Elasticity

Elasticity of Demand and
Supply
Elasticity
• Elasticity is a general concept that can be used to quantify the
response in one variable when another variable changes.
% A
elasticity o f A w ith resp ect to B 
% B
Price Elasticity of Demand
• Measures the responsiveness of demand to changes in
price, given other things constant.
• It is the ratio of the percentage change in quantity demanded

to the percentage change in price.
% ch an ge in q u an tity d em an d ed
p rice elasticity o f d em an d 
% ch an g e in p rice
• Its value is always negative, but stated in absolute terms.
• The value of the line of the slope and the value of elasticity
are not the same.
Characteristics of Demand
Elasticity
Value of Type of Magnitudes of Response to
Elasticity Demand Change Price Changes
 > |1| Elastic %Qd > %P Responsive
 < |1| Inelastic %Qd < %P Unresponsive
 = |1| Unitary elastic %Qd = %P Proportional
Type of Substitutes
Elasticity Available
Elastic Many
Inelastic Few
Shape of Demand According to
Elasticity
Type of Demand Inclination
Elastic Relatively Flat
Inelastic Relatively Steep
Extreme Elasticity
Elasticity Value Type of Elasticity Substitutes Available

=0 Perfectly Inelastic None
= Perfectly Elastic Infinite
Hypothetical Demand Elasticity
for Four Products
Hypothetical Demand Elasticities for Four Products
% CHANGE IN
% CHANGE QUANTITY
IN PRICE DEMANDED ELASTICITY
PRODUCT (% D P) (% D Qd) (% D Qd/% D P)
Insulin 10% 0% 0 Perfectly inelastic
Electricity 10% -1% -0.1 Inelastic
Chiken 10% -10% -1 Unitary elastic
Bananas 10% -30% -3 Elastic
Calculating Percentage Changes
• Elasticity is a ratio of percentages, and it involves computing
percentage changes.
P2  P1
% ch an g e in p rice  x 100%
P1
Q 2  Q1
% change in quantity dem anded  x 100%
Q1
• Using the values on the graph to
compute elasticity, then
%Quantity Demanded= 5-10/10= -50%
% Change in Price=( 3-2)/2 = 50%
Elasticity= 50%/50%= -1
Computing the Value of
Elasticity
• The midpoint formula to
compute elasticity is:
Q 2  Q1
x 100%
%  Q d ( Q1  Q 2 ) / 2

% P P2  P1
x 100%
( P1  P2 ) / 2
Interpreting the Value of
Elasticity
Here is how to interpret two different values of
elasticity:
• When e = 0.2, a 10% increase in price leads to a 2%

decrease in quantity demanded, given other things
constant.
• When e = 2.0, a 10% increase in price leads to a 20%
decrease in quantity demanded, given other things
constant.
Elasticity Changes along a
Straight-Line Demand Curve
• Price elasticity of demand
decreases as we move
downward along a linear
demand curve.
• Demand is elastic on the upper

part of the demand curve and
inelastic on the lower part.
Elasticity Changes along a
Straight-Line Demand Curve
 6.4 • Along the elastic range,
elasticity values are greater
than one.
 .29
• Along the inelastic range,
elasticity values are less
than one.
Elasticity and Total Revenue
Effect of an
increase in Effect of a
Type of Change in quantity price on total decrease in price
demand Value of Ed versus change in price revenue on total revenue
Elastic Greater than 1.0 Larger percentage change Total revenue Total revenue
in quantity decreases increases
Inelastic Less than 1.0 Smaller percentage Total revenue Total revenue
change in quantity increases decreases
Unitary Equal to 1.0 Same percentage change Total revenue Total revenue does
elastic in quantity and price does not change not change
• When demand is inelastic, price and total revenues are directly

related. Price increases generate higher revenues.
• When demand is elastic, price and total revenues are indirectly
related. Price increases generate lower revenues.
Determinants of Demand
Elasticity
• Availability of substitutes -- demand is more elastic
when there are more substitutes for the product.
• Importance of the item in the budget -- demand is more
elastic when the item is a more significant portion of the
consumer’s budget.
• Time frame -- demand becomes more elastic over time.
Other Important
Elasticities
• Income elasticity of demand – measures the responsiveness

of demand to changes in income.
% chang e in q uan tity d em an d ed

in com e ela sticity of d em and 
% ch an ge in in co m e
EI >0 implies normal good.
EI <0 implies inferior good.
• Normal goods may be necessity or luxury.
Other Important
Elasticities
• Cross-price elasticity of demand: A measure of the

response of the quantity of one good demanded to a change
in the price of another good.
% ch an ge in q u an tity o f Y dem and ed

cross - p rice elasticity of dem an d 
% ch an g e in p rice o f X
Cross Elasticity of Demand
 When two goods are substitutes, then increase in the price of
one good decreases its own demand and increases the demand
of another good. In this case cross elasticity of demand is
positive
 In the case of complementary goods the increase in the price

of one good decreases the demand for both the goods. In this
case cross elasticity of demand is negative
Promotional
(or Advertising) Elasticity
of Demand
• The advertising elasticity of demand measures an extent to
which the demand of a product will be influenced by
advertisement and other promotional activities.
• Advertising elasticity of demand measures the responsiveness
of quantity demanded to changes in the expenditure on
advertising and other sales promotional activities.
ðQ A
eA = .
ðA Q
Other Important Elasticities
• Elasticity of supply: A measure of the response of quantity

of a good supplied to a change in price of that good. Likely
to be positive in output markets.
% ch an g e in q u an tity su p p lied
elasticity o f su p p ly 
% ch an g e in p rice
Other Important Elasticities
• Elasticity of labor supply: A measure of the response of

labor supplied to a change in the price of labor.
% chan g e in q u an tity of lab or su p plied

elasticity o f lab o r su p p ly 
% ch an g e in th e w ag e rate
Importance of Elasticity
• Relationship between changes in price and total revenue.
• Importance in determining what goods to tax (tax revenue)
• Importance in analysing time lags in production
• Influences the behaviour of a firm

Elasticity

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Elasticity of Demand and

• It is the ratio of the percentage change in quantity demanded

Elasticity Value Type of Elasticity Substitutes Available

• When e = 0.2, a 10% increase in price leads to a 2%

• Demand is elastic on the upper

• When demand is inelastic, price and total revenues are directly

• Income elasticity of demand – measures the responsiveness

% chang e in q uan tity d em an d ed

• Cross-price elasticity of demand: A measure of the

% ch an ge in q u an tity o f Y dem and ed

 In the case of complementary goods the increase in the price

• Elasticity of supply: A measure of the response of quantity

• Elasticity of labor supply: A measure of the response of

% chan g e in q u an tity of lab or su p plied

• Importance in determining what goods to tax (tax revenue)

• Importance in analysing time lags in production

• Influences the behaviour of a firm

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