CHAPTER 3

ELASTICITY
PREPARED BY:
NOR HAMIZA MOHD GHANI
UiTM JOHOR
Jan’10
 ELASTICITY

CHAPTER OBJECTIVES
• To explain the concept of elasticities.
•To calculate elasticities of demand ( price, income
and cross).
 ELASTICITY

DEFINITION OF ELASTICITY:
Measures the responsiveness/ sensitiveness of
quantity demanded or quantity supplied due to a
changes in its determinants.
 ELASTICITY

ELASTICITY OF DEMAND
Measures the responsiveness/sensitivity of
quantity demanded due to the changes in its
determinants.

There are 3 types elasticity of demand:

1. Price elasticity of demand
2. Income elasticity of demand
3. Cross elasticity of demand
 ELASTICITY

PRICE ELASTICITY OF
DEMAND(d)
Measure the responsiveness of the quantity demanded due to the change in its
price .

Formula:
d = % ∆ in quantity demanded
% ∆ in price
Reminder:

Negative sign-ignored

Where :
Q2= New Quantity Demanded
Q1= Original Quantity Demanded
P1 = Original Price Level
P2 = New Price Level
 ELASTICITY
5 DEGREE OF PRICE
ELASTICITY OF DEMAND

Elasticity Degree Of Elasticity % Changes

d > 1 Elastic %P < %Q

d < 1 Inelastic %P > %Q

d =1 Unitary elastic %P = %Q

d = 0 Perfectly inelastic %Q= 0

d =  Perfectly elastic %P=0

DEGREE OF PRICE ELASTICITY OF DEMAND
ELASTICITY INTERPRETATION DIAGRAM

1. Ep > 1 A smaller % change in the price Price

Elastic demand of a product will lead to a
bigger % change in the Qd
Quantit
y
2.Ep < 1 A bigger % change in the price Price

Inelastic demand of a product will lead to a

smaller % change in the Qd
Quantit
y
3. Ep = 1 A % change in price equals a %
Unitary elastic change in Qd Price

Quantit
y
4. Ep = infinite A small % change in price leads Price
Perfectly elastic to an infinite & change in Qd
demand

Quantit
Price y

The Qd does not change even

5. Ep = 0 though the price changes.
Quantit
Perfectily inelastic y
 ELASTICITY

INCOME ELASTICITY OF DEMAND (Y )

DEFINITION:
MEASURES THE SENSITIVITY/ RESPONSIVENESS
OF THE QUANTITY DEMANDED DUE TO A
CHANGE IN INCOME.

Formula:
Where :
Y = % ∆ in quantity demanded Q2= New Quantity Demanded
% ∆ in income Q1= Original Quantity Demanded
Y1 = Original Income Level
Y2 = New Income Level
 ELASTICITY

INCOME ELASTICITY OF DEMAND (Y )

Elasticity interpretation Examples

y > 1 Luxury goods Diamonds, luxury cars

0< y < 1 Normal goods Shirt, shoes , pen

y =0 Necessities goods Rice, vegetables

y < 0 Inferior/ giffen goods Used car, low grade fruits

 ELASTICITY

CROSS ELASTICITY OF DEMAND

DEFINITION:

MEASURES OF THE RESPONSIVENESS/SENSITIVITY OF QUANTITY

DEMANDED FOR ONE PRODUCT (QDx) DUE TO A CHANGE IN
PRICE OF A RELATED PRODUCT (Py)
Formula:
x = % ∆ in quantity demanded of good X
% ∆ in price of good Y
 ELASTICITY

CROSS ELASTICITY OF DEMAND

Elasticity Interpretation

x > 0 substitute goods

x < 0 complementary goods

x = 0 Not related goods

 ELASTICITY

EXERCISE
Price of good Qtty demanded for Qtty demanded Income per month
M (RM) good L (units) for good M (units) (RM)

15 100 500 2000

20 80 350 3000
25 50 200 4000
30 20 150 5000

a) Define the price elasticity of demand and calculate the price elasticity
of DD for Good M if the price increases from RM 20 to RM 25. State
whether the demand is elastic @ inelastic.
b) Calculate the cross elasticity of demand for Good L if the price of Good
M decreases from RM 25 to RM 20. Determine the relationship
between the two goods.
c) Calculate the income elasticity of demand for Good M & L if income
increases from RM 3000 to RM 4000.
 PRICE ELASTICITY OF SUPPLY (s)

Measure the responsiveness of the quantity supplied due to the change in its
price .
Formula:
s = % ∆ in quantity supplied
% ∆ in price

Where :
Q2= New Quantity Supplied
Q1= Original Quantity Supplied
P1 = Original Price Level
P2 = New Price Level
DEGREE OF PRICE ELASTICITY OF SUPPLY
ELASTICITY INTERPRETATION DIAGRAM

1. Ep > 1 A smaller % change in the price Price

Elastic supply of a product will lead to a
bigger % change in the Qs
Quantit
y
2.Ep < 1 A bigger % change in the price Price

Inelastic supply of a product will lead to a

smaller % change in the Qs
Quantit
y
3. Ep = 1 A % change in price equals a %
Unitary elastic change in Qs Price

Quantit
y
4. Ep = infinite A small % change in price leads Price
Perfectly elastic to an infinite & change in Qs
supply

Quantit
Price y

The Qs does not change even

5. Ep = 0 though the price changes.
Quantit
Perfectily inelastic y
Determinants of Price Elasticity of Demand

1.Substituability
Goods with higher substitutes have more elastic DD compare with lower
substitutes goods.

2. Importance of the good

DD for necessity goods are inelastic compare to DD for less important
goods are more elastic

3. Income level
Higher income level will tend to have inelastic DD because they become
less sensitive towards price changes.

4. Time dimensions
Price changes of a good in a shorter period: inelastic DD
(not enough time to look for substitutes & buyers respond less to these
price changes)
Price changes in the long run: Elastic DD

5. Habits
People who smoke and drinks will have inelastic DD for cigarettes and
alcohol

6. Relative importance of the good in the budget

Goods that takes the higher portion of consumer’s income will have elastic
DD compare to goods that takes smaller portion of income.
 Determinants of Price Elasticity of Supply

1.Period of the production process

- If the production process takes a long time then the response n quantity
supplied will be small (inelastic)
-shorter the process of the good, SS is considered as elastic
-Longer the process, SS will be inelastic

2.Time frame for SS

- Short run – SS is inelastic; ag: agricultural products
(due to insufficient availability of time to organize & adjust supply to demand )
-Long run- SS is elastic eg: manufacturing products

3.Change in the cost of production.

-if the change in production cost involves small amount of cost, then the
change in the quantity supplied can be in large amount (elastic)
*if change in cost of production is small, SS will be elastic
* if change in cost of production is big, SS will be inelastic

4. Substitutability of input used

-Production that requires specific factor of production, SS is more inelastic
* if inputs can be easily substituted, SS will be elastic.
* if inputs can’t be easily substituted, SS will be inelastic.

5.Degree of Perishability
-if the product is easily damaged @ has short expiration date then the SS will
be inelastic.
-High perishability- SS is inelastic; eg: agricultural products
-Low perishability- SS is elastic; eg: manufactured products
 Price Elasticity of DD (Ed) & Relation To Total Revenue (TR)
-To know the reaction of consumers towards a price change
-Useful for the seller to adjust his selling price since it will effect his TR
- TR = P (price) x Q (quantity)
DD is elastic DD is inelastic DD is Unitary elastic
P P
P

6
5 8 4
D
5 3

D
D
Q Q
Q
20 8 10 3 4
10

Po= 5, Qo= 20, TR = 100 Po= 5, Qo= 10, TR = 50 Po= 3, Qo= 4, TR = 12

P1= 6, Q1 = 10, TR = 60 P1= 8, Q1 = 8, TR = 64 P1= 4, Q1 = 3, TR = 12
P Q TR P Q TR P Q TR

negative relationship between positive relationship between

P & TR P & TR

More substitute goods Less substitute goods

THANK YOU