Lecture 3 : ELASTICITY

Elasticity
Elasticity measures the sensitivity of a dependent
variable (Y) to changes in an independent variable (X).

%Y

%X

Price Elasticity of Demand

Price Elasticity of Demand (D) measures the sensitivity of
quantity demanded to changes in price.

%Qd Qd / P Qd P
D

%P
P / P
P Qd

Example: Given the following demand curve,

solve for the price elasticity of demand for price
increase from P300 to P345.

Degrees of Elasticity
1.

Inelastic ( |D|< 1, % Qd < % P )

Demand is inelastic if a
specific percentage change in
price produces a smaller
percentage change in quantity
demanded.

Degrees of Elasticity
2.

Elastic ( | D |> 1, % Qd > % P )

Demand is elastic if a
specific percentage change in
price produces a larger
percentage change in quantity
demanded.

Degrees of Elasticity
3.

Unit-Elastic ( | D |= 1, % Qd = % P )

Demand is unit-elastic if a
specific percentage change in
price produces the same
percentage change in quantity
demanded.

Extreme Cases of Elasticity

1.

Perfectly Inelastic (D = 0)

Demand
is
perfectly
inelastic if quantity demanded
is totally unresponsive to any
changes in price.

Extreme Cases of Elasticity

2.

Perfectly Elastic (D = )

Demand is perfectly elastic

if quantity demanded can be
of any amount at a particular
product price.

Example: Given the following demand curve,

solve for the price elasticity of demand for price
decrease from P300 to P345.

Example: Given the following demand curve,

solve for the price elasticity of demand
between P300 and P345.

Price Elasticity of Demand

Point Elasticity Formula

Qd P
P Qd

Arc Elasticity Formula

Qd AveP
P AveQd

Elasticities on a Linear Demand Line

Qd = 800 50P
A
B
C

D
E
F
G
H
I

What is the price elasticity of

demand at a price of
$2.51/gallon?
What is the price elasticity of
demand at a price of
$2.92/gallon?

Determinants of D
1.

Substitutability
with many substitutes demand is price elastic
with few substitutes demand is price inelastic

2.

Proportion of expenditure to income

larger proportion demand is price elastic
smaller proportion demand is price inelastic

Determinants of D
3.

Type of Product
luxury demand is price elastic
necessity demand is price inelastic

4.

Time Horizon
long run demand is price elastic
short run demand is price inelastic

Determinants of D
Time
Horizon
Example:
Demand
for
Gasoline
in the SR
and LR

Determinants of D
Time
Horizon and
Durability
Example:
Demand for
Cars in the
SR and LR

Price Elasticity of Demand: Application

1.

The Effects of
Price
Changes to
Total Revenue
for a given
Price
Elasticity of
Demand

Price Inelastic Demand

higher price will lead to higher total revenue
lower price will lead to lower total revenue

2.

Price Elastic Demand

higher price will lead to lower total revenue
lower price will lead to higher total revenue

3.

Price Unitary Demand

any changes in price will leave the total revenue

unchanged

Price

Quantity Demanded

4.5

10

12

14

16

18

Price Elasticity of Demand Total Revenue

10

Estimating Price and Income

Elasticities of Demand of Selected
Food Commodities in the
Philippines
log Qd x log 0 1 log Px 2 log Y 3 log Py

Source: Bureau of Agricultural Statistics (2011)

Data Coverage: 2008-2009 for 9,122 households

Commodity

Price Elasticity of Demand

Rice

-0.047275

Corn

-0.591622

Camote

-0.593669

Cassava

-0.093564

Gabi

-0.102501

Potato

-0.855866

Banana

-0.521633

Ampalaya

-0.328495

Eggplant

-0.379795

Chicken

-0.254441

Pork

-0.316288

Milkfish

-0.105976

Tilapia

-0.175608

Income Elasticity of Demand

Income Elasticity of Demand (I) measures the sensitivity
of the demand to changes in income.

%Qd
I
%I

11

Income Elasticity of Demand

Point Elasticity Formula

Qd I
I
I Qd

Estimating Price and Income

Elasticities of Demand of Selected
Food Commodities in the
Philippines
log Qd x log 0 1 log Px 2 log Y 3 log Py

Source: Bureau of Agricultural Statistics (2011)

Data Coverage: 2008-2009 for 9,122 households

Arc Elasticity Formula

Qd AveI
I
I AveQd

Commodity

Income Elasticity of Demand

Rice

0.166509

Corn

-0.086016

Camote

0.058480

Cassava

0.035008

Gabi

-0.146088

Potato

-0.188236

Banana

0.114274

Ampalaya

0.134316

Eggplant

0.043839

Chicken

0.212289

Pork

0.278588

Milkfish

0.150087

Tilapia

0.158514

12

Cross-Price Elasticity of Demand

Cross-Price Elasticity of Demand (XY) measures the
sensitivity of the demand for product X to changes in the
price of product Y.

%Qdx
xy
%Py

13

Cross-Price Elasticity of Demand

Point Elasticity Formula

xy

Qdx Py
Py Qdx

Arc Elasticity Formula

xy

Qdx AvePy
Py AveQdx

14

Price Elasticity of Supply

Price Elasticity of Supply (S) measures the sensitivity of
quantity supplied to changes in price.

%Qs
s
%P

Price Elasticity of Supply

Point Elasticity Formula

Qs P
P Qs

Arc Elasticity Formula

Qs AveP
P AveQs

15

Degrees of Elasticity
1.

Inelastic ( S < 1, % Qs < % P )

Supply is inelastic if a
specific percentage change in
price produces a smaller
percentage change in quantity
supplied.

Degrees of Elasticity
2.

Elastic ( S > 1, % Qs > % P )

Supply is elastic if a
specific percentage change in
price produces a larger
percentage change in quantity
supplied.

16

Degrees of Elasticity
3.

Unit-Elastic ( S = 1, % Qs = % P )

Supply is unit-elastic if a
specific percentage change in
price produces the same
percentage change in quantity
supplied.

Extreme Cases of Elasticity

1.

Perfectly Inelastic (S = 0)

Supply is perfectly inelastic

if quantity supplied is totally
unresponsive to any changes in
price.

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Extreme Cases of Elasticity

2.

Perfectly Elastic (S = )

Supply is perfectly elastic if

quantity supplied can be of
any amount at a particular
product price.

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