CHAPTER 3

ELASTICITY AND ITS

APPLICATION
Julsar T. Calonia
PRICE ELASTICITY of Demand

Elasticity
a measure of the responsiveness of quantity demanded or quantity supplied to one of its
determinants.
Price Elasticity of Demand measures how much the quantity demanded responds to a
change in price. Demand for a good is said to be elastic if the quantity demanded responds
substantially to changes in the price. Demand is said to be inelastic if the quantity demanded
responds only slightly to changes in the price.

The price elasticity of demand for any goods measure how willing consumers are to move away
from the good as its prices rises. Thus, the elasticity reflects many economic, social, and psychological
forces that shape consumer tastes.
PRICE ELASTICITY of Demand

SUMMARY OF PRICE ELASTICITY OF DEMAND

=1 Unitary Elastic
>1 Elastic
<1 Inelastic
 Mathematical Expression on Elasticity of
Demand
𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑑
%  𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏𝑸𝒅 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑄𝑑
𝑃 𝑟𝑖𝑐𝑒 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝐷𝑒𝑚𝑎𝑛𝑑 = =
%  𝒄𝒉 𝒂𝒏𝒈𝒆 𝒊𝒏 𝑷 𝐶h𝑎𝑛𝑔𝑒𝑖𝑛 𝑃
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃

%  𝑐h𝑎𝑛𝑔𝑒𝑖𝑛𝑄𝑑=
𝑐h𝑎𝑛𝑔𝑒𝑖𝑛𝑄𝑑 𝑐 h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑄𝑑 % 𝑐h 𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃
Total Revenue (TR) in Pricing Decision

Revenue -we refer to total as the total sale of product by the

producer or seller.

TR = P X Q
Where: TR is the Total revenue; P is the price; and Q is the
Quantity
 Example of Inelastic
Nana sells Marang to P50 and her Qd1=200. When she decides to sell it
for P60.00, her Qd2=180. Should Justine sell her Marang at P50 or P60?

%  𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛𝑄𝑑 − 0.09

𝑃 𝑟𝑖𝑐𝑒 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝐷𝑒𝑚𝑎𝑛𝑑= = =− 0.5
%  𝑐h𝑎𝑛𝑔𝑒𝑖𝑛 𝑃 0.18
Therefore the price elasticity of demand is INELASTIC
 Total Revenue Computation

TR1 = P1 x Q1 From the solution above, we can

= 200 x 50 conclude that when Nana increases her
= 10,000
price while demand is inelastic, she gets
TR2 = P2 x Q2 a bigger total revenue. She will then
= 180 x 60 maximize her profit by raising her price
= 10,800 to P60
 Example of Elastic
IF Theresa sells tilapia for P80 per kilo, the demand for it is 200, when
she rises it by P20, the quantity demanded diminishes to 100. At what
price will Theresa maximize her profit? Is the demand is elastic or
inelastic?

%  𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛𝑄𝑑 − 0.67

𝑃 𝑟𝑖𝑐𝑒 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝐷𝑒𝑚𝑎𝑛𝑑= = =− 3.05∨3.05
%  𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃 0.22
Therefore the price elasticity of demand is ELASTIC
 Total Revenue Computation

TR1 = P1 x Q1 From the solution above, we can

= 80 x 200 conclude that at an elastic demand for
= 16,000
tilapia, profit is maximized at the original
TR2 = P2 x Q2 price
= 10 x 100
= 10,000
Mina sells tuyo for P100 per pack and gets 200 packs
quantity demanded. However, if she lowers her price to
P50, quantity demand doubles. Is the demand for Tuyo
elastic or inelastic? At what price Mina gets a bigger
revenue.
 Example of Unitary elastic
Mina sells tuyo for P100 per pack and gets 200 packs quantity
demanded. However, if she lowers her price to P50, quantity demand
doubles. Is the demand for Tuyo elastic or inelastic? At what price Mina
gets a bigger revenue.

%  𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛𝑄𝑑 0.67

𝑃 𝑟𝑖𝑐𝑒 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝐷𝑒𝑚𝑎𝑛𝑑 = = =1
%  𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃 0.67
Therefore the price elasticity of demand is Unitary ELASTIC
 Total Revenue Computation

TR1 = P1 x Q1 From the solution above, we can

=100 x 400 conclude that at an Unitary elastic
= 10,000
demand for Tuyo, profit is constant or
TR2 = P2 x Q2 remain the same at the original price.
= 50 x 200
= 10,000
 Activity

Claire sells bulad for P50. At this price, she is

able to sell 200 units of daing. When she
decided to cut its price by half, she noticed that
she is able to sell 220 units, did Claire raise her
profit? Compute the elasticity of demand for
daing.
 Answer

%  𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛𝑄𝑑 0.10

𝑃 𝑟𝑖𝑐𝑒 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝐷𝑒𝑚𝑎𝑛𝑑= = =− 0.15∨0.15
%  𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃 − 0.67
Therefore the price elasticity of demand is INELASTIC
 Total Revenue Computation

TR1 = P1 x Q1
=50 x 200 Notice that at an inelastic demand,
= 10,000 even if Claire cut the price by half and
the demand rises, she still gets a better
TR2 = P2 x Q2
deal by staying with the old price.
= 25 x 220
= 5,500
Income Elasticity Demand

Income Elasticity of Demand is the degree of

responsive of a percentage change in quantity
demanded with a percentage change in Income.
 Income Elasticity Demand
Income
Where: Qd is the quantity Demanded and Y is Income

𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑑
%  𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑑=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑄𝑑
𝑐h𝑎𝑛𝑔𝑒𝑖𝑛𝑌
%  𝑐h𝑎𝑛𝑔𝑒𝑖𝑛𝑌 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑌
Summary of Income Elasticity of Demand

Income Elasticity of Demand Interpretation

>1 Luxury Goods

<1 Necessity

>0 Normal Goods

<0 Inferior good

 Example: Cerine earns a monthly salary of P5,000 and she consumes P1,000 worth of chicken
per month. When her income increased by P 2,500 per month, she started to consume P 2,000
worth of chicken meat a month. Is Cerrine’s demand for chicken meat normal?, inferior,
necessity, or luxury?

Income
Note that the is greater than 1, hence the demand for chicken is normal and might even consider a
luxury
Example: Every month, Aling Laura earns P 5,000 as a fishball vendor. During
this period, she also consumes P 100 worth of tuyo. When her income increased
by 2500, she began lessening her monthly consumption of tuyo to P 50. from the
given, is tuyo is normal, an inferior, common good for Aling Laura?
 Answer
=

Income

Note that the is greater than 1, hence the demand for chicken is normal and might even consider a
enferior
 Cross Elasticity of Demand

The Cross Elasticity of Demand is the degree of responsiveness of a

percentage change in quantity

Cross Of Demand Relation of Goods

=0 X and Y are not related
>0 Substitute
<0 Complements
 Substitute Goods

The cross elasticity of demand for substitute goods is always positive

because the demand for one good increases when the price for the
substitute good increases. For example, if the price of coffee increases,
the quantity demanded for tea (a substitute beverage) increases as
consumers switch to a less expensive yet substitutable alternative. This
is reflected in the cross elasticity of demand formula, as both the
numerator (percentage change in the demand of tea) and denominator
(the price of coffee) show positive increases.
 Complementary Goods
Alternatively, the cross elasticity of demand for
complementary goods is negative. As the price for one item
increases, an item closely associated with that item and
necessary for its consumption decreases because the demand
for the main good has also dropped. For example, if the price
of coffee increases, the quantity demanded for coffee stir sticks
drops as consumers are drinking less coffee and need to
purchase fewer sticks. In the formula, the numerator
(quantity demanded of stir sticks) is negative and the
denominator (the price of coffee) is positive. This results in a
negative cross elasticity
 Cross elasticity of demand

Cross

=
 Goods Qd1 Qd2 P1 P2
X 4 5 4 5
Y 2 3 2 3

= =

Cross

Note that the is 0.55 is greater than 0, hence the Product X and Y are Substitute
 Activity
Goods Qd1 Qd2 P1 P2
X 2 5 5 3
Y 2 3 3 1
 Answer
Goods Qd1 Qd2 P1 P2
X 2 5 5 3
Y 2 3 3 1

= =

Cross

Note that the is -0.55 is lesser than 0, hence the Product X and Y are complements
 Price Elasticity of Supply

Is study how to measure the

relationship quantity supplied and
price
Elastic – producers are able to increase production even with an increase in the cost of production.
Inelastic – producers are hindered to produce more
Unitary elastic – when there is a considerable increase in price of goods being sold, supply becomes
elastic. However, when the change in price is insignificant, supply is inelastic.
Summary of Price Elasticity of Supply

Price Elasticity of Supply Quantity Supplied

=1 Unitary elastic
>1 Elastic
<1 Inelastic
 Mathematical Expression on Elasticity of
Supply
𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄 𝑠
%  𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏𝑸 𝒔 𝐴𝑣𝑒𝑟𝑎𝑔𝑒𝑄 𝑠
𝑃 𝑟𝑖𝑐𝑒 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 Supply = =
%  𝒄𝒉 𝒂𝒏𝒈𝒆 𝒊𝒏 𝑷 𝐶h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃
𝐶h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃

%  𝑐h𝑎𝑛𝑔𝑒𝑖𝑛𝑄 s=
𝑐h𝑎𝑛𝑔𝑒𝑖𝑛𝑄 𝑠 𝑐 h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃
𝐴𝑣𝑒𝑟𝑎𝑔𝑒𝑄 𝑠 % 𝑐h 𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃
 Example
The old price of sardines is P10. At P10, a producer can supply 100 cans
of them. When the selling price changes to PHP 12, the producer was
able to increase its production to 120 cans.

%  𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄 𝑠 0.18
𝑃 𝑟𝑖𝑐𝑒 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 Supply = = =1
%  𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃 0.18
Therefore the price elasticity of Supply is Unitary ELASTIC
 Activity

Suppose that the old price of instant noddle’s is P5 and seller produce
100 packs of them. When the price rose by P2, the producer has doubled
his production.
 Answer
Suppose that the old price of instant noddle’s is P5 and seller produce
100 packs of them. When the price rose by P2, the producer has doubled
his production

%  𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄 𝑠 0.67
𝑃 𝑟𝑖𝑐𝑒 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 Supply = = =2.03
%  𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃 0.33
Therefore the price elasticity of supply is ELASTIC
 Activity

A 14-inch TV is originally sold at P5,000. at that price, an appliance

store is able to sell 100 TV in the market. The following month, the new
price of TV is P7,500. However, the store has only increased its output
by 5 units.
 Answer
A 14-inch TV is originally sold at P5,000. at that price, an appliance
store is able to sell 100 TV in the market. The following month, the new
price of TV is P7,500. However, the store has only increased its output
by 5 units.

%  𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄 𝑠 0.05
𝑃 𝑟𝑖𝑐𝑒 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 Supply = = =0.13
%  𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃 0.04
Therefore the price elasticity of supply is Inelastic