 Elasticity = responsiveness/sensitiveness

 Elasticity of demand
◦ Price elasticity of demand
◦ Cross Elasticity of demand
◦ Income elasticity of demand

 Elasticity of supply
 Price elasticity of demand is a measure of how much the
quantity demanded of a good responds to a change in
the price of that good.

Price elasticity of demanded = - % change in qty demanded X

% change in price X
OR

EPD = - QDX1 – QDX0 X P0 _

QDX0 P1 – P0
 Because the price elasticity of demand
measures how much quantity demanded
responds to the price, it is closely related to
the slope of the demand curve.
 (a) Perfectly Inelastic Demand: Elasticity Equals 0

Price
Demand

Quantity demanded does

$5 not respond to price
4 changes
1. An
increase
in price . . .

0 100 Quantity

2. . . . leaves the quantity demanded unchanged.

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 (b) Inelastic Demand: Elasticity Is Less Than 1

Price Quantity demanded does

not respond strongly to
price changes.
$5

4
1. A 22% Demand
increase
in price . . .

0 90 100 Quantity

2. . . . leads to an 11% decrease in quantity demanded.

 (c) Unit Elastic Demand: Elasticity Equals 1
Price
Quantity demanded
changes by the same
percentage as the price
$5

4
1. A 22% Demand
increase
in price . . .

0 80 100 Quantity

2. . . . leads to a 22% decrease in quantity demanded.

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 (d) Elastic Demand: Elasticity Is Greater Than 1
Price
Quantity demanded responds
strongly to changes in price
$5

4 Demand
1. A 22%
increase
in price . . .

0 50 100 Quantity

2. . . . leads to a 67% decrease in quantity demanded.

 (e) Perfectly Elastic Demand: Elasticity Equals Infinity
Price
Quantity demanded changes
1. At any price infinitely with any change in
above $4, quantity price
demanded is zero.
$4 Demand

2. At exactly $4,
consumers will
buy any quantity.

0 Quantity
3. At a price below $4,
quantity demanded is infinite.
 Total revenue is the amount paid by buyers
and received by sellers of a good.
 Computed as the price of the good times the

quantity sold.

TR = P x Q
 With an inelastic demand curve, an increase
in price leads to a decrease in quantity that is
proportionately smaller. Thus, total revenue
increases.

 Price and TR positive relationship

 With an elastic demand curve, an increase in
the price leads to a decrease in quantity
demanded that is proportionately larger.
Thus, total revenue decreases.

 Price and TR negative relationship

 Price Qty D Qty D
(Elastic) (inelastic)
1 100 100
3 20 80

TRRM1 = RM1 x 100 = RM100

TRRM3 (D elastic) = RM3 x 20 = RM60

= Price , TR

TRRM3 (D inelastic) = RM3 x 80 = RM240

= Price , TR
 Availability of Close Substitutes
◦ Many substitute – demand elastic
◦ Less/no substitute – demand inelastic

 Necessities versus Luxuries

◦ Luxury good – demand elastic
◦ Necessity good – demand inelastic

 Budget/income spent
◦ Big budget – demand elastic
◦ Small budget – demand inelastic
 Habit
◦ Habit – demand inelastic

 Time horizon
◦ Short run – demand inelastic
◦ Long run – demand elastic

 Income level
◦ High income – demand inelastic
◦ Low income – demand elastic
 Income elasticity of demand measures how much the
quantity demanded of a good responds to a change in
consumers’ income.

P e rc e n ta g e c h a n g e
in q u a n tity d e m a n d e d
In c o m e e la s tic ity o f d e m a n d =
P e rc e n ta g e c h a n g e
in in c o m e
OR
EI = QD1 – QD0 X I0 _

QD0 I1 – I0
 Interpretation of income elasticity
◦ + ve = > 1 normal/luxury good
0 – 1 necessity good
◦ - ve = inferior good

 Higher income raises the quantity demanded for

normal goods but lowers the quantity demanded
for inferior goods.

 Goods consumers regard as necessities tend to be

income inelastic
◦ Examples include food, fuel, clothing, utilities, and
medical services.

 Goods consumers regard as luxuries tend to be income

elastic.
◦ Examples include sports cars, furs, and expensive
foods.
 Cross elasticity of demand measures how much the
quantity demanded of a good responds to a change in
price of another good

Cross elasticity of demand = % change in qty demanded X

% change in price Y
OR
ECXY = QDx1 – QDx0 X PY0 ____
QDx0 PY1 – PY0

Interpretation
◦ +ve = X and Y are substitute good
◦ -ve = X and Y are complementary good
 Price elasticity of supply is a measure of how
much the quantity supplied of a good
responds to a change in the price of that
good.

 Price elasticity of supply is the percentage

change in quantity supplied resulting from a
percent change in price.

Price elasticity of supply = % change in qty supplied X

% change in price X
 (a) Perfectly Inelastic Supply: Elasticity Equals 0

Price
Supply

$5

4
1. An
increase
in price . . .

0 100 Quantity

2. . . . leaves the quantity supplied unchanged.

Copyright©2003 Southwestern/Thomson Learning

 (b) Inelastic Supply: Elasticity Is Less Than 1

Price

Supply
$5

4
1. A 22%
increase
in price . . .

0 100 110 Quantity

2. . . . leads to a 10% increase in quantity supplied.

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 (c) Unit Elastic Supply: Elasticity Equals 1
Price

Supply
$5

4
1. A 22%
increase
in price . . .

0 100 125 Quantity

2. . . . leads to a 22% increase in quantity supplied.

Copyright©2003 Southwestern/Thomson Learning

 (d) Elastic Supply: Elasticity Is Greater Than 1
Price

Supply

$5

4
1. A 22%
increase
in price . . .

0 100 200 Quantity

2. . . . leads to a 67% increase in quantity supplied.

Copyright©2003 Southwestern/Thomson Learning

 (e) Perfectly Elastic Supply: Elasticity Equals Infinity
Price

1. At any price
above $4, quantity
supplied is infinite.

$4 Supply

2. At exactly $4,
producers will
supply any quantity.

0 Quantity
3. At a price below $4,
quantity supplied is zero.

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 Percentage change in cost of production
◦ Small change in cost – supply elastic
◦ Big change in cost – supply inelastic

 Availability of substitute of inputs

◦ Inputs are easily substitute – supply elastic
◦ Inputs are difficult to substitute – supply
inelastic
 Gestation period
◦ If production period is short (manufactured
goods) – supply elastic
◦ If production period is long (agriculture goods)
– supply inelastic

 Time period.
◦ Short run – inelastic supply
◦ Long run – elastic supply