increases from 21 to 25, using the arc method.
When P = 21; Qs = 7 and P = 25; Qs = 9.

(𝑄𝑄2 − 𝑄𝑄1 )/(𝑄𝑄2 + 𝑄𝑄1 )

𝑒𝑒𝑠𝑠= (𝑎𝑎𝑎𝑎𝑎𝑎) =
(𝑃𝑃2 − 𝑃𝑃1 )/(𝑃𝑃2 + 𝑃𝑃1 )
(9 − 7)/(7 + 9)
=
(25 − 21)/(21 + 25)
(2)/(16)
=
(4)/(46)
= 1,4375

Interpret your answer: Supply is Elastic

 5.3 THE PRICE ELASTICITY OF SUPPLY

Try this Question

Given the supply equation P = 0.5Q, calculate the price elasticity of
supply,

(a) At P = 6. Interpret the answer.

(b) When the price increases from 8 to 10, using the arc method.

Interpret your answer.

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