Ch.

17 Elasticity

Economics 9th Ed, R.A. Arnold

 Elasticity
The concept of elasticity is applied to situation
swhere we are interested to study the percentage
changes of two related variables e.g. P and Qd

E.g. a seller may want to know, by what % the

quantity demanded will increase if the price of a
good decreases by 1 %? This answer is given by
the price elasticity of demand
 Price Elasticity of Demand, Ed

E.g. a tea-seller reduces the price of tea by 10 %

and observes that the quantity demanded has
increased by 20%
Therefore, %∆P = - 10 and %∆Qd = + 20
Ed = - 2 . But we always take the | absolute value
| in price elasticity of demand
Hence, |Ed| = | - 2 | = 2
Interpretation of our result in last slide: if the
tea-seller reduces price by 1% the quantity
demanded of tea will increase by 2%
This is an example where the demand is elastic;
occurs when %∆Qd > %∆P , Ed > 1 .
Another example: A rice seller increases the
price of rice by 15% and sees that the quantity
demanded has fallen by 5 %.
Here, %∆Qd = - 5 and %∆P = + 15
Using formula in last slide:
| Ed | = |- 0.33 | = 0.33
Interpretation of result in last slide: if the price
increases by 1% then the quantity demanded
decreases by 0.33%
Here, Ed < 1 (occurs when %∆Qd < %∆P) so we
say the demand is inelastic
If Ed = 1, (occurs when %∆Qd = %∆P). Then we
say the demand is unit elastic
There are two other situations/possibilities:
Price changes by a very small amount and the
quantity demanded changes by a very large
amount
Using equation (1), Ed = ∞
Here the demand is perfectly elastic
The demand is perfectly inelastic when a change
in price does not affect the quantity demanded.
Hence, % ∆ Qd = 0. Using equation (1) Ed = 0
The next slide summarizes the above discussions
In the next slide we look at the graphical representation
of the different types of price elasticities of demand (above)
 Application of Price Elasticity of
Demand
Total Revenue (TR) = Price (P) x Quantity (Q)
If, Ed = 5 (elastic demand; Ed > 1), it means if P
increases by 1% then Qd will decrease by 5%.
Using above equation, TR will decrease.
If, P decreases by 1% then Qd will increase by
5%. Using above equation, TR will increase.
If, Ed < 1 then inelastic demand. If P increases by
1% then Qd decreases by less than 1%. TR
increases. If, P decreases, TR decreases.
 Determinants of Price Elasticity of
Demand (Ed)
1. Number of substitutes: If a good has many substitutes
then Ed will be more as compared to a good which has
fewer substitutes. Why? If there are more substitutes then
buyers can easily shift to them when the price of a
product increases hence Qd changes by a larger % and
hence value of Ed will larger (demand more elastic).
2. Necessities versus luxuries: If a good is a necessity (e.g.
water), Ed will be less as compared to a good which is a
luxury (e.g. grape juice). If the price of a necessity
increases then Qd will fall by a small % hence Ed smaller
and demand less elastic.
3. Time: As more time passes after the price change, the
higher will be the Ed **(End of Quiz 2 Syllabus)**
Other Elasticity Concepts
P.S. Here we DO NOT take the absolute value
because the sign (+ or -) gives us valuable info.
In the example last slide, the quantity demanded of
a good and the price of a substitute are directly
(positively related).
So, Ec > 0 i.e. positive for substitutes
The higher the Ec, the closer the substitutes (the
better the substitutes). Why? Think about this.

And negative i.e. Ec < 0 for complements. The

quantity demanded of a good and the price of
complements are negatively related. If one
increases the other decreases.
The Relationship Between Taxes and
Elasticity
In figure, Gov is taxing $1 per DVD sold.
Remember: If the demand is less elastic (more
inelastic) the D curve will become steeper (more
vertical). You should do the graphical analysis as an
exercise. You will see that the consumer ends up paying
more of the tax.
When demand is perfectly
inelastic the consumer/
buyer pays all of the tax.