AS Economics (Micro)

UBI
Chapter 4: Elasticities

Elasticity of Demand elasticity of supply

v&¥ÉD
PED
PES
I

Topicsfchapteis
all elasticities
① Definitions & formula of ' '

① Types
n
n

PED & PES

determinants
③
firms gout
&
elasticities to
.

all
④ Uses
of PED & PES
⑤ Methods
of changing

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Price Elasticity of Demand (PED): It is the responsiveness of quantity demanded to changes in
price. PED is always negative.

①
Where
Qa¥= ✗ 100

}
x 100

And
k¥ 1×100 ②
x 100

So

③
¥¥×¥
Types of Price Elasticity of Demand

Characteristics Price elastic Unitary elastic Price inelastic

1 Definition Small change in price Same change in price Large change in price
causes a large causes equal causes a small
proportionate proportionate change proportionate
change in quantity in quantity demanded change in quantity
demanded demanded

2 Value PED > 1, eg 2.5, 5 ect PED = 1 PED < 1, eg 0.5, 0.75
've
- -
.

* D= -1-2
etc
ignore the
sign
3 Type of goods HisLuxuries eg car, ACs - Necessities, addictive
eg wheat, cigarettes

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 Elastic unitary Inelastic .

4 Shape of demand Flatter, as P < Q Hyperbola, as P = Q Steeper, as P > Q

curve
P P P
P ,

P
F. A
Pi
A
D R
B C
BC
Bc D
D
Q, Q2 Q, Qz Q, Qz
Q Q
5 Relationship between In price in As P = QD, TR/TE In price in
price and TR/TE as QD by a remains unchanged Boo
TR/TE as QD t by a
revenue/expenditure lot, hence the whether price or little, hence
producer should Thus price should producer should
-860
increase price to remain constant increase price to
increase revenue In the above diagram, increase revenue
In the above diagram, TR/TE at P1 = A+B, while In the above diagram,
TR/TE at P1 = A+B, TR/TE at P2 = B+C. So TR/TE at P1 = A+B,
while TR/TE at P2 = TR = C-A, and as C = A, while TR/TE at P2 =
B+C. So TR = C-A, and TR stays constant B+C. So TR = C-A, and
as C > A, TR as C > A, TR

2 Extreme types of PED

P
Perfectly Elastic PED -_ a

Horizontal Demand
D
Price Remains the same when quantity
changes.

P D
Q
Perfectly Inelastic
PED __ 0

Vertical Demand

When Change in price causes no change in

↳ demand.

p9=9TR .
0
of
EgP9ly1°f→TR9by
/

,TñPby1of→TTR byeessttom of
/

Jfgoodismelastie

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Note: - The formula for the hyperbola demand curve, or unitary elastic demand, uses the
midpoint approach, called the arc elasticity of demand. i.e.

}
Not Important
Where

And

,
Straight line Demand Curve and Varying Elasticities , ,,

ÑPEypED=
The upper part of Demand Curve P
is elastic as PED is more than 1.
?
The lower part of the Demand
Curve is inelastic as PED is less
1

YED<
than 1.

And The midpoint is unitary elastic PE D=o

with PED equal to 1. D →
k
Relationship of Price and Total Revenue

Unitary Inelastic

As the Price rises there is no difference in Total It has a positive relation between
Revenue. The Total Revenue remains constant as
the Price changes. Price and Total Revenue as when the Price rises
the Total Revenue also increases.

P n P n

TR
TR
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④
YgER-!"%ÉÉP→ihitay_
EEE:#
"

④T_R&iR→y.a→

fglasti-geghulary-EEL.LI
elastics

Pt→QT→TR%P1^→Qt→TR9tYtmP= Q

✗ we -
we H9ñQ→
E%É→ ? D. in TR
NO
Pt→oI
ago -
 Pn
Elastic
It has a negative relation between
Price and Total Revenue as when
the Price decreases the Total
Revenue increases.

FR
Determinants of PED
1) Nature of Product
Necessities are inelastic while luxuries are elastic.
change with very less when the price is changed similarly in case of luxuries their
demand changes by a lot when the price is changed.
2) Number of substitutes
Products with less substitutes are inelastic while products with more goods are elastic.
The product with more substitutes means that the consumer has a lot of choice which
can mean that its demand is more elastic.
3) Time
In emergencies (Short Run) goods are inelastic while, when there is more time available
(Long Run) goods are elastic. This is because the consumer has more time to choose the
product in Long Run.
4) Proportion of Income Spent
When small proportion of income is spent on a good it is inelastic while when a large
proportion of an income is spent on a good it is elastic.

Price Elasticity of Supply (PES)

It is the responsiveness of changes in quantity supplied to changes in price. It is always
positive.
NP vs car

ya P as Rs3o RSZOL
50 10000

Ptbylf
I
.

2 75 12000

Rs Go Rs 224
=
¥% ,
✗
¥ TRs③
=z¥-×÷÷É=0
"

D
.

Dt
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g. R v s L .

R : - In S .
R
only labour,
change can
,
while all other fops are
fixed
""^

?
write
•
Mt "

spay

m
Characteristics Price elastic Unitary elastic Price inelastic
1 Definition Small change in price Same change in price Large change in price
causes a large % causes equal causes a small ¥
change in quantity proportionate change change in quantity
supplied in quantity supplied supplied

2 Value PED
Bs > 1, eg 2.5, 5 ect PED
as = 1 PED
$ < 1, eg 0.5, 0.75
etc

3 Shape of supply curve Flatter, as P < Q Starting from origin Steeper, as P > Q
* .

☒→ &
¥ ¥
,
✗

,
P P P
S
pz
52
Pay
P , S
S}
°
Y
,

>
a. →
a Qi a
Q Q . .
.
.
this .. . .
Note came >

pygmy up
: - move

B
PEST

A
elastic that means

Determinants of Price Elasticity of Supply ( When

is
supply is ,

1) Level of Capacity supply can

easily change)
If there is excess capacity available then the supply is elastic. And if there Iis no capacity b- 9 production
meaning that the capacity is full then supply is inelastic. firm has no entree space or
room
as

2) Time Period (Time the produces has to produce)

Supply is considered inelastic in the Short Run while it is considered Elastic in the Long
Run. It is because the producer has more time to produce and can change the supply
easily in the Long Run hence making it more elastic.
3) Storability
More the storability and the durability of a good more elastic it is. Because when a good
is more durable and storable its supply can be easily changed hence making it more
elastic.
4) Level of Employment entree workers available no
as

Supply as inelastic at full employment as it can t be changed1-while when there is

unemployment supply is considered elastic as it can be changed easily for example by
hiring more workers.
5) Ability to Import Inputs
Greater the ability to import, more elastic the supply even at full employment.as can
supply
easily
increase .

b) Time taken
for good b- finish : the more
time required to
complete
change quickly
a
-

it can't be
good the
a

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inelastic the
,

Rice
more
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 Income Elasticity of Demand (YED)
It is the responsiveness of the quantity demanded to changes in income. It can positive, zero or
negative.
✗
¥

Types of Income Elasticity of Demand

Positive Zero Negative

As Income rises the quantity
demanded also rises. These
types of goods are called
Normal Goods.
There exists a positive
relation between Income and
Quantity Demanded as
ability to buy both rise
YED>1: Super agoelastic
Normal/Luxuries (elastic )
As income rise the quantity
demanded remains the same.
There is no relationship
between income and
quantity demanded. These
goods are the essentials of
life, eg water
As Income rises the quantity
demanded falls. These
goods are called inferior
goods like bus travel.
There is a negative
relationship as when income
rises, people prefer normal
goods since their
affordability has increased
and so the willingness to
buy inferior goods falls
S ,

YED<1: Important goods/

necessities ( inelastic)
s,

¥
¥-1T Qi Q2
.
as
YT Dz
D, Qu Qi
.

Dz
D '

I
Gross Price Elasticity of Demand (XED)
It is the responsiveness of the quantity demanded of one product (Good A) to changes in the
price of another product (Good B). It can be either positive, negative or zero.

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Positive
Increase in price of good B
causes an increase in
demand of good A.
These goods are called
substitutes or alternately
demanded goods. Eg Coke
and Pepsi. PBT Oa ?
"
→
XED>1: Close substitutes
(elastic)
XED<1: Bad substitutes
(inelastic)
PB
QA
SIR SOHAIB ALAVI
Types of XED
Zero
Increase in price of good B
causes no change in the
demand of good A. There
exists no relationship
between these goods.
They are unrelated goods
like salt and sugar or
shoes and tv.
°
QA
sohaib.alavi@gmail.com
=÷÷÷ .
Negative
Increase in price of good B
causes a decrease in
demand of good A. These
goods are complementary
goods/ goods in joint
demand. E.g. cars and
petrol.
XED> -1: Close
complements (elastic)
XED< -1: Bad complements
(inelastic)
%
QA
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uses /Practical Applications PED & PES for Firms and Govt
1) Determination of Total Revenue for firms and government
As discussed earlier in depth for goods with elastic demands firms should lower their
prices and government should lower their taxes to increase the total revenue. For goods
with inelastic demand, firms should increase their prices and government should
increase taxes to increase total revenue. Enplanation pg 3 table
.

on

2) Determinants of investment prospects and Price stability

PED is useful to determine the price stability of an industry and hence give a better idea
of whether to invest in an industry or not.

As we can see in the elastic

Si 52
demand industry, increase in Ss
supply or investment leads to a
→
small decrease in price which →
After investment or
means returns are high as prices TIN OR subsidy, price fall small
are stable in such an industry. That P, subsidy but output rise high
price stability
is not the case with an industry Pat increased TR/GDP
"
with inelastic demand. Hence Pz
businesses or enterprises invest in
industries that have an elastic D ,

demand for their goods.

Similarly for governments they see ☒ →Qz→Q }
which industries should be
Si sz
subsidized to have the biggest
s
impact on output (elastic }
Imr
industries). However if the 9in
PI OR subsidy
governments want to lower the After investment or subsidy,
price of essential commodities
subsidy to such inelastic industries
Pat price fall large and output
rise small

would lead to a large decrease in

price and hence government
Pst
achieved its aim
D.
QFQ?Q }

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 shared
Nole ; Indirect Tax burden is
-
by
both producer & consumer
↳ ¥9 ¥4 .

3) Incidence of Indirect tax

Incidence means burden of a tax on a good. Through Price Elasticity of Demand and
Price Elasticity of Supply consumers and producers can find who has to pay the greater
proportion (burden) on a good. Here we will see 3 cases.
Sz
s,
When PED=PES
firstly the Pretax price is P0 and then after
and Indirect tax is imposed the price that Pc A- B
A
-

consumers pay is Pc. The post-tax price that

the seller receives is Ps and the government Po
revenue is A+B. The tax burden on consumer B
is A and the tax burden on seller is B . Ps
When PED=PES burden on consumer is equal
to the burden on the seller that is A = B . So, D
,
the burden of tax is shared

Q - Q
Sz
When PED is less than PES
s,
The price before tax is P0 , however after tax is
imposed the price becomes Pc and this is the Pc
price that the consumer pays and the price A A-> B
the seller receives is Ps . The government Po
B
revenue is denoted by the area A+B. with the Ps
consumers burden being A and the sellers
burden B .
As A > B , the incidence of tax is greater on D,
the consumer.
Q2 Qi S,
When PED is more than PES Sz

In the graph we can see that the governments

revenue is A+B, with the sellers burden being Pc B
B and the consumers burden A . When PED is A
more than the PES the seller has a greater
Po
burden than the consumer i.e. B > A. Hence if B
demand is more elastic the incidence of tax is
greater on the seller.
Ps D,

Qu Qi

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 Economic Intuition
1) If demand is inelastic Consumer Burden is greater as consumers demand will not change
much when price changes, so the seller transfers a greater burden of Indirect tax on
consumer knowing that his demand will not fall much.
2) If supply is inelastic seller burden is greater as seller would want to share a greater
burden fearing that the demand of his product will fall by a lot if he increases the prices
more due to Indirect tax.

NOTE: when demand is perfectly elastic, all burden falls on the producer, and when supply is
perfectly elastic, all burden falls on the consumer.
the whose curve is inelastic
Conclusion : burden- will be on

greater person
4) Price Elasticity and subsidies benefits
Si Sz
for Probate consumer Ps -

co Pt Pt
When PED is more than PES
The initial price is P0 , however when
B .
A< B
subsidy is given the price falls to Pc . This Po - --- - - -

A
is the price paid by the consumers and Pc
the price received by the sellers rises to Ps
. The consumers benefit is A and the
sellers benefit is B. D.
As demand is more elastic the benefit of
subsidy is greater on the seller as A < B.
Produces keeps the majorTDbenefitlot
small tin P will
with
himself as he knows
Qi Q2
that a
by a .

When PED is less than PES Si

The initial price is P0 , however when
sa
subsidy is given the price falls to Pc . This
is the price paid by the consumers and Ps y
B
the price received by the sellers rises to Po -- . .

Ps. The consumers benefit is A and the A A>B

sellers burden is B. Pc
As supply is more elastic the benefit of
subsidy is greater on the consumer, as A > D,
B. Producer transfer greater benefitto consumer
a as

he knows that price will have to be reduced

by more Qi Qz
9 sales
whose
to

Benefit
those
.

Conclusion : -

of subsidy will be
greater on cane

is inelastic
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 5) How can Price Elasticity of Supply be used to see whether firms sales would increase if
demand rise DT → Sales 9 how much ?
by
Elastic Supply Inelastic Supply
S,
S,
Pz
Pz
P ,
P,

a
D ,

D
D ,
-
D ,

Q , Qz
Sales increase by a lot in response to increase
in demand when supply is elastic. This is
because supply has the ability to easily
change in response to change in demand,
may be due to higher capacity.
Qi Qz
Sales increase by less in response to
increased demand when supply is inelastic.
ily changeable
due to lesser capacity, even when demand
changes, and as a result price changes more.

How can producers change their Price Elasticity of Supply and Price Elasticity of Demand

Price Elasticity of Demand Price Elasticity of Supply

1) Advertisements
If the firm wants to make the demand
elastic, it will advertise its product as
perception of it. Conversely if it wants
to make its demand inelastic it will
show its product as a necessity.
2) Market Power
Strong and powerful firms can change
their demands elasticity through
substitutes. If they want to make their
demand inelastic large firms• will
__oo{
overtake its competitors via mergers
etc. And If it wants to make its
demand more elastic it will increase
its substitutes by introducing multiple
products.
So PED can be changed by larger firms with
greater market power and share more easily
4)durable through preservatives
1) Training
Through training the productivity of
workers will rise which will the lead to
easily increasing the elasticity of
supply.
2) Trade Barriers
If trade barriers are lowered then
firms would be able to import cheap
raw materials which would makes its
supply more elastic.
3) Subsidies
BY receiving subsidies firms cost of
production goes down which would
mean that the firm can employ more
factors of production which would
then increase the capacity of a firm
hence making the supply more elastic
A firm making product
its steerable
OR
more

by making
elastic
warehouses to store hoods will make supply more
,

due to the above factors supplycan be

easily Torte from market
-

as

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 :÷÷÷÷÷÷i÷÷÷÷ ÷ ÷i
ifo÷r ÷÷÷÷÷i¥÷÷
.
of
-
et
(X
) I
g rew
e .
i
:i÷÷÷÷÷÷÷ ÷
A
¥÷÷÷i÷÷÷÷÷÷÷is
go of =
& =
o
-0
Eirik
Uses of Income Elasticity of Demand for Firms and Government
The Boom versus Bust argument is used in YED by both government and firms. Boom is when
the economy is growing meaning that GDP is increasing. Bust is when the economy is going
through a recession.

Firm Government
If there is boom then that would mean that In boom government should increase
peoples income are rising. So in case of boom corporation taxes on normal goods as firms
firms should increase their production of profits are rising (+ YED) and this would lead
normal good as they have a positive YED and to an increase in government revenue as
increase the price of normal goods to take well.
advantage of an increased demand of normal
goods and hence increase their total In case bust government should subsidize
revenue. normal goods industry to help them out and
no new taxes should be introduced.
If there is bust then that would mean that
peoples purchasing power is decreasing. So
In case of bust firms should switch to inferior
goods as they have a negative YED as the
demand of inferior goods would rise and
along with that they should increase effective
advertisement to increase demand of normal
goods.+ discount offers on normal goods to
AD

Uses of Cross Price Elasticity of Demand

Substitutes
If the price of a substitute rises what should a
firm do?
Lets take example of 2 substitutes coke and
Pepsi.
Substitutes have a positive XED. If price of
coke rises then then Pepsi should increase
their price but by less then the increase of
price in coke to increase their total revenue.
Moreover Pepsi should increase their
advertisements to further increase their
demand.+ Sales 9 .
Complements
If Price of a complement rises what should a
jointly demand firm do?
Complements have a negative XED.
For example if the prices of tyres rise as their
XED is negative car firms should decrease
their prices by more than the increase in
price of tyres to increase the demand of cars.
Moreover advertisements are also very
important to overcome the reduced demand
of cars due to an increase in price of tyres.

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 → m= •
%:=E¥g

+ a)
F-
Limitations of Elasticity
1) Difficult to calculate when variables are volatile for example price volatility.
2) Calculations of elasticity based on ceteris paribus ie holding all other factors constant
which is not practical.
3) Elasticities calculated through statistical samples which are many time biased.
s

Which elasticity is best?

Firms Government
PED is better as they can change price of a Income Elasticity of Demand is better as then
good more easily especially of their own their policies according to change in income
good. levels in an economy (Boom and BUST)

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