Chapter 6. The Concept of Elasticity Elasticity. In economics, means responsiveness.

In general, it is the ratio of the

percent change in one variable to the percent change in another variable. It is a tool used by
economist for measuring the reaction of a function to changes in parameters in a relative way.
You may wondered why there are goods that you purchase more (less) when price
Price elasticity of demand. The responsiveness of consumer’s demand to change in
becomes (less) while there are goods that even prices become too high still you purchase the
price of the good sold.
same quantity of that good. If you have asked yourself why and tried to look for an answer,
you are actually applying the concept of elasticity. Income elasticity of demand. The responsiveness of consumer’s demand to change
in their income.
In this chapter, you will learn the definition of elasticity, calculate elasticity, and
learn why this concept is very important to our everyday decision making as a consumer. Cross elasticity of demand. The responsiveness of demand good, in relation to
changes in price of other related goods.

Elastic demand. When the elasticity of demand is greater than one, indicating a high
B – Desired Learning Outcomes (DLOs) responsiveness of quantity demanded or supplied to changes in price

Elastic supply. When the elasticity of either supply is greater than one, indicating a
At the end of the unit, the students must have:
high responsiveness of quantity demanded or supplied to changes in price
1. Discussed the concepts of elasticity of demand and supply.
Inelastic demand. when the elasticity of demand is less than one, indicating that a 1
2. Calculate the elasticity values of demand and supply in a given changes in
percent increase in price paid by the consumer leads to less than a 1 percent change in
price and quantity.
purchases (and vice versa); this indicates a low responsiveness by consumers to price changes
3. Applied the concept of elasticity to various economic situations.
Inelastic supply. When the elasticity of supply is less than one, indicating that a 1
C. Topics
percent increase in price paid to the firm will result in a less than 1 percent increase in
production by the firm; this indicates a low responsiveness of the firm to price increases (and
1. Elasticity of Demand and Supply vice versa if prices drop)
2. Types and Categories of Elasticity
Price elasticity. The relationship between the percent change in price resulting in a
3. Determinants of Elasticity
corresponding percentage change in the quantity demanded or supplied.
4. Application of Demand and Supply Elasticities
5. Elasticities of Demand and Supply and Tax Incidence Price elasticity of demand. Percentage change in the quantity demanded of a good
or service divided the percentage change in price

Price elasticity of supply. Percentage change in the quantity supplied divided by the
D – Content Focus
percentage change in price.
Definition of Terms

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 Unitary elasticity. When the calculated elasticity is equal to one indicating that a Where the symbol Î (Greek letter ‘delta’) signifies an absolute change. You may
change in the price of the good or service results in a proportional change in the quantity have observed that the most common method used by economics textbooks in the
demanded or supplied measurement of demand price elasticity is the arc elasticity. The formula for this indicator is:

Elasticities of Demand and Supply

Both the demand and supply curve show the relationship between price and the
number of units demanded or supplied. Price elasticity is the ratio between the percentage
change in the quantity demanded (Qd) or supplied (Qs) and the corresponding percent
change in price. The price elasticity of demand is the percentage change in the quantity
demanded of a good or service divided by the percentage change in the price. The price Where: Q1 – Original Quantity Demanded
elasticity of supply is the percentage change in quantity supplied divided by the percentage Q2 – New Quantity Demanded
P1 - Original Price
change in price. P2 - New Price

Midpoint formula is preferable when calculating the price elasticity of demand

Elasticity of Demand because it gives the same answer regardless of the direction of the change.

A measure of the extent to which the quantity demanded of a good changes when the Graphically, this illustrates as…
price of the good changes. To determine the price elasticity of demand, we compare the
percentage change in the quantity demanded with the percentage change in price. Figure 6. 1 The Demand Curve as affected by the price changes

When we speak of the price elasticity of demand, we are dealing with the sensitivity
of quantities bought to a change in the product price. Thus, this concept describes an action
that is within the producer’s control (Keat & Young, 2006).

We can therefore define demand price elasticity as the percentage change in quantity
demanded caused by a 1 percent change in price. Thus, we can derive price elasticity of
demand using the following equation:

We can illustrate the concept of elasticity through the following example:

Suppose we have the following price and quantity schedule for ice cream cone.

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 Interpretation of Elasticity Coefficient

For economists, solving the elasticity coefficient is only a tool rather an end in itself.
What is important to them (and to us also) is to understand the meaning of the computed
elasticity. Our concern now is how to analyze and interpret the elasticity coefficient. Actually,
there are only certain rules to remember in analyzing and interpreting the elasticity
coefficient, as you will note in the following discussion.

Demand for a product is said to be inelastic if consumers will pay almost any price
Assuming that we want to determine how consumers would react if price of ice
for the product, while demand for a product may be elastic if consumers will only pay a
cream cone will decrease. Applying the formula, we can solve the elasticity coefficient
certain price, or a narrow range of prices, for the product. Inelastic demand means that a
assuming that price will decrease from 2.20 to 1.80 and the quantity will increase from 8 to 14
producer or seller can raise prices without much hurting demand for its product, and elastic
units.
demand means that consumers are sensitive to the price at which a product is sold and will
Q 2−Q 1 only buy it if the price rises by what they consider too much.
/P 2− p 1
(Q 2+Q1)/2
Ep= We already know that a fall in the price of a good results in an increase in the
(P 2+ P 1)/ 2
quantity demanded by consumers. However, the demand for a good is inelastic when the
14−8 change in quantity demanded is less than the change in price. Thus, we can say that demand is
/1.80−2.20 inelastic if the computed elasticity coefficient is less than 1 (Ep<1). Generally, goods and
(8+14)/2
¿ services for which there are no close substitutes are inelastic. Basic foods items such as; rice
(1.80+2.20)/2 pork, beef, fish, vegetables, medicines (like antibiotics), and oil products, are some examples
of goods that are inelastic.
6 6
/−0.4 /−0.4
11 11
¿ = Figure 6.2 explains the slope is inelastic when demand curve is steeper. In fact the
2 2 more the demand curve becomes vertical the greater it becomes inelastic. Even the large
amount of price changes, result to a smaller change in the quantity demanded for a certain
Ep = -I2.72I percent
product. This implies that less quantities of a good purchased when there is a large change in
As you may have observed, price elasticity is always negative, although when we price. In this situation, consumer’s response in buying of good is lesser than the change in
analyze and interpret the coefficient, we ignore the negative sign thus only the absolute value price.
is interpreted. What could be the reason for this? It is always negative due to the very nature
of demand: if price increases, less quantity of a good is demanded therefore quantity change is Figure 6.2 Inelastic Demand Curve
negative, leading to a negative price elasticity of demand. Conversely, if price falls, this The figure illustrates an
negative value will lead to a negative price elasticity of demand value. inelastic demand curve. An
inelastic demand curve is
steeper than a typical demand
3 curve. This is because a large
change in price (broken line
ab) calls forth a smaller
change in quantity demanded,
 a
a C

C b
b

The question, what determines elasticity? Accordingly, many factors may affects
demand elasticity. These include a) availability of good substitute for the goods, b) number of
uses the good can be put into, c) the price of the good relative to the consumer’s purchasing
Figure 6.3 denotes that the slope of an elastic demand curve is flatter. Thus, the more power, and d) the time frame under consideration.
the demand curve becomes horizontal the greater it becomes elastic. This is because a small
change in price results to a larger change in the quantity demanded. Take note of the broken However, the most important determinant of elasticity is the availability of good
line (ab) is shorter than the broken line (bc). This means that more quantities of a good is substitute for the goods. If there are many good substitutes for the product sold in the market,
demanded when price changes even by small amount. In this case, we can say that consumers elasticity for that product will be high. Moreover, if the product itself is a good substitute for
respond greatly to a small change in price.
other goods, its demand elasticity will also be high. However, the broader the definition of a
Clothes, appliances, cars, among others are examples of goods that are elastic. commodity, the lower its price elasticity will tend to become because there is less opportunity
Therefore, we can say that demand is elastic if the computed elasticity coefficient is greater for substitutes.
that 1 (Ep>1). In general, goods and services that may have many substitutes which
consumers may switch to are elastic. For the product like appliances and techno gadgets, the situation maybe entirely
different. Thus, we can expect that the demand for an air conditioning unit to be considerably
Figure 6.3 Elastic Demand Curve high than that for the price. Another reason for the high elasticity of this product is that an
appliance purchase can be postponed because there is a choice between buying and repairing.
The figure illustrates an elastic Faced with a higher purchase price, a consumer may choose to repair instead of purchasing a
demand curve. An elastic brand new product.
demand curve is flatter than a
typical demand curve. This is Lastly, as market broaden, more and more product substitution becomes possible.
because a smaller change in
Advances of mode of transportation and communication accompanied by decreases in their
price (broken line ab) calls
cost have increased the size of markets over time. Thus, the number of substitutes competing
forth a greater change in
for consumers’ demand has increased.
quantity demanded, (broken
line bc).
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 There are also two notable (extreme types) cases of Price Elasticity of Demand. The
first is when is perfectly elastic. Perfectly elastic demand is represented graphically as a
horizontal line. In this case, any increase in price will lead to zero units demanded. On the
other hand, demand is perfectly elastic when a certain price demand is infinite (A good with
a very high elasticity of demand). In other words, if a firm increased the price by 1%, it would
see all its demand evaporate. If demand is perfectly elastic, then demand will be horizontal.

Examples of Perfectly Elastic Demand

Foreign currency exchange. If you are buying foreign currency, it is likely to

exhibit the features of perfect competition. A buyer could choose from many different sellers.
The product (e.g. dollars) is identical. Perfect information about cheapest currency dealer
would be easy to find.
The second is perfectly inelastic demand. Perfectly inelastic demand is graphed as a
vertical line and indicates a price elasticity of zero at every point of the curve. This means that
Therefore, if one firm increased the price of dollars, above market equilibrium – no
the same quantity will be demanded regardless of the price
one would buy from that firm. They would buy from cheaper alternatives.

Similarly, if you are buying potatoes from Covent garden, it is easy to check prices.
Therefore, if a farmer increases price above the equilibrium, demand will fall significantly Figure 6.5 Perfectly Inelastic Demand Curve
meaning demand is very elastic.

Figure 6.5 illustrates the

Figure 6.4 Perfectly Elastic Demand Curve Perfectly Inelastic Demand
Curve. Perfectly inelastic
demand is represented
Figure 6.4 illustrates the graphically by a vertical line.
Perfectly Elastic Demand This means that the same
Curve. Perfectly elastic quantity will be demanded
demand is represented regardless of the price.
graphically by a horizontal
line. In this case the PED
value is the same at every
point of the demand curve.
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 Since PED is measured based on percent changes in price, the nominal price and
quantity mean that demand curves have different elasticities at different points along the
curve. Elasticity along a straight line demand curve varies from zero at the quantity axis to
infinity at the price axis. Below the midpoint of a straight line demand curve, elasticity is less In the same manner, like elasticity of Demand, computation for ELASTICITY OF
than one and the firm wants to raise price to increase total revenue. Above the midpoint, SUPPLY is similar to elasticity of demand.
elasticity is greater than one and the firm wants to lower price to increase total revenue. At the
midpoint, E1, elasticity is equal to one, or unit elastic. However, elasticity of supply pertains to the reaction or response of the sellers or
producers to price changes of goods sold. There are also categories of supply elasticity, such
as Elastic (>1), inelastic (<1) and unit elastic (=1).

Now that you have a clear idea why some goods that you purchase are more (less)
Figure 6.6 Unitary Elastic Demand Curve than the price changes, it is now time for you to apply the concept that you have learned in
your everyday activity as a consumer. It is expected that this concept will help you in your
decision making as a consumer (and maybe later as a producer).

Other Demand Elasticities

Cross-Price Elasticity of Demand

The cross-price elasticity of demand measures the change in demand for one good in
response to a change in price of another good. The cross-price elasticity of demand shows the

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relationship between two goods or services. More specifically, it captures the responsiveness
of the quantity demanded of one good to a change in price of another good. Cross-Price
Elasticity of Demand (EA,B) is calculated with the following formula:

The cross-price elasticity may be a positive or negative value, depending on whether

the goods are complements or substitutes. If two products are complements, an increase in
demand for one is accompanied by an increase in the quantity demanded of the other. For
example, an increase in demand for cars will lead to an increase in demand for fuel. If the
price of the complement falls, the quantity demanded of the other good will increase. The
value of the cross-price elasticity for complementary goods will thus be negative.
Figure 6.7. Illustrates Complementary Cross-Price Elastic Demand Curve. Two goods that
complement each other have a negative cross elasticity of demand: as the price of good (A,E) rises,
the demand for good (B, F) falls.

Figure 6.7 Cross-Price Elasticity Demand Curve - Complements
A positive cross-price elasticity value indicates that the two goods are substitutes.
For substitute goods, as the price of one good rises, the demand for the substitute good
increases. For example, if the price of coffee increases, consumers may purchase less coffee
and more tea. Conversely, the demand for a substitute good falls when the price of another
good is decreased. In the case of perfect substitutes, the cross elasticity of demand will be
equal to positive infinity.

Figure 6.8 Cross-Price Elasticity Demand Curve - Substitutes

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 The income elasticity of demand measures the responsiveness of the demand for a
good or service to a change in income. The income elasticity of demand (YED) measures the
responsiveness of demand for a good to a change in the income of the people demanding that
good, ceteris paribus. It is calculated as the ratio of the percentage change in demand to the
percentage change in income:

Below is an example of income schedule. The data in the table denotes how much
quantity a consumer could be able to purchase in a specific income and their responses in case
an increase of income would occur.

Figure 6.8. Illustrates Substitute Cross-Price Elastic Demand Curve. Two goods that are substitutes
have a positive cross elasticity of demand: as the price of good (X,S) rises, the demand for good
(Y,T) rises

Sample Questions:

1. When the price of bananas increases by %20, percent, the quantity demanded of
apples increases by 30% percent. What is the value of the cross-price elasticity of
demand? Applying the formula for income elasticity demand, we can calculate the percentage
Solution: change of quantity demanded over the increase of income.
% Change of DX
Ex y = Suppose, the consumer’s increase its income from 4,000 to 5,000 and would be able
% change of DY
to but decrease its purchases from 400 to 300, therefore
= 20%/30%
= 0.67% or 2/3

Income Elasticity Demand

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 1. High income elasticity of demand (YED>1): An increase in income is
accompanied by a proportionally larger increase in quantity demanded. This is
typical of a luxury or superior good.
2. Unitary income elasticity of demand (YED=1): An increase in income is
accompanied by a proportional increase in quantity demanded.
3. Low income elasticity of demand (YED<1): An increase in income is accompanied
by less than a proportional increase in quantity demanded. This is characteristic of a
necessary good.
Ey=((300−400)/((300+400)/2))/((5000−4000)/((5000+4000)/2)) 4. Zero income elasticity of demand (YED=0): A change in income has no effect on
= (-100/350)/(1000/4500) the quantity bought. These are called sticky goods.
= -0.29 (-29%)/0.22 (22%) 5. Negative income elasticity of demand (YED<0): An increase in income is
Ey = - 1.32% accompanied by a decrease in the quantity demanded. This is an inferior good (all
other goods are normal goods). The consumer may be selecting more luxurious
substitutes as a result of the increase in income.
The sign of EY could be positive or negative depending on the nature of the good in
question.
Samples Questions:
If an increase in income leads to an increase in demand, the income elasticity of that
good or service is positive. A positive income elasticity is associated with normal goods. In
1. Suppose that when people income increases by 20% they buy less 10% fast food. In
contrast, if a rise in income leads to a decrease in demand, the good or service has a negative
this situation, what type of good would fastfood be?
income elasticity of demand. A negative income elasticity is associated with inferior goods.
Answer: Inferior Good
In all, there are five types of income elasticity of demand:
Calculating the Income Elasticity:
Figure 6.9 Income Elasticity: Inferior, Basic or Necessity, Luxury Solution:
% Change of Qd
E y=
% change of Y

= -10%/20%
= - 0.5

2. Suppose we know that when people’s income increase by 5% in the country, the
demand for healthcare increase by 10%. What kind of good do people consider
healthcare? Inferior or Normal Goods.
Answer: Normal Good

Calculating the Income Elasticity:

Solution:
% Change of Qd
E y=
% change of Y
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 tax. Makes sense, right? Except like many economic myths, it is not true. The analysis, or
= 10%/5% manner, of how a tax burden is divided between consumers and producers is called tax
=2 incidence. Tax incidence depends on the price elasticities of supply and demand

Application of Own Price Elasticity:
Own Price Elasticity of Demand and Total Revenue
Since, Total Revenue (TR) = Price of the good x Quantity Sold. If Price
increases, Quantity demanded decreases but the effect on Total Revenue (TR) is
uncertain unless the Elasticity of Demand (εd) is known.
The tax incidence depends on the relative price elasticity of supply and demand.
When supply is more elastic than demand, buyers bear most of the tax burden, and when
demand is more elastic than supply, producers bear most of the cost of the tax. Tax revenue
is larger the more inelastic the demand and supply are.
The example of cigarette taxes introduced previously demonstrated that because
demand is inelastic, taxes are not effective at reducing the equilibrium quantity of smoking,
and they mainly pass along to consumers in the form of higher prices. With other products,
however, the burden of the tax can be very different.

Similarly, when a government introduces a tax in a market with an inelastic supply,

1. If price increases, there will be percentage decrease in Quantity demanded and
greater (>) the percent increase in Price. Therefore, decreases Total Revenue (TR)
2. If price increases, percentage change in quantity demanded is lower than the change
in price. Therefore, there is an increase in Total Revenue
3. However, if demand is unit elastic. Percent decrease in quantity demanded is equals
to the increase in price. Nothings change in TR.
such as, for example, beachfront hotels, and sellers have no alternative than to accept lower
prices for their business, taxes do not greatly affect the equilibrium quantity. The tax burden
now passes on to the sellers. If the supply was elastic and sellers had the possibility of
reorganizing their businesses to avoid supplying the taxed good, the tax burden on the sellers
would be much smaller. The tax would result in a much lower quantity sold instead of lower
prices received. Figure 1 illustrates this relationship between the tax incidence and elasticity
of demand and supply.
E – Self-Check/Assessment
PART I. Multiple Choice
Instructions: Fill the blank with the letter of your answer before the number.

Elasticities of Demand and Supply and Tax Incidence ___________1. The coefficient-of-demand elasticity is:
a. the change in total revenue divided the change in price.
b. the percentage change in quantity demanded divided by the percentage change in
In this situation, the question, who bears the greater portion of the tax? Is it the
price.
consumer? On the other hand, the producer?
c. constant for all ranges of every demand curve, regardless of shape.
d. the quantity demanded divided by the change in price.
People often assume that when government imposes a tax on purchases of some
product, producers simply raise the price of the product so that consumers end up paying the
_______2. Elasticity of demand is important because it shows how:

10
 a. higher prices result from shifts in the supply curve. _______7. You hate washing dishes so you buy paper plates every time you shop. No
b. total revenue changes when declining price induces rising quantity along the matter how many paper plates you hoard, you always pay the same price per plate. To
demand curve. you the supply curve of paper plates in each period is
c. a percentage reduction in quantity induces an increase in price along the demand a. Inelastic
curve. b. Perfectly inelastic
d. a fall in price induces a percentage change in the supply curve. c. Elastic
d. Perfectly elastic
_______3. Why are farm revenues higher in years of lower production due to bad e. Unit elastic
weather?
_______8. A vertical supply curve may be described as:
a. Demand is more elastic than supply. a. Inelastic
b. Supply is perfectly elastic. b. Perfectly inelastic
c. Demand is inelastic; a leftward shift in supply will increase total revenue c. Elastic
d. Supply is inelastic; a leftward shift in supply will increase total revenue. d. Perfectly elastic
e. Unit elastic
_______4. If a store sells 500 bottles of perfume a month when the price is P6 and only
sells 460 bottles a month when the price rises to P7, then the price elasticity of demand is: F – Self-Reflect
(show your solution, 3 points)
a. 0.54 and inelastic 1. If you are a government official, how would you encourage farmers to help increase
b. 1.85 and elastic. the price of tomato? Explain using the concept of elasticity. (20 points)
c.  1.85 and inelastic. ____________________________________________________________________
d.  0.54 and elastic ____________________________________________________________________

_______5. If the cross-price elasticity of demand between meat and fish is 2.50, we can ____________________________________________________________________
say that: ____________________________________________________________________
a.    Meat and fish have elastic demand
____________________________________________________________________
b.   Meat is a normal good
c.   Meat and fish are substitute goods ____________________________________________________________________
d.   a and b are correct ____________________________________________________________________
_______6. Suppose a specific tax is applied to C2 (cool and clean) drink. After the ____________________________________________________________________
application of the tax it was observed that the consumers share 25% of the tax. What ____________________________________________________________________
can you conclude about the price of elasticities of supply and demand?
a. demand is perfectly inelastic and supply is perfectly elastic ____________________________________________________________________
b. the elasticity of demand is equal to the elasticity of supply ____________________________________________________________________
c. demand is relatively more elastic than supply
____________________________________________________________________
d. supply is relatively more elastic than demand
____________________________________________________________________

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 ____________________________________________________________________
____________________________________________________________________ MARY GRACE A. APOLONA
____________________________________________________________________ Course Instructor
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________

Rubrics for Essay Question

Criteria for Written Exercises (As Agreed by the whole class)

Content (Correctness and Appropriateness of Ideas Presented) – 10

point
Convention (Linguistic Appropriateness – Grammar, Phonology, Semantics)
– 5 point
Quality (Neatness, refinement and skillfulness) – 5 points
Total = 10
References:

Pagoso, C., et. al (2015). Principles of Economics. pp. 53-68

Marcelino, et al. 2010. Principles of Economics (With Taxation and Agrarian Reform
Simplified) pp. 59-73.

Nebres, A. (2008). Economics: Concepts, Theories, and Application. pp. 65-80

Prepared by:

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