Concepts of

Elasticity
What is Elasticity?
In microeconomics, elasticity refers to the responsiveness or sensitivity of the
quantity demanded or supplied of a good or service to changes in various
economic factors, primarily changes in price, income, or the prices of related
goods. Elasticity measures how much the quantity demanded or supplied will
change in response to a change in one of these factors. It plays a crucial role in
understanding consumer behavior, producer behavior, and market dynamics.
3 Types of Elasticity Demand
-Price Elasticity of Demand

-Income Elasticity of Demand

-Cross Elasticity of Demand

Price Elasticity Demand
Price Elasticity of Demand (PED), often referred to simply as price elasticity, is a concept in
economics that measures the responsiveness of the quantity demanded of a good or service to changes
in its price, while other factors remain constant. In other words, it quantifies how sensitive consumers
are to changes in price. Price elasticity is crucial for understanding consumer behavior and market
dynamics, and it plays a significant role in pricing decisions, taxation policies, and the analysis of
market responses to various economic events.

The formula for calculating the Price Elasticity of Demand (PED) is as follows: Point Method
Here's how to interpret the Price Elasticity of Demand:
1.Elastic Demand (PED > 1):
1. If the absolute value of PED is greater than 1, demand is considered elastic.
2. Elastic demand means that consumers are highly responsive to price changes.
3. A small percentage increase in price leads to a relatively larger percentage decrease in the quantity
demanded, and vice versa.
4. Firms should be cautious with price changes, as they can significantly affect total revenue.
2.Inelastic Demand (PED < 1):
1. If the absolute value of PED is less than 1, demand is considered inelastic.
2. Inelastic demand implies that consumers are not very responsive to price changes.
3. A change in price leads to a relatively smaller percentage change in the quantity demanded.
4. Firms can increase or decrease prices with less impact on the quantity demanded, but total revenue may not
change substantially.
3.Unitary Elasticity (PED = 1):
1. When PED is exactly equal to 1, demand is unitary elastic.
2. A change in price results in a proportional percentage change in the quantity demanded.
3. Total revenue remains the same regardless of price changes.
4.Perfectly Elastic Demand (PED = ∞):
1. In theory, if PED equals infinity, demand is perfectly elastic.
2. Consumers are so responsive to price changes that they will only buy the good at a specific price, and any
increase in price results in a demand drop to zero.
3. This is rarely observed in real-world markets.
5.Perfectly Inelastic Demand (PED = 0):
4. In theory, if PED equals zero, demand is perfectly inelastic.
5. Consumers will buy the same quantity of the good regardless of price changes.
6. This is also rare in practice.
Arc Elasticity Method :
Comparing Point Elasticity and
Arc Elasticity Demand
Point elasticity and arc elasticity are two methods used to calculate the price elasticity of demand, and
they have some key differences that make them suitable for different types of analysis. Here's a
comparison of point elasticity and arc elasticity of demand:
•Point Elasticity: Point elasticity calculates the price elasticity of demand at a specific point on the
demand curve. It measures the responsiveness of quantity demanded to a small change in price at that
specific point.
•Arc Elasticity: Arc elasticity, on the other hand, calculates elasticity over a range or interval between
two points on the demand curve. It provides an average elasticity over that range, considering both the
initial and final points.
Calculation:
•Point Elasticity: It is calculated using the formula: Point Elasticity (Ep) = (% Change in Quantity Demanded) / (% Change
in Price). It focuses on changes at a single point.
•Arc Elasticity: It is calculated using the formula: Arc Elasticity (Ea) = ((Q2 - Q1) / ((Q2 + Q1) / 2)) / ((P2 - P1) / ((P2 +
P1) / 2)). It considers the change over an interval between two points.
3. Sensitivity:
•Point Elasticity: Point elasticity is more sensitive to changes in price and quantity at the specific point chosen for analysis.
It gives an exact measure of elasticity at that point.
•Arc Elasticity: Arc elasticity is less sensitive to fluctuations at a single point because it calculates an average elasticity over
a range. It smoothes out variations.
4. Applicability:
•Point Elasticity: Point elasticity is suitable when you want to know the exact elasticity at a particular price and quantity.
It's useful for pinpointing elasticity at specific price levels.
•Arc Elasticity: Arc elasticity is preferred when you have data for a range of prices and quantities and want to capture the
average responsiveness of demand over that range. It's used when price and quantity changes significantly.
5. Examples:
•Point Elasticity: If you want to know how consumers' demand for a specific product changes in response to a small price
increase, point elasticity would be more appropriate.
•Arc Elasticity: If you want to analyze how the demand for a product changes over a broader range of prices, especially
when there are significant fluctuations, arc elasticity provides a better representation.
Interpretation of the Elasticity
Coefficient
The elasticity coefficient, also known as the price elasticity of demand or income elasticity of demand,
provides important information about the responsiveness of the quantity demanded of a product or
service to changes in its price or changes in income
Income Elasticity Demand
Income Elasticity of Demand (YED), often referred to as income elasticity, is an economic concept
that measures how sensitive the quantity demanded of a good or service is to changes in consumer
income, while keeping all other factors, including the price of the good, constant. It helps economists
and businesses understand how changes in income levels affect consumer behavior and, by extension,
the demand for various goods and services.

The formula for calculating the Income Elasticity of Demand (YED) is as follows:
The result can be positive, negative, or zero, and it indicates the following:
1.Positive Income Elasticity (Elastic Demand): If the income elasticity is positive (greater than 0), it means
that as income increases, the quantity demanded for the good or service also increases. This is typical for
normal goods, and the magnitude of the elasticity indicates the strength of the relationship. For example, luxury
cars often have a high positive income elasticity because demand for them increases significantly as income
rises.

2.Negative Income Elasticity (Inferior Demand): If the income elasticity is negative (less than 0), it means
that as income increases, the quantity demanded for the good or service decreases. This is typical for inferior
goods, which are products that people buy less of as their income rises. An example could be low-quality or
generic food products that people buy when they have lower incomes but switch to higher-quality alternatives
when they can afford them.

3.Zero Income Elasticity (Income Inelastic Demand): If the income elasticity is zero, it means that changes
in income have no effect on the quantity demanded for the good or service. This is common for essential goods
like basic groceries or utilities where people need a relatively consistent amount regardless of their income.
Income elasticity is a useful concept for businesses and
policymakers. It helps companies anticipate changes in
consumer demand based on economic trends and adjust
their marketing and production strategies accordingly. It
also has implications for government policy, such as
taxation and social welfare programs, as it can help identify
which goods and services are more or less sensitive to
changes in income.
Cross Elasticity of Demand
The cross elasticity of demand measures the responsiveness of demand to changes in the prices of
other goods, indicating how much more or less of a particular product is purchased as other price
change

The cross elasticity is define as the percentage change in quantity demand of one good (X) divided by
the percentage change in the price of the related goods (Y).

Exy
Here's what the values of XED can tell us:

1.If XED is positive (+): This indicates that the two goods are substitutes. In other words, when
the price of Good B (the reference good) increases, the quantity demanded of Good A (the focal
good) also increases, and vice versa. For example, if the price of coffee (Good A) rises, the demand
for tea (Good B) may increase because consumers switch to tea as a substitute.

2.If XED is negative (-): This indicates that the two goods are complements. In this case, when the
price of Good B rises, the quantity demanded of Good A falls, and when the price of Good B falls,
the quantity demanded of Good A increases. For example, if the price of gasoline (Good B)
increases, the demand for cars (Good A) may decrease because they are used together.

3.If XED is close to zero (near 0): This suggests that the goods are unrelated or have very low
cross elasticity. Changes in the price of one good have little to no impact on the quantity demanded
of the other. These goods are often referred to as unrelated or independent.
Elasticity of Supply
Supply elasticity refers to the reaction or response of the sellers or producers to price changes of goods
sold, in other words it is a measure of the degree of responsiveness of supply to a given change in
price. Moreover it is the percentage change in quantity supplied given a percentage change in price.
Thus,

Es
There are three main categories of supply elasticity:

1.Elastic Supply: If the elasticity of supply is greater than 1 (i.e., the absolute value of the elasticity
coefficient is greater than 1), it is considered elastic. This means that the quantity supplied is highly
responsive to changes in price. In other words, when the price increases, the quantity supplied
increases proportionally, and when the price decreases, the quantity supplied decreases
proportionally.

2.Unitary Elastic Supply: If the elasticity of supply is equal to 1, it is referred to as unitary elastic
supply. In this case, the percentage change in quantity supplied is exactly equal to the percentage
change in price. Producers adjust their output precisely to match changes in price.

3.Inelastic Supply: If the elasticity of supply is less than 1 (i.e., the absolute value of the elasticity
coefficient is less than 1), it is considered inelastic. This implies that the quantity supplied is not
very responsive to changes in price. Inelastic supply means that producers are unable or unwilling
to adjust their output significantly in response to price changes.
Several factors can influence the elasticity of supply:

•Time Horizon: In the short run, supply may be less elastic because producers cannot easily
adjust their production capacity. In the long run, supply can become more elastic as producers
have more time to adapt and make changes to their production processes.

•Availability of Resources: The availability of inputs and resources can impact supply elasticity.
If essential resources are scarce or have limited substitutes, supply may be less elastic.

•Production Technology: The ease with which producers can adjust their production processes
and scale up or down can affect supply elasticity. Advanced technology and flexible production
methods can lead to more elastic supply.

•Government Regulations: Government policies, such as price controls or quotas, can restrict a
producer's ability to respond to price changes, making supply less elastic.
Understanding the elasticity of supply is essential for
businesses and policymakers to make informed decisions
about pricing, production, and resource allocation in the
economy. It helps in predicting how changes in market
conditions will impact the quantity of goods and services
available to consumers.
CHAPTER SUMMARY ;)
ELASTICITY – Means Responsiveness or Reaction

DEMAND ELASTICITY – Is a measure of the degree of responsiveness of quantity demanded of a product

to a given change in one of the independent variables which affect demand for that product

PRICE ELASTICITY DEMAND – Is the responsiveness of consumers demand to change in price of good
sold.

INCOME ELASRICITY DEMAND – Is the responsiveness of consumers demand to a change in their

income

CROSS ELASTICITY DEMAND – Is the responsiveness of demand for a certain good, in relation to
changes in price of other related goods.

SUPPLY ELASTICITY – Refers to the reaction or response of the sellers or producers to price change of
goods sold.