Elasticity

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Definition
Definition
2

Elasticity measures the sensitivity of either

demand or supply to a change in any of their

determinants.
Elasticity measures how responsive or
unresponsive the quantity demanded (or supplied)
is to changes in a given factor.
Elasticity allows you to predict how a price change
will affect the behavior of buyers or sellers.
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Types of Elasticity
3

Price elasticity of demand.

Price elasticity of supply.
Income elasticity of demand.

Cross Price elasticity.

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Factors Affecting Demand

Elasticity
4
Percent of consumers budget
spent on item
The smaller the percent, the
more inelastic
Nature of the good
necessities more inelastic
than non-necessities
durable goods more elastic
than for nondurable goods
Length of time period over which
elasticity is measured
short run more inelastic than
long-run

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Availability of substitutes:
Number and closeness of
substitutes--more and closer
means greater elasticity
A related factor is how widely,
or narrowly, a market is defined:
Demand for food is much more
inelastic than demand for cereal
because of the relative number
ofsubstitutes in each case
Demand for a product is more

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The Price Elasticity of Demand

5

Measures the response of the quantity

demanded to a change in price.

How responsive do you think is the quantity
demanded of prescription drugs to a change in
price?
How responsive do you think is the quantity
demanded of bananas to a change in price?

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The Elasticity Formula

6

Percentage Change in Quantity Demanded

ed =

Percentage Change in price

%Change in Quantity Supply

es=
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%Change in Price

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The Elasticity Formula

7

Qd2-Qd1/ Qd1

ed =

P2-P1/P1
Qs2- Qs1/Qs1

es=
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P2-P1/P1

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1. Compute elasticity of demand for

2002
PRICE

QUANTITY

2001 : PY

2002 CY

12

2003

20

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The Elasticity Formula

9

12-4/ 4

ed =

2-3/3
8/4

ed=

1/3

ed= 2/.33 =- 6.06, 6.-6.06

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For every 1% inc. in Price, Qd dec. by

6.06%
For every 1% dec. in Price, Qd inc. by
6.06%

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The Price Elasticity of Demand

11

Measures the responsiveness of the quantity

demanded to a change in price.

There is a negative relationship between the price
and the quantity demanded.
The price elasticity of demand is ALWAYS
NEGATIVE.

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Price elasticity of demand is ALWAYS

NEGATIVE
12

Always write a negative

sign in front!

epd =

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Change in Quantity / Average Quantity

Change in Price / Average Price

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Five Types of Elasticities

13

Consider only the absolute value of the elasticity:

|E|
The absolute value of the elasticity can be
|e|>1
InElastic
|e|=1
Unitarily Elastic
|e|<1
Elastic
/e/=0
Perfectly Inelastic
/e/=
Perfectly Elastic

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Sensitive Demands are Elastic Demands (e > 1)

14

Percentage Change in Quantity Demanded

epd =

Percentage Change in price

If the numerator (DQ%) is larger than the

denominator (DP%) then epd is greater than one.
A relatively small change in price causes a
relatively large change in quantity demanded.
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Example
15

It has been observed that a 5% increase

in the price, caused a 10% reduction
in the quantity demanded.

epd = 10% / 5% = - 2
Elasticity of Demand is greater than one:
Elastic
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Insensitive Demands are Inelastic Demands

(e < 1)
16

Percentage Change in Quantity Demanded

epd =

Percentage Change in price

If the numerator (DQ%) is smaller than the

denominator (DP%), then epd is less than one.
A relatively large change in price causes a
relatively small change in quantity demanded.
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Example
17

It has been observed that a 20% decrease in the

price of good X, caused a 5% increase in the
quantity demanded of X.

d
ep

= 5% / 20% = - 0.25

Elasticity of Demand is less than one:

Inelastic
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The Elasticity Changes Along the Demand

Curve
18

|e| > 1

|e| = 1
|e| < 1

Midpoint
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Perfectly Elastic Demand

When the elasticity is a

very large number (close

to infinity) demand is
0.61
said to be perfectly
elastic.
0.6
A perfectly elastic
demand would show
that at the slightest
increase in the price, the
quantity demanded
would drop to zero.
0 Units
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tsbalgos, )(

|e| =

100 Units
19

Perfectly Inelastic Demand

When the elasticity is a

very small number

1.20
(close to zero) demand
is said to be perfectly
inelastic.
A perfectly inelastic
demand would show
that even after a large 0.6
change in the price the
quantity demanded
would not change at all.
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|e| = 0
100 Units
20

21

What Determines the Elasticity?

The number of substitutes available.
The Definition of the market.
The length of time consumers have to react to a

price change.
Necessities tend to have inelastic demands,
whereas luxuries have elastic demands.

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Example: Doctor visits, sailboats.

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The number of Substitutes Available.

22

The more
substitutes
exist for a
given good, the
easier it would
be for
consumers to
switch.
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The more
sensitive
(elastic)
demand would
be to price
changes
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23

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24

tsbalgos, )(

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2. Which product will be less

elastic? Why?
25

a)
b)

c)
d)

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CARS
SPORTS CAR
TRUCKS
JEEPNEYS

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The amount of time to react

26

The longer the time allowed, the easier it is for

consumers to find an alternative or modify their

behavior.
Goods have more elastic demands over longer time
horizons.
Example: Gasoline.

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The Price Elasticity of Demand and Revenues

27

Total Revenues = Price x Quantity

An increase in price will increase TR only if the

quantity demanded does not fall too much.

If the increase in price is larger than the drop in
quantities, TR will increase.
3. This is precisely what happens if demand is
_____________

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Elasticity and Total Revenues

28

Px Q
This is the case when |e| > 1.

TR =

TR = P x

This is the case when |e| < 1.

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If a company increases prices and as a result:

29

Total Revenues

Total Revenues Increase.

Decrease.
We can conclude that the
rise in revenues due to
higher prices, was
completely offset by the
drop in quantities sold.

We can conclude that the

Demand is
Elastic

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quantities sold did not

drop enough to offset the
rise in revenues due to
higher prices
Demand is
Inelastic

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Total Revenues, Changes in prices and

30
Elasticity

Decrease
Price to
Increase TR

Increase Price
to Increase
TR

|e| = 1
If demand is UNIT elastic an
increase/decrease in price
would leave TR unchanged

Midpoint
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Cross Elasticity
31

% change in Q to %
change in price of some
other good
Measures closeness of
substitutes and
complements
positive for substitute
commodities
negative for complements
EX can be calculated
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Xd = %DQdx / %DPy = Qx1-Qx0/(Qx1+Qx0)

Py1-Py0/(Py1+Py0)

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END

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