Table of Contents

1. The Measurement of Elasticities..................................................................................................... 2

1.1 Price Elasticity of Demand: ..................................................................................................... 2
1.1.1 Perfectly Inelastic: ........................................................................................................... 2
1.1.2 Inelastic: .......................................................................................................................... 3
1.1.3 Elastic or Unit Elastic: ...................................................................................................... 3
1.1.4 Perfectly Elastic: .............................................................................................................. 3
1.2 Factors that affect Price Elasticity: .......................................................................................... 4
1.2.1 Number of Substitutes Available: ....................................................................................... 4
1.2.2 Price of Product in Relation to Income: .............................................................................. 4
1.2.3 Cost of Substitution:............................................................................................................ 4
1.2.4 Brand Loyalty: ..................................................................................................................... 4
1.2.5 Necessary Goods: ............................................................................................................ 4
1.3 Arc and Point Elasticity: .......................................................................................................... 4
1.4 Point Elasticity and Total Expenditures: ................................................................................. 5
1.5 Income Elasticity of Demand: ................................................................................................. 5
1.5.1 Normal Goods ................................................................................................................. 6
1.5.2 Normal Necessities ......................................................................................................... 6
1.5.3 Luxury Goods and Services ............................................................................................. 6
1.5.4 Inferior Goods ................................................................................................................. 6
1.6 Cross Elasticity of Demand:..................................................................................................... 7
1.7 Price Elasticity of Supply: ........................................................................................................ 7

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1. The Measurement of Elasticities
1.1 Price Elasticity of Demand:
The elasticity of demand measures how factors such as price and income affect the demand for a
product. Price elasticity of demand measures how the change in a product’s price affects its
associated demand.
The coefficient of price elasticity of demand (e) measures the percentage change in the quantity
of a commodity demanded per unit of time resulting from a given percentage change in the
price of the commodity. Since price and quantity are inversely related, the coefficient of price
elasticity of demand is a negative number. In order to avoid dealing with negative values, a
minus sign is often introduced into the formula for e. Letting DQ represent the change in the
quantity demanded of a commodity resulting from a given change in its price (DP), we have

Demand is said to be elastic if e > 1, inelastic if e < 1, and unitary elastic if e = 1.

For our examples of price elasticity of demand, we will use the price elasticity of demand
formula: Widget Inc. decides to reduce the price of its product, Widget 1.0 from $100 to $75.
The company predicts that the sales of Widget 1.0 will increase from 10,000 units a month to
20,000 units a month. To calculate the price elasticity of demand, first, we will need to calculate
the percentage change in quantity demanded and percentage change in price.
% Change in Price = ($75-$100) / ($100) = -25%
% Change in Demand = (20,000-10,000) / (10,000) = +100%
Therefore, the Price Elasticity of Demand = 100%/-25% = -4.
This means the demand is relatively elastic.
1.1.1 Perfectly Inelastic:
When the price elasticity of demand or PED is zero, then the demand is perfectly inelastic. That is,
there is no change in the quantity demanded in response to the change in price. The demand
curve remains vertical. Demand is completely unresponsive to the change in price.

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1.1.2 Inelastic:
If the percentage of change in demand is less than the percentage of change in price, then the
demand is inelastic. For instance, let us say that the price of a chocolate increases from Rs.10 to
Rs.20 and the associated demand decreases from ten chocolates to five chocolates. So now the PED
will be 50% divided by 100%, which is 0.5. Hence, the demand here is inelastic.

1.1.3 Elastic or Unit Elastic:

When the percentage of change in demand is the same as the percentage of change in price, then
the demand is unit elastic. For example, let us say that the price of a candy drops from Rs.10 to
Rs.5 and the demand increases from 10 candies to 15 candies. Here, the percentage of change in
demand is equal to the percentage of change in price (50% divided by 50%, which is 1).

1.1.4 Perfectly Elastic:

If the percentage of change in demand is more than the percentage of change in price, then the
demand is perfectly elastic. For instance, if a 10% increase in price causes a 20% drop in demand,
then the coefficient of PED is 3, which means that the demand is perfectly elastic.

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1.2 Factors that affect Price Elasticity:
Now that you are familiar with the coefficient of the price elasticity of demand, let us understand
the factors that affect the elasticity of demand.
1.2.1 Number of Substitutes Available:
If there are several substitutes or brands available for a product, then the elasticity of demand for
the product will be high because consumers can shift from one brand to another depending on the
change in price. Chocolates, for instance, is a good example of substitutes. Consumers can choose
between several brands of chocolates.
1.2.2 Price of Product in Relation to Income:
Now when a household’s income changes, the demand for goods and services also varies in
response to the income. Hence, the demand for products and services becomes elastic.
1.2.3 Cost of Substitution:
In some cases, the result of changing from one brand to another may be quite high. For instance,
if a certain cable service has a lock-in period of deposit, then an existing consumer cannot change
to another service, although inexpensive, without losing the deposit. Hence, the demand becomes
inelastic.
1.2.4 Brand Loyalty:
Sometimes, consumers are loyal to a specific product. In such cases, the price change in that
product will not affect its associated demand. Brand loyalty, therefore, makes the demand
inelastic.
1.2.5 Necessary Goods:
Necessary goods such as medicines and petrol usually have an inelastic demand. As consumers
have to purchase these goods irrespective of the change in price, the demand remains
unresponsive.

1.3 Arc and Point Elasticity:

Arc elasticity is the elasticity of one variable with respect to another between two given points.
It is used when there is no general function to define the relationship between the two variables.
Arc elasticity is also defined as the elasticity between two points on a curve. The concept is
used in both mathematics and economics.
The Formula for the Arc Price Elasticity of Demand Is:

% 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
𝑃𝐸𝑑 =
% 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒

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If the price of a product decreases from $10 to $8, leading to an increase in quantity demanded
from 40 to 60 units, then the price elasticity of demand can be calculated as:
% change in quantity demanded = (Qd2 – Qd1) / Qd1 = (60 – 40) / 40 = 0.5
% change in price = (P2 – P1) / P1 = (8 – 10) / 10 = -0.2
Thus, PEd = 0.5 / -0.2 = 2.5

Point elasticity of demand is the ratio of percentage change in quantity demanded of a good to
percentage change in its price calculated at a specific point on the demand curve. Point
elasticity of demand is actually not a new type of elasticity. It is just one of the two methods of
calculation of elasticity, the other being arc elasticity of demand. All major measures of
elasticity i.e. (price) elasticity of supply, income elasticity, cross elasticity of demand/supply
have their point elasticity and arc elasticity versions even though point elasticity method is
simpler and more popular method.

1.4 Point Elasticity and Total Expenditures:

A straight-line demand curve (extended to both axes) is elastic above its midpoint, has unitary
elasticity at the midpoint, and is inelastic below its midpoint. There are no such generalizations
for curvilinear demand curves. In the special case when a demand curve takes the shape of a
rectangular hyperbola, e = 1 at every point on it. Regardless of the shape of the demand curve,
as the price of a commodity falls, the total expenditures of consumers on the commodity (P
times Q) rise when e > 1, remain unchanged when e = 1, and fall when e < 1.

1.5 Income Elasticity of Demand:

Income elasticity of demand refers to the sensitivity of the quantity demanded for a certain
good to a change in real income of consumers who buy this good, keeping all other things
constant. The formula for calculating income elasticity of demand is the percent change in
quantity demanded divided by the percent change in income. With income elasticity of demand,
you can tell if a particular good represents a necessity or a luxury.

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The coefficient of income elasticity of demand measures the percentage change in the amount
of a commodity purchased per unit time resulting from a given percentage change in a
consumer’s income. The formula for calculating income elasticity is: % Change in demand
divided by the % change in income.

Consider a local car dealership that gathers data on changes in demand and consumer income
for its cars for a particular year. When the average real income of its customers falls from
$50,000 to $40,000, the demand for its car plummets from 10,000 to 5,000 units sold, all other
things unchanged. The income elasticity of demand is calculated by taking a negative 50%
change in demand, a drop of 5,000 divided by the initial demand of 10,000 cars, and dividing
it by a 20% change in real income — the $10,000 change in income divided by the initial value
of $50,000. This produces an elasticity of 2.5, which indicates local customers are particularly
sensitive to changes in their income when it comes to buying cars.
1.5.1 Normal Goods
Normal goods have a positive income elasticity of demand so as consumers' income rises more
is demanded at each price i.e. there is an outward shift of the demand curve.

1.5.2 Normal Necessities

Normal necessities have an income elasticity of demand of between 0 and +1 for example, if
income increases by 10% and the demand for fresh fruit increases by 4% then the income
elasticity is +0.4. Demand is rising less than proportionately to income.

1.5.3 Luxury Goods and Services

Luxury goods and services have an income elasticity of demand > +1 i.e. demand rises more
than proportionate to a change in income – for example a 8% increase in income might lead to
a 10% rise in the demand for new kitchens. The income elasticity of demand in this example
is +1.25.

1.5.4 Inferior Goods

Inferior goods have a negative income elasticity of demand meaning that demand falls as
income rises. Typically, inferior goods or services exist where superior goods are available if
the consumer has the money to be able to buy it. Examples include the demand for cigarettes,
low-priced own label foods in supermarkets and the demand for council-owned properties.

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1.6 Cross Elasticity of Demand:
The cross elasticity of demand is an economic concept that measures the responsiveness in the
quantity demanded of one good when the price for another good changes. Also called cross-
price elasticity of demand, this measurement is calculated by taking the percentage change in
the quantity demanded of one good and dividing it by the percentage change in the price of the
other good. The coefficient of cross elasticity of demand of commodity X with respect to
commodity Y measures the percentage change in the amount of X purchased per unit of time
resulting from a given percentage change in the price of Y. Thus

1.7 Price Elasticity of Supply:

The coefficient of price elasticity of supply measures the percentage change in the quantity supplied
of a commodity per unit of time resulting from a given percentage change in the price of the
commodity. Thus

When the supply curve is positively sloped (the usual case), price and quantity move in the same
direction and es > 0. The supply curve is said to be elastic if es > 1, inelastic if es < 1, and unitary elastic
if es = 1. Arc and point es can be found in the same way as arc and point e. When the supply curve is
a positively sloped straight line, then, all along the line, es > 1, if the line crosses the price axis; es < 1,
if it crosses the quantity axis; and es = 1, if it goes through the origin.

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