Kwame Nkrumah University of

Science & Technology, Kumasi,

Ghana

ECON 151:
ELEMENTS OF ECONOMICS

Samuel Tawiah Baidoo (Ph.D)

Department of Economics
KNUST
 Kwame Nkrumah University of
Science & Technology, Kumasi,
Ghana

Elasticity
 Kwame Nkrumah University of
Science & Technology, Kumasi,
Ghana

Introduction
 As indicated earlier, when the price of a good
rises (or falls), quantity demanded falls (rises).
 Economists would like to know by how much
quantity demanded falls or rises in response to a
price change.
 In other words, we would like to know how
responsive demand is to price changes.
 For instance, consumers’ response to a change in
the price of oil would differ from that of Voltic
Mineral Water.
 Market demand and Price Change

c b
Price

P2

a
P1 D'

D
O Q3 Q2 Q1 Quantity
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Ghana

Elasticity
 Elasticity is the economic measure of the response of
one variable to a change in another.
 Elasticity of demand measures the degree of
responsiveness of quantity demanded to changes in the
determinants of demand.
 Since not all the factors that affect demand can be
measured quantitatively, we will discuss three types of
demand elasticity:

 Price Elasticity of Demand

 Income Elasticity of Demand and
 Cross-Price Elasticity of demand
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Price Elasticity of demand

 Price elasticity of demand measures the degree of
responsiveness of quantity demanded to changes
in the commodity’s own price.

 Elasticity compares the size of the change in

quantity demanded to that of price.

 Since quantity and price are measured in different

units, the only sensible way to measure elasticity
is to use proportionate or percentage changes.
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Measurement of Price Elasticity

Or
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Measurement of Price Elasticity:

Percentage change in quantity is given as:

---------------------------------(1)

Percentage change in Price is given as:

------------------------------(2)
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Price Elasticity of demand

 Dividing equation (1) by equation (2) implies:

 Solving this will yield an alternative method.

 This is given as:
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Price Elasticity of demand: Example

 Assume that the price of Yam decreases from GH
¢5 to GH¢4 per tuber and this causes the quantity
demanded to increase from 5 tubers per day to 10
tubers. What is the price elasticity of demand?

 From this information,

, ,
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Price Elasticity of demand: Example

 Kwame Nkrumah University of
Science & Technology, Kumasi,
Ghana
Price Elasticity of demand: Example
Percentage change in quantity is given as:

Percentage change in Price is given as:

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Ghana

Interpretation of Elasticity Figures

 Since demand curves are generally downward
sloping, it implies that percentage change in
price and that of quantity would have opposite
signs.
 That is, a percentage increase in price would be
accompanied by a percentage decrease in
quantity demanded and vice versa.
 Either way, the price elasticity of demand is
always negative. In this class, we would ignore
the negative sign and interpret the absolute
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Interpretation of Elasticity Figures

 If PED = 0, then demand is Perfectly inelastic.

 This means that demand does not respond at all to

changes in price. That is, no matter the price,
quantity demanded is the same.

 The demand curve is thus vertical as shown on the

next slide:
 Perfectly inelastic demand (PÎD = 0)

P D

P2
b

P1 a

O Q1 Q
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Ghana

Interpretation of Elasticity Figures

 If PED = ∞, then demand is Perfectly Elastic.

 This means that demand responds infinitely to a

small change in price. That is, a small change in
price brings about infinitely large change in
quantity demanded.

 This is shown by a horizontal demand curve

 Infinitely elastic demand
P

a b
P1 D

O Q1 Q2 Q
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Interpretation of Elasticity Figures

 If PED>1, then demand is fairly Elastic.
 This is where a change in price causes
proportionately larger change in the quantity
demanded.

 In this case, the value of elasticity will be greater

than 1 since we are dividing a larger figure by a
smaller figure.

 This is shown by a relatively flatter demand curve

Elastic demand between two points
P

b
5
a
4
D

0 10 20 Q
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Interpretation of Elasticity Figures

 If 0<PED<1, then demand is fairly Inelastic.
 This is where a change in price causes
proportionately smaller change in the
quantity demanded.
 In this case, the value of elasticity will be
less than 1 since we are dividing a smaller
figure by a larger figure.
 This is shown by a relatively steeper demand
curve
 Inelastic demand between two points
P

8
c

a
4

0 15 20 Q
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Ghana

Interpretation of Elasticity Figures

 If PED =1, then demand is said to be unitary
Elastic.
 This is where price and quantity demanded
change by the same proportion.

 In this case, the value of elasticity will be 1

since we are dividing a figure by itself.

 The demand curve is a rectangular hyperbola:

 Unitary Elastic
P

po c

p1 a

0 Q0 Q1 Q
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Summary of Price Elasticity of Demand

 Fairly Elastic Demand - Ed will be > 1

 Fairly Inelastic Demand - Ed will be < 1

 Unitary Elastic Demand - Ed will be = 1

 Perfectly Inelastic Demand - Ed will be = 0

 Perfectly Elastic Demand - Ed will be = 

 Kwame Nkrumah University of
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Determinants of price elasticity of demand

 Number and closeness of substitute goods
If a commodity has close substitutes, its demand tend to be elastic
while a commodity with no close substitutes which would be bought
even at a higher price tend to be inelastic in demand.

 Degree of necessity of the commodity:

If a commodity is essential and has no close substitutes (eg salt) its demand tends to
be price inelastic, on the other hand goods which are not essential tend to be price
elastic in demand.

 The proportion of income spent on the good

Inexpensive goods tend to be price inelastic since it takes a small percentage of
consumer’s income, while expensive commodities tend to be elastic.
 Kwame Nkrumah University of
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Determinants of price elasticity of demand

 Time
In the short run, demand is inelastic since price change would have
little influence on quantity demanded for most commodities. In the
long run however, demand becomes price elastic. (Through
information - adjustment takes time).

 Durability of commodity
Durable items are more inelastic in demand than non-durable ones.
Durable goods are those with a long life span.
 Habit Formation
 The number of new buyers
 Number of uses of the commodity
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Price elasticity of demand and consumer

expenditure
 Total Revenue (expenditure) = P x Q

 A price increase has two effects on revenue:

 Higher P means more revenue on each unit
you sell.
 But you sell fewer units (lower Q), due to
Law of Demand.
 Which of these two effects is bigger?
 It depends on the price elasticity of demand.
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Price elasticity of demand and consumer

expenditure
If demand is price elastic: If demand is price inelastic:

Increasing price would Increasing price would

reduce TR (%Δ Qd > % Δ P) increase TR (%Δ Qd < % Δ P)

Reducing price would

Reducing price would reduce
increase TR (%Δ Qd > % Δ P)
TR (%Δ Qd < % Δ P)
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Determinants of price elasticity of demand

If demand is elastic, then

price elasticity of demand > 1

% change in Q > % change in P

 The fall in revenue from lower Q is greater

than the increase in revenue from higher P,
so revenue falls.
 Kwame Nkrumah University of
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Ghana

Determinants of price elasticity of demand

If demand is inelastic, then

price elasticity of demand < 1

% change in Q < % change in P

 The fall in revenue from lower Q is smaller

than the increase in revenue from higher P,
so revenue rises.
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Determinants of price elasticity of demand

If demand is Unitary elastic, then

price elasticity of demand = 1

% change in Q = % change in P

 The fall in revenue from lower Q is the

same as the increase in revenue from higher
P, so revenue remains the same.
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Determinants of price elasticity of demand

 Arc Elasticity

 Arc elasticity measures elasticity between two

points on the demand curve.

Q/averageQ ÷ P/average P

 Or
 Measuring elasticity using the arc method
10

m
8

n
6

P (£)

2 Demand

0
0 10 20 30 40 50
Q (000s)
 Measuring elasticity using the arc method
10
DQ DP
Ped = ¸ mid P
mid Q
m
8

7 P = –2
n
6
Q = 10
P (£) Mid P
4

2 Demand

0
0 10 15 20 30 40 50
Mid Q Q (000s)
 Measuring elasticity using the arc method
10
DQ DP
Ped = ¸ mid P
mid Q
m
8 10 -2
=
15
¸ 7
7 P = –2
n
6
Q = 10
P (£) Mid P
4

2 Demand

0
0 10 15 20 30 40 50
Mid Q Q (000s)
 Measuring elasticity using the arc method
10
DQ DP
Ped = ¸ mid P
mid Q
m
8 10 -2
=
15
¸ 7
7 P = –2 = 10/15 x -7/2
n
6
Q = 10
P (£) Mid P
4

2 Demand

0
0 10 15 20 30 40 50
Mid Q Q (000s)
 Measuring elasticity using the arc method
10
DQ DP
Ped = ¸ mid P
mid Q
m
8 10 -2
=
15
¸ 7
7 P = –2 = 10/15 x -7/2
n
6 = -70/30
Q = 10
P (£) Mid P
4

2 Demand

0
0 10 15 20 30 40 50
Mid Q Q (000s)
 Measuring elasticity using the arc method
10
DQ DP
Ped = ¸ mid P
mid Q
m
8 10 -2
=
15
¸ 7
7 P = –2 = 10/15 x -7/2
n
6 = -70/30
Q = 10 = -7/3 = -2.33
P (£) Mid P
4

2 Demand

0
0 10 15 20 30 40 50
Mid Q Q (000s)
Q If the price of good X rises from £9 to £11 and
as a result quantity demanded falls from 100
units to 60 units, what is the price elasticity of
demand between these prices?
20% 20% 20% 20% 20%

A. 2/–80 = –0.025
B. –80/2 = –40
C. 0.2/–0.5 = –0.4
D. –0.5/0.2 = –2.5
E. –1

A. B. C. D. E.
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Price elasticity of supply

 Measure the degree of responsiveness of quantity
supplied to changes in the price of the commodity.
For point elasticity,

Or
 Kwame Nkrumah University of
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Price elasticity of supply

For Arc Elasticity:

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Price elasticity of supply

 If the percentage change in quantity supplied is less
than the percentage change in price, supply is inelastic
(i.e. es<1) - it is difficult for suppliers to react swiftly
to changes in price.

 If on the other hand, the percentage change in quantity

supplied is greater than the percentage change in price,
supply is elastic (i.e. es> 1) - suppliers can react
quickly to changes in price.

 If the percentage changes in both quantity supplied

and price are equal, the supply is unitary elastic (i.e.
e = 1)
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Price elasticity of supply

 Unlike the PED, where the steepness or flatness determines
the elasticities, the flatness or steepness of supply curve is a
misleading guide to elasticity. With PES we look at the point of
intersection of the supply curve and the price and the quantity
axes.

1. Inelastic - if supply curve intersect the quantity axis

2. Elastic – if supply curve intersect the price axis

3. Unitary – If supply curve is drawn from the origin (0)

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Price elasticity of supply

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Ghana

Determinants of Price elasticity of supply

Nature of the good or service-some goods are fixed in supply (eg.
Mineral deposits-inelastic in supply).

Input availability (input unavailability- inelastic supply)

Existence of spare capacity (inexistence of spare capacity-

inelastic supply)

Stage of production (stage where increasing output increases unit

cost-reducing profit-inelastic supply).

Factor mobility (if immobile - supply will be inelastic)

Effects of the weather (bad weather-inelastic supply)

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Determinants of Price elasticity of supply

Durability of good or availability of storage facilities (if durable or
have storage facility-[store them to await better prices]-supply will
be elastic)

Number of markets (if one market-[no alternative market]-supply

is inelastic)

Quantity of commodity in stock (higher quantity of stock - supply

is elastic)

Number of firms in the industry (greater number of firm - supply

is elastic)

Time available for adjustment (short run-inelastic; long run -

elastic)
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Determinants of Price elasticity of supply

 The more easily sellers can change the quantity they produce, the
greater the price elasticity of supply.

 For many goods, price elasticity of supply

is greater in the long run than in the short run,
because firms can build new factories,
or new firms may be able to enter the market.
 Q In which one of the following cases is
good X likely to have a more
price-elastic supply than good Y?
A. It is more costly to shift from
producing X to another product
than from Y to another product.
B. The supply of Y is considered
over a longer period of time
than X.
C. X is a minor by-product of Y.
D. Consumers find it easier to find
alternatives to Y than to X.
E. The cost of producing extra units
increases more rapidly in the
case of Y than in the case of X.
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Income Elasticity of Demand

 Measure the degree of responsiveness of quantity
demanded to changes in the income of the
consumer.
For point elasticity,

Or
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Income Elasticity of Demand

For Arc Elasticity:

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Interpretation of Income Elasticity
Figures
Income elastic if ey > 1

Income inelastic if 0 < ey < 1

Negatively income elastic if ey < 0

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Interpretation of Income Elasticity
Figures
Normal Good – demand rises as income rises and vice
versa. ey = +ve

If 0 < ey < 1 = the good is normal and a necessity

If ey > 1 , the good is normal and a luxury

Inferior Good – demand falls as income rises and vice

versa.
ey = negative i.e. ey < 0
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Determinants of Income Elasticity

 Degree of necessity

 Proportion of income spent on the good

Q The data in the table refer to the income
elasticities of demand for various commodities.
Which one is a normal good and income inelastic?
Wine and spirits 2.60
Travel abroad 1.14
Dairy produce 0.53
Bread and cereals –0.50
Coal –2.02

A. Wine and Spirits

B. Travel Abroad
C. Dairy Produce
D. Bread and cereals
E. Coal
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Cross-Price Elasticity of Demand

 Measure the degree of responsiveness of
quantity demanded of one commodity to
changes in the price of another commodity.

Or
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Cross-Price Elasticity of Demand

For Arc Elasticity:

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Interpretation
 If the value is positive, then the two goods are
substitutes implying that percentage increase in the
price of one good lead to an increase in the demand
for the other good, and vice versa all other things
being equal.
 If the value is negative, then the two goods are
complements implying that percentage increase in the
price of one good leads to a decrease in the demand
for the other good, and vice versa, all other things
being equal
 If the value is zero, then the two goods are said to be
unrelated.
Q If a rise in the price of good X results
in the amount of money spent on
good Y remaining the same, then

A. X and Y are perfect substitutes. 20% 20% 20% 20% 20%

B. X and Y are perfect complements.

C. the cross-price elasticity of
demand for Y with respect to X
is infinite.
D. the cross-price elasticity of
demand for Y with respect to X
is 1.
E. the cross-price elasticity of
demand for Y with respect to X
is Zero. A. B. C. D. E.
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