Elasticity

Prof. K. V. Bhanu Murthy

Definition
 Elasticity of Demand
 “Rate of change of Quantity Demanded with respect to Rate
of change of the determinant of demand”
 Own price elasticity
 “Rate of change of Quantity Demanded (Qdx) with respect
to Rate of change of own price (Px)”
 Єdx = [% ∆Qdx/% ∆Px]
Types of Elasticity
 1. Own Price – wrt own price(Px) is Edx<0
 2. Income Elasticity – wrt Income Edx
 Єdx = [% ∆Qdx/% ∆I]=> Positive for normal goods
 3. Cross Elasticity – wrt to related goods
 - Єdx = [% ∆Qdx/% ∆Ps]>0
 - Єdx = [% ∆Qdx/% ∆Pc]<0
Elasticity of Supply
 Elasticity of Supply is defined as the
 “Rate of Change of Quantity Supplied (Qsx) with respect to
Rate of Change of determinant of Supply.”
 “Rate of Change of Quantity Supplied (Qsx) with respect to
Rate of Change of own price (Px).”
 Єsx = [% ∆Qsx/% ∆Px]>0
 Measure of Elasticity - Sign
 For measuring own price elasticity
 Єdx =[(New Quantity -Original Quantity)/ Original Quantity)]
[(New Price –Original Price)/ Original Price )]

 Єdx =[(Q2 –Q1)/ Q1)] [(P2 –P1)/ P1 )]

 Therefore:
 Єdx = [% ∆Qdx/% ∆Px]
 It is a measure of responsiveness of demand (Qdx)to own price (Px).
 Since P1 >P2 => Єdx <0 (Negative) in sign.
 Hence, each measure of elasticity is measured by a vector that has sign
(+/-) and magnitude.

P1
P2
O
Q1 Q2
Measuring Elasticity
Єdx =[(Q2 –Q1)/ Q1)] [(P2 –P1)/ P1 )]

Px Єdx =[(120 –100)/ 100)] [(10 –12)/ 12 )]

a Єdx =[20 / 100)] [(–2)/ 12 )]

P1
b
P2 Єdx = (-)[20%] [(16%)]

Єdx = (-){[5] [(4)]}

Єdx = (-) {[5] [(4)]}=(-)1.25

Q1 Q2
Qdx
Magnitude of Elasticity
 If elasticity is high (large) the demand function is known as
“Elastic”.
 Єdx = Elastic
 If [% ∆Qdx>% ∆Px]
 Єdx = Inelastic
 If [% ∆Qdx<% ∆Px]
 If [% ∆Qdx] = % ∆Px is Єdx is “Unitary Elastic”
 If [% ∆Qdx] wrt % ∆Px is “zero” Єdx is “Perfectly
Inelastic”
 If [% ∆Qdx] wrt % ∆Px is “∞” Єdx is “Perfectly
elastic”
Point Elasticity
 Point elasticity is the price elasticity of demand at a specific point on the
demand curve instead of over a range of it.
 To get point PED we need to re-write the basic formula to include an
expression to represent the percentage, which is the change in a value divided
by the original value, as follows:
 Єdx = [(∆Qdx/Qdx)/(∆Px/Px)]
 We can then invert the denominator, to get:
 Єdx = [(∆Qdx/Qdx)*(Px/∆Px)]
 We can reverse the order of the multiplication, so this can be rewritten as:
 Єdx = [(∆Qdx/∆Px)*(Px/Qdx)]
 Elasticity has now been spilt into two parts, the over which is the ratio of the
change in quantity to the change in price – this is the gradient (slope) of the
demand curve – and Px/Qdx, which is related to the actual point on the
curve at which a measurement is made (original price/original quantity).
 As we move down the curve Px will fall and Qx will rise.
Point Elasticity
 Defined as Єdx = [(∆Qdx/∆Px)*(Px/Qdx)]
 (∆Qdx/∆Px) = Slope which is constant for a straight-line demand curve.
 If Qdx = Zero=> Єdx = Infinite;
 If Px = Zero Єdx = Zero;
 Therefore, as PX falls the lower segment (below the point of intersection of the ray
from the origin and the point on the demand curve (ab) , which is (e), equals ‘eb’.
 The slope being constant elasticity of demand can be defined as:
 Єdx = [Lower Segment/ Upper Segment]
 Єdx = [eb/ ea]
 At P the 45 o line intersects the demand curve.
 Here Єdx = [eb= ea]= 1
 Above P Єdx = [eb> ea]>1
 Below P Єdx = [eb< ea]<1
 At ‘a’ since ‘ea’ is zero => Єdx =α
 At ‘b’ since ‘eb’ is zero => Єdx =0
 Measuring Point Elasticity
Єdxa = [eb>0 and ea=Zero] = ∞
a
Px
Єdxp = [eb> ea]> 1
Єdxe = [eb= ea]= 1
p

Єdxc = [eb< ea]< 1

c

Єdxb = [eb= 0 and ea>0]= 0

45o Line
b
Qdx
Arc Elasticity
Derivation of ARC Elasticity
 Parallel DD Curves

Px e2
e1

Q1 Q2 Qdx
Which is more elastic?
 For both curves the slope is the same.
 [(∆Qdx/∆Px)]
 Impute in formula for elasticity:
 (Px/Q2)< (Px/Q1)
 In other words, the curve which is nearer to the origin has greater
elasticity than which is farther from the origin.
 Thus even two parallel straight line demand curves have different
elasticities at each and every point.
 Intersecting DD Curves
N

K
P

O
Q M S Qdx
Flatter Curve
 Price elasticity on the RS curve at point K is SK/KR = OP/PR.
 Similarly, elasticity at point K on the NM curve is MK/KN =
OP/PN. But OP/PR > OP/PN.
 Therefore, SK/KR > MK/KN.
 Thus the flatter curve RS has greater elasticity than the steeper
curve NM at point K.
 But unlike parallel curves in this case we cannot comment on the
whole curve because at different points the elasticity is different.
 Thus, at some points NM is more elastic and at other points RS is
more elastic.