Elasticity of demand and supply

ELASTICITY
Sensitivity of the quantity
demanded to price is
called: price elasticity of
demand:

= % change in quantity demanded =  Q / Q

EP
% change in price P/P
Own Price Elasticity of
Demand
⚫ Own price elasticity: A measure of the
responsiveness of the quantity demanded of a
good to a change in the price of that good; the
percentage change in quantity demanded
divided by the percentage change in the price
of the good.
⚫ Elastic demand: Demand is elastic if the
absolute value of the own price elasticity is
greater than 1.
Types of elasticities
⚫ elastic: the quantity demanded changes more
than in proportion to a change in price

⚫ inelastic: the quantity demanded changes

less than in proportion to a change in price
Elasticity and slope
Price
The demand curve can be a
range of shapes each of which
is associated with a different
relationship between price and
the quantity demanded.

Quantity Demanded
Slope of the Demand Curve
⚫ P is the
change in P
Price Demand

price. (P<0) slope =

Q
⚫ Q is the P
change in P
P+ P
quantity. Q

⚫ slope =
P/ Q

Q Q + Q Quantity
⚫ Elastic demand : Demand is elastic if the
absolute value of own price elasticity is
greater than 1.
⚫ Inelastic demand: Demand is inelastic if the
absolute value of the own price elasticity is
less than 1.
⚫ Unitary elastic demand: Demand is unitary
elastic if the absolute value of the own price
elasticity is equal to 1.
⚫ Perfectly elastic demand : e= infinity
⚫ Perfectly inelastic demand : e = 0
Linear Demand Curve:
price
E = infinity e=lower segment/upper segment

E=1

E=0
Qty
Determinants of Elasticity
⚫ 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

⚫ Price of the product- lower the price, lower the elasticity

⚫ Luxury or Necessity - for example,

addictive drugs

⚫ Time period – the longer the time under consideration the more
elastic a good is likely to be
Cross-Price Elasticity
⚫ Cross-price elasticity: A measure of the
responsiveness of the demand for a good to
changes in the price of a related good; the
percentage change in the quantity demanded
of one good divided by the percentage change
in the price of a related good.
⚫ The cross-price elasticity is positive whenever
goods are substitutes.
⚫ The cross-price elasticity is negative whenever
goods are complements.
Cross-price elasticity of
demand
how quantity of one good
changes as price of
another good increases

%change in quantity demanded

%change in price of another good
Q / Q Q Po
EQ, Po = =
Po / Po Po Q
Income elasticity of demand

% change in quantity demanded

EI =
% change in income
Q / Q Q I
= =
Y / Y Y Q
Income Elasticity
⚫ Income elasticity: A measure of the
responsiveness of the demand for a good to
changes in consumer income; the percentage
change in quantity demanded divided by the
percentage change in income.
⚫ The income elasticity is positive whenever the
good is a normal good.
⚫ The income elasticity is negative whenever the
good is an inferior good.
Factors affecting Income elasticity:

⚫ Nature of the good:

⚫ inferior goods have negative income elasticity
⚫ Normal goods have positive income elasticity
⚫ Luxury goods have income elasticity greater
than one
⚫ Necessary goods have income elasticity less
than one
Advertising Elasticity
⚫ The own advertising elasticity of demand for
good X defines the percentage change in the
consumption of X that results from a given
percentage change in advertising spent on X.
Elasticity and Total Revenue
⚫ If demand is elastic, an increase (decrease)
in price will lead to a decrease (increase) in
total revenue.
⚫ If demand is inelastic, an increase (decrease)
in price will lead to an increase (decrease) in
total revenue.
⚫ Total revenue is maximized at the point
where demand is unitary elastic.
price revenue elasticity

Increases increases E< 1

increases decreases E>1

decreases decreases E<1

decreases increases E>1

Increases/ constant E=1

decreases
Elasticity of Supply
⚫ Price Elasticity of Supply:
⚫ The responsiveness of supply to changes
in price
⚫ If es is inelastic (<1)- it will be difficult for suppliers to react
swiftly to changes in price
⚫ If es is elastic(>1) – supply can react quickly to changes
in price

% Δ Q_u_ant_it_y_Sup_p_l_ie_d
es =
% Δ Price
Application of elasticity:
⚫ Incidence of taxation: Supply
after tax
supply

e1 tax
pt
eqm
p1
p0

demand