Chapter THREE

Elasticity

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Learning Outcomes
i. Students are able to discuss the concepts
of elasticity of demand.
ii. Students are able to distinguish between
price elasticity of demand, cross elasticity
of demand and income elasticity of
demand.
iii. Students are able to explain price elasticity
of supply.
iv. Students are able to discuss the
determinants of price elasticity of demand
and supply.

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 Elasticity of Demand.
Cross elasticity of
demand.

Price elasticity of Income elasticity

demand. of demand.

Three types of
elasticity of
demand.

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Price Elasticity of
Demand
It measures the sensitivity or
responsiveness of quantity demanded
due to a change in the price of the
product.

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 Formula of Ed

Where;
Q0 = Original quantity
Q1 = New Quantity
P0 = Original price
P1 = New price

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 Degree of Price
Elasticity of Demand

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 Elastic demand (Єp > 1)
• The demand is elastic when the P
coefficient is more than 1.
• It means the percentage change in
quantity demanded is greater than
P1
percentage change in price.
P0 Dd
• This type of demand basically related to
products that have many substitutes.
• Examples: Toyota, Honda, Nissan, Ford,
Proton, Mitsubishi, BMW, Mercedes Q
Q1 Q0

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 Inelastic demand (Єp < 1)
P
• The demand is inelastic when the
coefficient is less than 1.
P1
• It means the percentage change in price is
greater than percentage change in quantity
demanded. P0
• Good that has no substitutes has inelastic
demand. Dd
• Examples: Electricity and water Q
Q1 Q0

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 Unitary elastic demand (Єp = 1)
P
• The demand is unitary when the
coefficient is equal to 1.
P1
• It means the percentage change in
price is equal to the percentage
change in quantity demanded.
P0
• No such product for this demand. Dd

Q
Q1 Q0

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Perfectly inelastic demand (Єp = 0)
P
• The demand is perfectly inelastic
when the coefficient is 0. Dd
• It means quantity demanded does P1
not change as the price change.
• Examples: Drug for drug addicts; P0
insulin for diabetic patients.

Q
Q0

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 Perfectly elastic demand (Єp = ∞)
• The demand is perfectly elastic when P
the coefficient is an infinite number.
• It means a small percentage change in
price leads to an infinite percentage
change in quantity demanded. P0 Dd
• Examples: Control price items such as
sugar, oil, rice, flour, petrol .
Q
Q0 Q1

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Determinants of Price Elasticity of Demand
Number of
Substitute
S
I Consumer
Habit
Proportion of
income level.
G
T
C Time
Status of goods –
luxuries versus
necessities

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 Number of Substitute
• Generally, the large number of substitute goods that are
available, the greater the elasticity of demand.
• For example, Toyota, Honda, Ford and many others
became perfect substitute for Proton.
• So the demand for Proton must be elastic. If the price of
Proton increases, so many potential customer will shift to
other car- HONDA, TOYOTA etc.---quantity demanded for
PROTON decline significantly (will be reduced in large
quantity)
• For good that has no close substitute such as electricity,
the demand is highly inelastic.

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 Proportion of income level
• Other things equal, the higher the price of good relative to our incomes and hence
to our budgets, the greater the goods price elasticity.
• A 10% increase of house’s price will give significant impact on our income and
budget. This increase is big proportion to income and this causes quantity
demanded decline significantly. Price elasticity for such good tends to be high.
• For low priced item, 10% increase in low-priced item will affect a small decline in
quantity demanded. These increases are insignificant our budget or small
proportion to our income. Therefore, the demand for this good is inelastic.

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 Status of goods – Luxuries versus necessities
• Electricity is consider necessities, a price increases will not significantly reduce
the amount power used by people. Its demand is inelastic/perfectly inelastic
• On the other hand, Rolex is considered luxury good, an increase in price will
cause the demand will decrease, therefore, the demand is elastic.
• Luxury good has elastic demand.
• Necessity good has inelastic demand.

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 Time
• Generally, the longer the time period under consideration, the
demand will be more elastic.
• Consumer may not immediately reduce their purchases very much
when the price of beef rises by 10%, but in time they may shift to
chicken or fish, for which hey will develop a taste.
• The price elasticity is greater in the long run because consumers have
more time to adjust.

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 Consumer Habits
• Heavy smokers and heavy drinkers tend to have inelastic demand for
cigarettes and liquor respectively due to their habit.
• This is because cigarette and liquor become necessity to them.
• Almost every year, Malaysian government increased the tax on cigarette and
liquor, consequently increased on the price of the items, but the demand for
these goods were still high.

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Relationship between Total Revenue and Price
Elasticity of Demand.
Degree of Effects on Price and Quantity Effects on Total Revenue
Elasticity

Elastic Demand i. Price ↑, Quantity Demand ↓ Total Revenue ↓

ii. Price ↓, Quantity Demand ↑ Total Revenue ↑

Inelastic Demand i. Price ↑, Quantity Demand ↓ Total Revenue ↑

ii. Price ↓, Quantity Demand ↑ Total Revenue ↓

Unitary Elastic i. Price ↑, Quantity Demand ↓ Total Revenue ↔

ii. Price ↓, Quantity Demand ↑ Total Revenue ↔
Thus, when seller wants to maximize profit from selling goods that have elastic
demand, he should lower the price.
But if the goods have inelastic demand, he should increase the price .
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 Cross Price Elasticity
of Demand
It measures the sensitivity of quantity demanded
of good X when the price of good Y changes.

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 Formula of Exy

Where;
QX0 = Original quantity
QX1 = New Quantity
PY0 = Original price
PY1 = New price

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Coefficient of Cross Elasticity of Demand

Positive Negative Zero

(Exy = positive) (Exy = negative) (Exy = 0)
• The relationship • The relationship • The two goods are
between two goods between two goods unrelated to each
is substitute. is complement. other.
• Example: Tea and • Example: Car and • Example: Pen and
Coffee. Petrol. Bread.

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Income Elasticity of
Demand
It measures the sensitivity or responsiveness
of quantity demanded of a good when the
consumer’s income changes.

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 Formula of EY

Where;
Q0 = Original quantity
Q1 = New Quantity
Y0 = Original income
Y1 = New income

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Coefficient of Income Elasticity of Demand
The good is a normal Television, book,
0 < EY <1 good. computer.

Positive The good is a luxury Luxury car,

(EY > 1) good. jewelry.

The good is a inferior Salted fish, broken

Negative good. rice, used car

The good is a
Zero (0) necessity good.
Electricity, water.

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Price Elasticity of Supply
It measures the sensitivity or responsiveness
of quantity supplied due to a change in its
price.

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 Formula of Es

Where;
Q0 = Original quantity
Q1 = New Quantity
P0 = Original price
P1 = New price

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 Degree of Price
Elasticity of Supply

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 Elastic supply (Єs > 1)
P
• The supply is elastic when the
coefficient is more than 1. Ss
• It means the percentage change in P1

quantity supplied is greater than P0

percentage change in price.

Q
Q0 Q1

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 Inelastic supply (Єs < 1)
P
• The supply is inelastic when the Ss
coefficient is less than 1.
P1
• It means the percentage change in
price is greater than percentage
change in quantity supplied. P0

Q0
Q
Q1

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 Unitary elastic supply (Єs = 1)

P
• The supply is unitary when the
coefficient is equal to 1. Ss
P1
• It means the percentage change in
price is equal to the percentage
change in quantity supplied. P0

Q
Q0 Q1

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 Perfectly inelastic supply (Єs = 0)
P
• The supply is perfectly inelastic when the
coefficient is 0. Ss
• It means quantity supplied does not P1
change as the price change.
P0

Q
Q0

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 Perfectly elastic supply (Єs < ∞)
P
• The supply is perfectly elastic when
the coefficient is an infinite number.
• It means a small percentage change
in price leads to an infinite P0 Ss
percentage change in quantity
supplied.

Q
Q0 Q1

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Determinants of Price Elasticity of Supply

C
G Time period
Perishability

S Substitute
availability of
T Gestation
input used
period
P Change in cost
due to the change
in supply

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 Change in cost of production
– Any change in supply requires a small change in production cost, the
supply is elastic.
– If the change in supply requires big change in cost, the supply will be
inelastic.

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 Gestation period
– If the time taken to produce a good is short, the supply is elastic (example:
Thin Crisp Waffles + Ice Cream).
– If the time taken to produce a good is long like agricultural products, the
supply is inelastic.

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 Substitute Availability of Input Used
– If the firm can use any kind of materials for its input (easily available type
of input), supply of its product elastic.
– If the firm uses very specialized inputs or production factors (not easily
available type of input, supply of its product inelastic.

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 Time period or adjustment period
– In the short run, the producers and the industry is still have limited way to
increase production and supply because they have insufficient time to
adjust, then the supply is inelastic.
– In the long run, the producers have sufficient time to adjust, then the
supply curve is elastic.
– Example, the firm can expand its factory, farmer can acquire additional
land, equipment and machinery.

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 Perishability
– If the product is less perishable like manufactured products, the supply is
elastic.
– If the product is perishable like agricultural products, the supply is
inelastic.

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