15B11HS211 Economics

ELASTICITY
15B11HS211 Economics

Topics to be covered:
• Demand Elasticity
• Price elasticity of Demand
• Income elasticity of Demand
• Cross Price elasticity of Demand
• Relationship between Total Revenue, Marginal Revenue and
Price elasticity of Demand

Resources that can be consulted:

• H. C. Petersen, W. C. Lewis and S. K. Jain, Managerial Economics, 4th ed.,
Pearson Education 2006.
• D. Salvatore, Managerial Economics in a Global Economy, 8 th ed.,
Thomson Asia, 2015.

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15B11HS211 Economics

ELASTICITY

• A general concept used to quantify the

response in one variable when another
variable changes
• elasticity of A with respect to B =
% A/ %B
• More precisely, elasticity of demand is
the percentage change in quantity
demanded divided by the percentage
change in one of the variables on
which demand depends. 3
15B11HS211 Economics

Calculating Elasticities
Price per P P
Pound Price per
Pound

P1 = 3 P1 = 3

P2 = 2 P2 = 2
D D

0 0 Q1 = 80
Q1 = 5 Q2= 10 Q Q2= 160 Q
Pounds of X per week Ounces of X per week

Pounds of X per month Ounces of X per month

Slope: Y = P2 – P1 Slope: Y = P2 – P1

X = Q2 – Q1 X = Q2 – Q1

= 2 – 3 = -1 = 2 – 3 = -1

10 – 5 = 5 160 –80 = 80 4
15B11HS211 Economics

Point Price Elasticity of Demand

Ratio of the percentage of change in quantity

demanded to the percentage change in price.
% Q
Ep =
% P

Q / Q Q P
Point Definition EP   
P / P P Q

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15B11HS211 Economics

Point Price Elasticity of demand

7

6 A -5

5
B -2

4
C -1
Px

3
F -0.5
G Dx
2 -0.2 Dx
1
H

0
J
0 100 200 300 400 500 600 700
Qx
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15B11HS211 Economics

The figure gives point price elasticity of demand, or the

elasticity at a given point on the demand curve.

For eg, Point price elasticity of demand at point B on Dx(the

market demand curve for commodity X) is
Ep =ΔQ . P = -100 . $5 = -1(5/1)= -5
ΔP Q $1 100
This means that the quantity demanded declines by 5% for each
1% increase in price, while holding constant all the other
variables in the demand function.
Similarly at point C on Dx, Ep = -1(4/2) = -2;
at point F, Ep = -1 (3/3) = -1
At point G, Ep = -1 (2/4) = - 0.5
At point H = Ep = -1 (1/5) = -0.2
Point A shows Ep= infinite i.e. perfectly elastic demand because
here ΔP is zero. Point J shows Ep = zero i.e. perfectly inelastic
demand here ΔQ is zero. 7
15B11HS211 Economics

Ex.
• Suppose a seller of a textile cloth wants to
lower of its cloth from Rs. 150 per metre to
Rs. 142.5 per metre. If previous sales
were 2000 metres per month and after
reducing the price the new sales has
increased to 2070 metres. Calculate the
price elasticity of demand of the product.

• Ep= 0.7
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15B11HS211 Economics

Arc Price Elasticity of Demand

• When Elasticity is to be found between 2
Points, we use Arc Elasticity.
Ep = Q2 - Q1 P2 - P 1
(Q2 + Q1)/2 (P2 + P1)/2

Q2  Q1 P2  P1
EP  
P2  P1 Q2  Q1

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15B11HS211 Economics

Example

 A consumer purchases 80 units of a commodity when its price is

Rs. 1 per unit and purchases 48 units when its price rises to Rs. 2
per unit. What is the price elasticity of demand for the commodity?
 It should be noted that the change in price from Rs. 1 to Rs. 2 is
very large i.e. 100%. Therefore, to calculate the elasticity we will
use Arc elasticity formula.
 Ep= 80-48/2-1 * 2+1/80+48
 = 0.75

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15B11HS211 Economics

Problem
Present Loss : $ 7.5 million
Present fee per student : $3,000
Suggested increase : 25%
Total number of students : 10000
Elasticity for enrollment at state universities is -1.3 with respect to tuition changes

1% increase in tuition = 1.3% decrease in enrollment

Increase of 25% decline in enrollment by 32.5%

3000 * 10000 = $30,000,000

3750 (new fee)* 6750(no. of students) = $25,312,500

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15B11HS211 Economics

Perfectly Inelastic Demand Perfectly Elastic Demand

Price P D Price P

0 Q 0 Q
Qty Demanded Qty Demanded

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15B11HS211 Economics
Perfectly inelastic demand
Qd does not change at all when price
changes
Inelastic demand

-1 < E  0
Unitary elastic demand

E = -1
Elastic demand

E < -1
Perfectly elastic demand

Qd drops to zero at the slightest increase in

price 13
15B11HS211 Economics

Exercise
• For each of the following equations, determine whether
the demand is elastic, inelastic or unitary elastic at the
given price.
a) Q =100 – 4P and P = $20
b) Q =1500 – 20 P and P = $5
c) P = 50 – 0.1Q and P = $20

a) -4, elastic
b) -0.07, Inelastic
c) -0.67, Inelastic
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15B11HS211 Economics

TOTAL AND MARGINAL REVENUE

& ELASTICITY

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15B11HS211 Economics

P=Price, Q=Quantity

TR (Total Revenue)=P X Q

MR (Marginal Revenue)= d(TR)/dQ=

d(PQ)/dQ

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15B11HS211 Economics

Price Quantity Total Marginal

Revenue Revenue
10 1 10
9 2 18 8
8 3 24 6
7 4 28 4
6 5 30 2
5 6 30 0
4 7 28 -2
3 8 24 -4
2 9 18 -6
1 10 10 -8
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15B11HS211 Economics

Total and Marginal Revenue

Price Quantity Total Marginal
Revenue Revenue
10 1 10
9 2 18 8
8 3 24 6
7 4 28 4
6 5 30 2
5 6 30 0
4 7 28 -2
3 8 24 -4
2 9 18 -6
1 10 10 -8
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15B11HS211 Economics

35
Total Revenue
30

25 Total Revenue
20

15

10

0
0 2 4 6 8 10 12
Quantity per period
15
MR/Price

10

5
Average Revenue
0
0 2 4 6 8 10 12
-5 Quantity Demanded
Marginal Revenue
19
-10
15B11HS211 Economics

Calculate Elasticity
Price Quantity Total Marginal
Revenue Revenue
10 1 10
9 2 18 8
8 3 24 6
7 4 28 4
6 5 30 2
5 6 30 0
4 7 28 -2
3 8 24 -4
2 9 18 -6
1 10 10 -8
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15B11HS211 Economics

Total Marginal Elasticity

Price Quantity Total Marginal Price
Revenue Revenue Elasticity
10 1 10 -10.00
9 2 18 8 -4.50
8 3 24 6 -2.67
7 4 28 4 -1.75
6 5 30 2 -1.20
5 6 30 0 -0.83
4 7 28 -2 -0.57
3 8 24 -4 -0.38
2 9 18 -6 -0.22
1 10 10 -8 -0.10
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15B11HS211 Economics

35
Total Revenue
30

25 Total Revenue
20

15

10

0
0 2 4 6 8 10 12
Quantity per period
15
Elastic
Ep < - 1
MR/Price

10 Unitary elastic
Ep = - 1
Inelastic
5
-1 < Ep < 0

0
0 2 4 6 8 10 12
-5 Quantity Demanded
Marginal Revenue
22
-10
15B11HS211 Economics

Marginal Revenue and Price Elasticity of

Demand

MR = d(PQ) = dQ*P + dP*Q

dQ dQ dQ

= P + QdP = P 1 + dP.Q
dQ dQ P

 1 
MR  P 1  
 EP 
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15B11HS211 Economics

• Example: At a price of Rs. 240 per

unit, the shoe company generate an
additional revenue of Rs. 336 for
every one additional pair of shoe
sold. Find out the price elasticity of
demand for the shoes.

Here, MR= Rs. 336/unit

P= Rs. 240/unit
Therefore, Ep=2.5
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15B11HS211 Economics

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15B11HS211 Economics

Exercise1
• A consultant estimates the price-quantity relationship for New
World Pizza to be at P = 50 – 5Q.
– At what output rate is demand unitary elastic?
– Over what range of output is demand elastic?
– At the current price, eight units are demanded
each period. If the objective is to increase
total revenue, should the price be increased
or decreased? Explain.

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15B11HS211 Economics

P =50 -5Q
MR = 50-10Q
• For unitary elastic MR = 0 so Q =5
• MR will be +ve when Q<5, so demand will be
elastic when 0<=Q<5.
• P for Q=8 is P=50-5*8 = 50-40 = 10

• Ep= -1/5*10/8 = -0.25. As demand is inelastic, when

we increase price, TR increases.

Q / P  1 / 5

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15B11HS211 Economics

Determinants of Price Elasticity of Demand

Demand for a commodity will be less elastic if:

• It has few substitutes
• Requires small proportion of total expenditure
• Less time is available to adjust to a price change

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15B11HS211 Economics

Determinants of Price Elasticity of Demand

Demand for a commodity will be more elastic if:

• It has many close substitutes
• Requires substantial proportion of total expenditure
• More time is available to adjust to a price change

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15B11HS211 Economics

Income Elasticity of Demand

The responsiveness of demand to changes in income.

Other factors held constant, income elasticity of a
good is the percentage change in demand associated
with a 1% change in income

Q / Q Q I
Point Definition EI   
I / I I Q

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15B11HS211 Economics

Income Elasticity of Demand

Q2  Q1 I 2  I1
Arc Definition EI  
I 2  I1 Q2  Q1

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15B11HS211 Economics

• Normal Goods ΔQ/ΔI = +ve, EI =

+ve
– Necessities 0 < EI  1
– Luxuries EI > 1

• Inferior Goods ΔQ/ΔI = -ve, EI = -ve

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15B11HS211 Economics

Exercise1
Demand of automobiles as a function of income is
Q = 50,000 + 5(I)
Present Income = $10,000
Changed Income = $11,000

I1 = $10,000, Q = 100,000
I2 = $11,000, Q = 105,000

EI = 0.512

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15B11HS211 Economics

Cross-Price Elasticity of Demand

Responsiveness in the demand for commodity X

to a change in the price of commodity Y. Other
factors held constant, cross price elasticity of a
good is the % change in demand for commodity
X divided by the % change in the price of
commodity Y

QX / QX QX PY
Point Definition E XY   
PY / PY PY QX

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15B11HS211 Economics

Cross-Price Elasticity of Demand

QX 2  QX 1 PY 2  PY 1
Arc Definition E XY  
PY 2  PY 1 QX 2  QX 1

Substitutes Complements
E XY  0 E XY  0

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15B11HS211 Economics

Exercise
• Acme Tobacco is currently selling 5000 pounds of pipe tobacco per
year. Due to competitive pressures, the average price of a pipe
declines from $15 to $12. As a result, the demand for Acme pipe
tobacco increase to 6,000 pounds per year.
• What is the cross elasticity of demand for pipes and pipe tobacco?
• Assuming that the cross elasticity does not change, at what price of
pipes would the demand for the pipe tobacco be 3,000 pounds per
year? Use $15 as the initial price of a pipe.

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15B11HS211 Economics

• EXY = {(6000-5000)/(12-15)}*{(12+15)/(6000+5000)
= -0.818

P1 = $15, Q2 = 3000 and Q1 = 5000

Therefore, P2 = 28.23

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15B11HS211 Economics

Importance of Elasticity in Decision making

• To determine the optimal operational policies

• To determine the most effective way to respond to
policies of competing firms
• To plan growth strategy

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15B11HS211 Economics

Importance of Income Elasticity

– Forecasting demand under different

economic conditions
– To identify market for the product
– To identify most suitable promotional
campaign

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15B11HS211 Economics

Importance of Cross price Elasticity

– Measures the effect of changing the price of a

product on demand of other related products
that the firm sells

– High positive cross price elasticity of demand

is used to define an industry

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15B11HS211 Economics

Problem
Qx = 1.5 – 3.0Px + 0.8I + 2.0Py – 0.6Ps + 1.2A

Px=$2 I=$2.5 Py=$1.8

Ps=$0.50 A=$1

Qx =1.5 – 3*2 + 0.8*2.5 + 2*1.8 – 0.6*0.50 + 1.2*1

=2

Ep = -3(2/2) = -3 EI = 0.8(2.5/2) = 1
Exy = 2(1.8/2) = 1.8 Exs = -0.6(0.50/2) = -0.15
EA = 1.2(1/2) = 0.6

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15B11HS211 Economics

Conclusion
• Elasticity is a practical measure that helps producers and policymakers.

• Price elasticity of demand measures how much the quantity demanded

responds to changes in the price If a demand curve is elastic, total revenue
falls when the price rises.

• If it is inelastic, total revenue rises as the price rises.

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15B11HS211 Economics

Role and Significance of Elasticity of Demand

The concept of Elasticity of demand has significant role to play in economic theory and
practice and we shall study the importance of this concept.

• Elasticity of demand in production

• Elasticity of demand in Price Fixation
• Elasticity of demand in Distribution
• Elasticity of demand in International Trade
• Elasticity of demand in foreign Exchange
• Elasticity of demand in nationalizing an Industry
• Elasticity of demand in Public Finance

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15B11HS211 Economics

Reference
• H.C. Petersen, W.C. Lewis, Managerial Economics, 4th ed., Pearson Education 2001.
• D. Salvatore, Managerial Economics in a Global Economy, 8 th ed., Thomson Asia,
2015.
• S. Damodaran, Managerial Economics, 2nd ed., Oxford University Press, 2010.
• P.A. Samuelson, W.D. Nordhaus, Economics, 19 th ed., Tata Mc-Graw Hill, 2010.
• S.K. Misra & V. K. Puri, Indian Economy, 37 th ed., Himalaya Publishing House, 2019.

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15B11HS211 Economics

Practice multiple-choice questions

The price elasticity of demand depends on

A) the units used to measure price but not the units used to measure quantity.
B) the units used to measure price and the units used to measure quantity.
C) the units used to measure quantity but not the units used to measure price.
D) neither the units used to measure price nor the units used to measure quantity.

Answer: neither the units used to measure price nor the units used to measure quantity.

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15B11HS211 Economics

Practice multiple-choice questions

The price elasticity of demand measures
A) the slope of a budget curve.
B) how often the price of a good changes.
C) the responsiveness of the quantity demanded to changes in price.
D) how sensitive the quantity demanded is to changes in demand.

Answer: the responsiveness of the quantity demanded to changes in price.

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15B11HS211 Economics

Practice multiple-choice questions

The price elasticity of demand equals
A) the percentage change in the quantity demanded divided by the percentage change
in the price.
B) the change in the quantity demanded divided by the change in price.
C) the percentage change in the price divided by the percentage change in the quantity
demanded.
D) the change in the price divided by the change in quantity demanded.

Answer: the percentage change in the quantity demanded divided by the percentage
change in the price.

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15B11HS211 Economics

Practice multiple-choice questions

The price elasticity of demand can range between
A) negative one and one.
B) zero and infinity.
C) zero and one.
D) negative infinity and infinity.

Answer: zero and infinity

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15B11HS211 Economics

Practice multiple-choice questions

Demand is perfectly inelastic when
A) the good in question has perfect substitutes.
B) shifts in the supply curve results in no change in price.
C) shifts of the supply curve results in no change in quantity demanded.
D) shifts of the supply curve results in no change in the total revenue from sales.

Answer: shifts of the supply curve results in no change in quantity demanded.

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15B11HS211 Economics

Practice multiple-choice questions

If the price elasticity is between 0 and 1, demand is
A) inelastic.
B) elastic.
C) perfectly elastic.
D) unit elastic.

Answer: inelastic.

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15B11HS211 Economics

Practice multiple-choice questions

Unit elastic demand
A) means that the ratio of a change in the quantity demanded to a change in the price
equals 1.
B) will be vertical.
C) means that the ratio of a percentage change in the quantity demanded to a
percentage change
in the price equals 1.
D) will be horizontal.

Answer: means that the ratio of a percentage change in the quantity demanded to a
percentage change in the price equals 1.

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15B11HS211 Economics

Practice multiple-choice questions

The more substitutes available for a product,
A) the larger is its income elasticity of demand.
B) the smaller is its income elasticity of demand.
C) the smaller is its price elasticity of demand.
D) the larger is its the price elasticity of demand.

Answer: the larger is its the price elasticity of demand.

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15B11HS211 Economics

Practice multiple-choice questions

If goods are complements, definitely their
A) income elasticities are negative.
B) income elasticities are positive.
C) cross elasticities are positive.
D) cross elasticities are negative.

Answer: cross elasticities are negative.

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15B11HS211 Economics

Practice multiple-choice questions

Demand is inelastic if
A) a leftward shift of the supply curve raises the total revenue.
B) the good in question has close substitutes.
C) the smaller angle between the vertical axis and the demand curve is less than 45
degrees.
D) large shifts of the supply curve lead to only small changes in price.

Answer: a leftward shift of the supply curve raises the total revenue.

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