Price Elasticity

Income
Elasticity
Managerial Economics
Presented by: April Love Nuqui

Flow of Presentation
- Concept of Elasticity
- Price Elasticity of Demand
- Income Elasticity of Demand
-Price Elasticity of Supply
-Importance in Economic Theory
and Practice
- Summary

Objectives
Be

able to:

Understand the concept of price elasticity and

income elasticity.
Calculate the elasticity using the given
formula.
Interpret the meaning of the elasticity value
derived from the calculations performed.
Apply the knowledge of elasticity to practical
uses.

Did you know?

Elasticity

in
PHYSICS
The ability of a body
to resist a distorting
influence or stress
and to return to its
original size and
shape when the
stress is removed.

Did you THINK about these?

Price Elasticity

Elasticity the concept

The

responsiveness of one
variable to changes in
another
When price rises what
happens to quantity
demanded?

Demand falls
BUT!
How much does demand fall?

Elasticity the concept

If

price rises by 10% - what happens to

quantity demanded (Qd)?

We know Q will fall

By more than 10%?
By less than 10%?
d

Elasticity

measures the extent to

which quantity demanded will change

Elasticity
Basic types used:

Price elasticity of demand PED

Price elasticity of supply PES
Income elasticity of demand YED

PRICE ELASTICITY OF DEMAND

The ratio of the percentage change in the quantity demanded to

the percentage change in price.

Price elasticity of
=
demand

Percent change in quantity demanded

Percent change in price

What Is the Price Elasticity of Demand

Used For?
It measures the size of the change in quantity demanded
when the price of a good changes.

Did you know?

Alfred Marshall
(26 July 1842 13 July 1924)
Devised Price Elasticity of
Demand

PRICE ELASTICITY OF DEMAND

Price elasticity of demand

Percentage change in quatity demanded

Percentage change in price

Example: If the price of an ice cream cone increases from $2.00 to

$2.20 and the amount you buy falls from 10 to 8 cones then your
elasticity of demand would be calculated as:

(10 8 )
100
20 percent
10

2
( 2.20 2.00 )
100 10 percent
2.00

PRICE ELASTICITY OF DEMAND

How

is it Calculated?

Mid-point method
(Q 2 Q1 )/[(Q 2 Q1 )/2]
Price Elasticity of Demand =
(P2 P1 )/[(P2 P1 )/2]

PRICE ELASTICITY OF DEMAND

Example: If the price of an ice cream cone increases from $2.00 to
$2.20 and the amount you buy falls from 10 to 8 cones the your
elasticity of demand, using the midpoint formula, would be
calculated as:

(10 8)
22 percent
(10 8) / 2

2.32
(2.20 2.00)
9.5 percent
(2.00 2.20) / 2

PRICE ELASTICITY OF DEMAND

Why Do Economists Use Elasticity to
Measure the Size of the Change?

Because elasticity is a ratio of two percentages.

Allows us to compare the demands for different goods.

PRICE ELASTICITY OF DEMAND

What

Does the Elasticity Number or

Coefficient Mean?
The absolute value of the elasticity coefficient

shows
whether the quantity change is bigger than the price
change, the same size as the price change, or smaller than
the price change.

The bigger the absolute value, the more sensitive or

responsive consumers are to a price change.

The smaller the absolute value, the less sensitive or

responsive they are to a price change..

PRICE ELASTICITY OF DEMAND

TYPES OF ELASTICITY
Hypothetical Demand Elasticity for Four Products
% CHANGE
INPRICE
(% P)
+10%

% CHANGE
IN QUANTITY
DEMANDED
(% QD)
0%

Basic telephone service

+10%

-1%

-0.1

Inelastic

Beef

+10%

-10%

-1.0

Unitarily elastic

Bananas

+10%

-30%

-3.0

Elastic

Insulin

PRODUCT

ELASTICITY
(% QD %P)
0.0
Perfectly inelastic

Price Elasticity of Demand

Perfectly Inelastic Demand

- Elasticity equals 0

Price

Demand

P5
1. An
increase
in price... 4

Quantity
100
2. ...leaves the quantity demanded unchanged.

Inelastic Demand

- Elasticity is less than 1

Price

1. A 25% P5
increase
in price... 4
Demand

Quantity
90 100
2. ...leads to a 10% decrease in quantity.

Unit Elastic Demand

- Elasticity equals 1

Price

1. A 25% P5
increase
in price... 4
Demand

Quantity
75
100
2. ...leads to a 25% decrease in quantity.

Elastic Demand

- Elasticity is greater than 1

Price

P5
1. A 25%
increase
in price... 4
Demand

Quantity
50
100
2. ...leads to a 50% decrease in quantity.

Perfectly Elastic Demand

- Elasticity equals infinity

Price
1. At any price
above P4, quantity
demanded is zero.
Demand

$4
2. At exactly P4,
consumers will
buy any quantity.
3. At a price below P4,
quantity demanded is infinite.

Quantity

Elasticity Versus Slope

Elasticity

of demand describes the shape

of a demand curve, but it is not the same
as slope.
Slope measures the rise or fall in a curve
divided by its horizontal run.
Elasticity measures the horizontal run by
the rise or fall.

PRICE ELASTICITY OF DEMAND

Price Elasticity of Demand and Total Revenue

Total Revenue (TR) of a seller equals the price of a good

times the quantity of the good sold.
Total revenue may increase, decrease or remain constant.
If demand is elastic, a price rise decreases total revenue.
If demand is elastic, a price fall increases total revenue.
If demand is inelastic, a price fall decreases total
revenue.
If demand is unit elastic, a price fall will sell more goods
while total revenue remains constant.

Elasticity and Total

Revenue

Total revenue is the amount paid by

buyers and received by sellers of a good.
Computed as the price of the good times
the quantity sold.

TR = P x Q

Elasticity
Price

Total revenue is price x

The importance of elasticity
quantity sold. In this
is the information it
example,
TRthe
= P5
x 100,000
provides on
effect
on
=
P500,000.
total revenue of changes in
price.
This value is represented by
the grey shaded rectangle.

P5

Total Revenue

D
100

Quantity Demanded (000s)

Elasticity
Price

If the firm decides to

decrease price to (say) P3,
the degree of price elasticity
of the demand curve would
determine the extent of the
increase in demand and the
change therefore in total
revenue.

P5

P3

Total Revenue

D
100

140

Quantity Demanded (000s)

Elasticity
Price (P)

Producer decides to lower price to attract sales

10

% Price = -50%
% Quantity Demanded = +20%
Ped = -0.4 (Inelastic)
Total Revenue would fall

Not a good move!

D
5 6
Quantity Demanded

Elasticity
Price (P)

10

Producer decides to reduce price to increase sales

% in Price = - 30%
% in Demand = + 300%
Ped = - 10 (Elastic)
Total Revenue rises
Good Move!

Quantity Demanded

20

The Total Revenue Test for

Elasticity
Increase in
Total Revenue

Decrease in
Total Revenue

Increase in
Price

INELASTIC
DEMAND

ELASTIC
DEMAND

Decrease in
Price

ELASTIC
DEMAND

INELASTIC
DEMAND

Elasticities,
Price
Changes and
Total
Revenue

Spending and Elasticity

If demand is inelastic, buyers spend more on
the good when its price is higher.
If demand is elastic, buyers spend less on
the good when its price is higher.
If demand is unit-elastic, buyers spend the
same amount on the good when its price is
higher.

Determinants of Elasticity

Time period the longer the time under consideration

the more elastic a good is likely to be

Number and closeness of substitutes the greater the

number of substitutes the more elastic

The proportion of income taken up by the product

the smaller the proportion the more inelastic

Luxury or Necessity - for example, addictive drugs

Factors Affecting Elasticity of Demand

Availability

of Substitutes

Demand for a good is more elastic when

close substitutes for it are available to buyers.

Factors Affecting Elasticity of Demand

Fraction

of Income Spent on the Good

As people spend higher fractions of their

incomes on a good, their demand for the
good becomes more elastic.
As they spend smaller fractions of their
income on a good, their demand for it
becomes less elastic.

Factors Affecting Elasticity of Demand

Adjustment

Time

Demand is more elastic when people have

more time available to adjust to a change in
price.

Determinants of Price Elasticity

of
Demand

Demand tends to be more inelastic

If the good is a necessity.

If the time period is shorter.
The smaller the number of close substitutes.
The more broadly defined the market.

Determinants of
Price Elasticity of Demand
Demand tends to be more elastic :

if the good is a luxury.

the longer the time period.
the larger the number of close substitutes.
the more narrowly defined the market.

What is likely to happen to

the demand for these
products when incomes rise
by 15%?

Income Elasticity

YED measures the responsiveness

demanded to a change in income.

of

quantity

it is the mathematical relationship between Y & Qd

YED = %Qd
% Y

If a change in income significantly alters the Qd, then

YED is said to be relatively elastic.

If a change in income does not have much affect on

Qd, then YED is said to be relatively inelastic.

Elasticity YED
Income

Elasticity of Demand (YED):

The responsiveness of demand to changes in

incomes

Normal

Good demand rises as

income rises and vice versa
Inferior Good demand falls as income
rises and vice versa

Income Elasticity
YED Tells us about
the type of good:

for all normal goods,

YED will be positive
(as we earn more, we
buy more)
-

Normal good

-for

Inferior good

inferior goods,
YED will be negative
(as we earn more, we
buy less)

Income Inelastic Demand

Y

Income Inelastic Demand

Y1

a large income change results

in only a small change in Qd
-

Y0

0<YED <1

found on necessities (we buy

the same amount regardless of
income changes)
-

D
Q0 Q1

Income Elastic Demand

Y

Income Elastic Demand

D
Y1

a small income change

results in a large change in Qd
-

Y0

1 < YED

found on optional products

(a little boost in income
suddenly adds these items to
our basket)
-

Q0

Q1

Income Elasticity
Types of Goods
Elasticity

Positive / Negative

Normal, Necessity

Inelastic

Positive

Inferior, Necessity

Inelastic

Negative

Normal, Optional

Elastic

Positive

Inferior, Optional

Elastic

Negative

Engels Law
As

income rises, the proportion of

income spent on food falls, even if actual
expenditure on food rises. In other
words, the income elasticity of demand
of food is between 0 and 1.
The law was named after the statistician
Ernst Engel (18211896).

Elasticity YED
Income Elasticity of Demand:

A positive sign denotes a normal good

A negative sign denotes an inferior good

Elasticity YED

For example:

Yed = - 0.6: Good is an inferior good but inelastic a rise in

income of 3% would lead to demand falling by 1.8%

WHY? Use your YED formula and plug it in:

(x/0.03)=-0.6
(-0.6)(0.03)=x
-0.018=x, or -1.8%

Yed = + 0.4: Good is a normal good but inelastic a rise in

incomes of 3% would lead to demand rising by 1.2%

Yed = + 1.6: Good is a normal good and elastic a rise in

incomes of 3% would lead to demand rising by 4.8%

Yed = - 2.1: Good is an inferior good and elastic a rise in

incomes of 3% would lead to a fall in demand of 6.3%

Income Elasticity of Demand

Negative

income elasticity of demand(ey

<0)
Zero income elasticity of demand (ey =0)
Income elasticity of demand less then
unity (ey <1)
Income elasticity of demand equal to
unity (ey =1)
Income elasticity of demand greater then
unity (ey >)

Income Elasticity of Demand

If Ey >1, demand is
considered to be
income elastic.
If Ey <1, demand is
considered to be
income inelastic.
If Ey =1, demand is
considered to be unit
elastic.

Elasticity

Price Elasticity of Supply:

The responsiveness of supply to changes in price

If PES is inelastic - it will be difficult for suppliers to
react swiftly to changes in price
If PES is elastic supply can react quickly to changes
in price

%
Quantity Supplied
____________________
PES =
% Price

Price Elasticity of Supply

Measures

the responsiveness of quantity

supplied to changes in price.
Defined as the percentage change in
quantity supplied of a good divided by
the percentage change in the price of the
good.
Supply can be classified as elastic,
inelastic, unit elastic, perfectly elastic, or
perfectly inelastic.

PES: determinantslength of time

PRICE ELASTICITY OF SUPPLY

What

Is the Price Elasticity of Supply?

The price elasticity of supply is the ratio of the percent

change in the quantity supplied to the percent change in

price.

Price elasticity of
=
supply

Percentage change in quantity supplied

Percentage change in price

The price elasticity of supply is interpreted in the same way as the

price elasticity of demand.

PRICE ELASTICITY OF SUPPLY

What Causes the Supply of Some Goods

To Be More Elastic or More Inelastic than
Others?

Substitution effects
Time: Same effect as elasticity of demand

PRICE ELASTICITY OF SUPPLY

Substitution effects

If it is easy for sellers to switch production and sales to another

good, if they have good alternative uses for their productive inputs,
then, ceteris paribus, the supply of the good tends to be more elastic
or less inelastic.

More or better substitutes Higher elasticity

If it is harder for sellers to switch to production and sales of

alternative goods, if inputs tend to be more specialized, then, ceteris

paribus, the supply of the good tends to be more inelastic or less
elastic.

Few or poorer substitutes Lower elasticity

Price Elasticity of Supply

Price Elasticity of Supply and

Time
The longer the
period of adjustment
to a change in price,
the higher the price
elasticity of supply.
Additional production
takes time.
Reducing production
takes time.

Importance in Economic Theory

and Practice
analyses

the price-demand relationship.

Pricing policy of the producer is greatly
influenced by the nature of demand for his
product.

Summary
1.

2.

Elasticity is a general measure of responsiveness that

can be used to answer various questions.
The price elasticity of demand the percent change in
the quantity demanded divided by the percent change
in the price (dropping the minus sign) is a measure
of the responsiveness of the quantity demanded to
changes in the price.

Summary
3.

4.

The responsiveness of the quantity demanded to price

can range from perfectly inelastic demand, where the
quantity demanded is unaffected by the price, to
perfectly elastic demand, where there is a unique price
at which consumers will buy as much or as little as they
are offered. When demand is perfectly inelastic, the
demand curve is vertical; when it is perfectly elastic, the
demand curve is horizontal.
The price elasticity of demand is classified according to
whether it is more or less than 1. If it is greater than 1,
demand is elastic; if it is exactly 1, demand is unitelastic; if it is less than 1, demand is inelastic. This
classification determines how total revenue, the total
value of sales, changes when the price changes.

Summary
5.

6.

The price elasticity of demand depends on whether

there are close substitutes for the good, whether the
good is a necessity or a luxury, the share of income
spent on the good, and the length of time that has
elapsed since the price change.
The income elasticity of demand is the percent change
in the quantity of a good demanded when a consumers
income changes divided by the percent change in
income. If the income elasticity is greater than 1, a
good is income elastic; if it is positive and less than 1,
the good is income-inelastic.

Summary
8.

9.

The price elasticity of supply is the percent change in

the quantity of a good supplied divided by the percent
change in the price. If the quantity supplied does not
change at all, we have an instance of perfectly inelastic
supply; the supply curve is a vertical line. If the quantity
supplied is zero below some price but infinite above
that price, we have an instance of perfectly elastic
supply; the supply curve is a horizontal line.
The price elasticity of supply depends on the availability
of resources to expand production and on time. It is
higher when inputs are available at relatively low cost
and the longer the time elapsed since the price change.

KEEP IN MIND
Income elasticity measures shifts in the demand curve
Price elasticity measures movements along the curve

Summary of the Four Elasticity

Concepts

END OF PRESENTATION