Elasticity of Demand

• The ratio between percentage change in

demand and percentage change in price is
called price elasticity of demand.

Price Elasticity of Demand  %change in quantity of demand

%change in price

Meaning of ratio

5:7= 5
7
 Unitarily Elastic Demand
• If percentage change in quantity of
demand is equal to percentage change in
price, demand is unitarily elastic.
Suppose a 5% change in price results in a
5% change in quantity of demand.
Price Elasticity of Demand  5% 1
5%
 Unitarily Elastic Demand

Price

8
6
4 Demand Curve

O Quantity Demanded
2 4 6 8
Figure- 4.1
 Elastic Demand
• If percentage change in quantity
demanded is larger than percentage
change in price, demand would be elastic.
Suppose a 5% change in price results in a
10% change in quantity of demand.
Price Elasticity of Demand 10%  2 1
5%
 Elastic Demand
Price

8 Demand Curve
A
6 
B
4 
2

O
2 4 6 8 10 12 14 Quantity
Figure- 4.2
 Perfectly Elastic Demand
• Perfectly Elastic Demand: If quantity of demand
changes without any change in price, demand is
perfectly elastic. In this special case demand
curve would be horizontal which is a
distinguishing feature of perfectly competitive
market structure where price remains fixed but
the consumers can buy any amount they desire.
Elasticity coefficient (e) turns out to be infinity ,
because something divided by zero is infinity
 Perfectly Elastic Demand Curve
.

Price

Demand Curve
P A B
0

O Quantity
Q Q
1 2
Figure- 4.3
 Inelastic Demand
• If percentage change in quantity of
demand is smaller than percentage
change in price, demand is inelastic.
• Suppose a 15% change in price results in
a 5% change in quantity of demand.
Price Elasticity of Demand  5%  1 1
15% 3
 Inelastic Demand
Price

Demand Curve
8
C
6 
4 D
2

O
2 4 5 6 8 10 12 14 Quantity
Figure- 4.4
 Perfectly Inelastic Demand
• When demand remains completely
unresponsive to price, i.e, no change in
demand occurs following changes in
price, demand is said to be perfectly
inelastic. Say, there is a 5% change in
price, but demand is unchanged
Price Elasticity of Demand  0%  0
5%
Perfectly Inelastic Demand Curve
Price

P A
1
Demand Curve

P B
2

O Quantity
Q
0
Figure- 4.5
 Formal Derivation
. %change in quantity of demand
Elasticity 
% change in price
Q100
Elasticity  Q  Q P
P100 Q P
P
Elasticity 
Q P
P Q
 Formal Derivation
. %change in quantity of demand
Elasticity 
% change in price
Q100
Elasticity  Q  Q P
P100 Q P
P
Elasticity 
Q P
P Q
Elasticity 
dQ P
dP Q
 Example
• Assume a demand function
Q  40010P
• Suppose price changes from 20 to 30.
Compute elasticity.
• Solution: When P = 20, Q = 200 Q  100
when P = 30, Q = 100 P10
Elasticity 
Q P  100. 20  1
P Q 10 200
 Use of derivative in elasticity
• demand function was
Q  40010P
• Given demand function
Q  40010P dQ  10
dP
dQ P
Elasticity ( ) 
dP Q
Elasticity ( )  10 P   10P
Here elasticity depends on price.
When price is 15, elasticity=-0.6, 400-10P 40010P
when price is 20, elasticity is -1
and when price is 30, elasticity is -3
For different price elasticity differs.
 Example
• demand function was
Q 52515P

Elasticity ( ) 
dQ P
dP Q dQ  15
• Given demand function Q 52515P
dP
Elasticity ( )  15 P  15P
525-15P 52515P
Here elasticity depends on price.
 Example (cont.)
• Elasticity ( ) 
dQ P
dP Q

   15P
52515P

Here elasticity depends on price.

 Examples (cont.)
• Again assume that price changes from 20
to 25. what is elasticity now?
• Comment on the results.
 Elasticity example
. 100
Q
P 2
assume a change in price from 5 to 10
 Cross Price Elasticity

• The ratio between percentage change in

quantity of demand for one good and
percentage change in price of another
good is termed as cross price elasticity of
demand.
 Example
• For illustration, assume the demand function:
Qx  f(Px,Py,Pz,M)
Qx :demand for X
Px :price of X
Py:price of Y
Pz:price of Z
• Demand for XMdepends
: incomeon its own price, price of Y, Z
and income (M). Two cross price elasticities can be
defined as below.
 Cross Price Elasticity
Elasticity of demand for X with respect to price of Y,
.

εxy  %change in demand for X

%change in price of Y
ΔQx Py
 .
ΔPy Qx
Qx Py
 .
Py Qx
 Cross Elasticity
.

Elasticity of demand for X with respect to price of Z,

εxz  %change in demand for X
%change in price of Z
ΔQx PZ
 .
ΔP Qx
Z
Qx PZ
 .
P Qx
Z
 Income Elasticity
• Income Elasticity is defined as the ratio
between percentage change in quantity of
demand and percentage change in
income.
Income Elasticity of Demand  %change in demand
%change in income
Qx M Qx M
Income Elasticity  η  .  .
M Qx M Qx
 .
.

q 100  2P 3P  M ; initial set (P 10, P 15, M 100)

A A B A B

Now assume P 10,P  5,M 100

A B
compute cross elasticity

Now assume P 10,P 15,M 81

A B
compute income elasticity

Comment on your results

 Types of goods on the basis of
elasticity
• If cross elasticity is positive, goods are
substitutes
• If cross elasticity is negative, goods are
complementary
• If income elasticity is positive, good is
normal
• If income elasticity is negative, good is
inferior.
 Measuring Elasticity Using Total Revenue Approach

• Total revenue is the product of price (P)

and quantity (Q).
This implies R = PQ

Price Quantity Revenue

100 20 2000
200 5 1000
 Three types
1. If increase in price leads to decrease in
revenue or decrease in price leads to increase
in revenue then demand is elastic.
2. If increase in price leads to increase in
revenue or decrease in price leads to
decrease in revenue then demand is inelastic.
3. If increase or decrease in price does not
cause any change in revenue then demand is
unitarily elastic.
 Elastic Demand

• Rise in price leads to fall in revenue,

therefore demand is elastic.

Price Quantity Revenue

100 20 2000
200 5 1000
 Inelastic Demand

• Rise in price leads to rise in revenue,

therefore demand is inelastic.

Price Quantity Revenue

100 20 2000
200 18 3600
 Unitarily Elastic Demand

• Rise or fall in price does not cause any

change in revenue, therefore demand is
unitarily elastic.

Price Quantity Revenue

100 20 2000
200 10 2000
 Point Elasticity Measurement Q . P  Q1Q2 . OP1
Elasticity = P Q P P OQ
1 2 1
MB . Q1A
Price = AM P A
1
QA
= MB . 1
D AM P A
1
QH QA
= 1 . 1
Q A PA
A 1 1
P
1 = Q1H  HA
P A AD
1
P B two triangles AQ1H and DP1A
2 M are similar. Therefore,
Q H P A Q H HA
1  1  1 
HA AD P A AD
1

int=
ap
o Quantity
at lower segment of the O Q Q H
t icit
y point
1 2
las upper segment of the point
E
Figure- 4.7
Point Elasticity along Straight-line Demand Function

Price
(e  )
D

(e 1)
H

(e 1)
C

 F (e1)

(e  0)
 Quantity
O H

Figure- 4.8
Point Elasticity versus Arc Elasticity

Price
50
(e 3)
A
40 
2 (earc  13)
7
30
25  B(e1)
20

10

O   Quantity
20 40 50 60 80 100
Figure- 4.9