INTRO TO ECONOMICS

UNIT 3
Elasticity
Anahuac University
László Szalai
ELASTICITY OF DEMAND AND SUPPLY
• A unit-free measurement of responsiveness
• Usually, we talk about the own price elasticity
• The elasticity of the demand is always negative
• We usually omit the minus sign (absolute value)
• If the price changes one per cent, how many per
cent does the demanded / produced quantity
change?
• We can measure it on sections of the demand / supply
or at particular points of the functions
 HOW TO CALCULATE?
• Equals to the quantity change (%) divided by the
price change (%) – denoted with 𝛆 (epsilon)
• Over a section
∆
𝑄 ∑ 𝑝 𝑄" − 𝑄# 𝑝# + 𝑝"
𝜀! = =
∆
𝑝 ∑ 𝑄 𝑝" − 𝑝# 𝑄# + 𝑄"
• At a particular point
𝜕𝑄 𝑝
𝜀! =
𝑝 𝑄
ELASTICITIES OF DIFFERENT DEMANDS
Good (broad type) Demand elasticity Good (narrow type) Demand elasticity
Fuels – 0.5 Dairy produce – 0.1
Food – 0.5 Bread and cereals – 0.2
Alcohol – 0.8 Entertainment – 1.4
Durables – 0.9 Expenditure abroad – 1.6
Services –1 Catering – 2.6
Data are for the United Kingdom

Lower elasticity (in absolute terms) means a smaller response

to price changes
 DETERMINANTS OF ELASTICITY
• The demand is considered elastic if 𝜀 > 1 and
inelastic otherwise
• Consumer tastes and necessity
• The more necessary a good is, the lower the demand
elasticity – These are the “must haves”
• Basic commodities and edibles, some household durables
• Addictive goods (cigarettes, alcohol, drugs)
• Stocks of necessity goods producers are considered defensive
stocks, as they provide a relative constant dividend and earnings
• Services and luxury goods tend to have higher elasticities
 SPECIAL CASES
p p
total inelastic total elastic

ε=0 ε =∞

Q
 SPECIAL CASES
p p
constant elasticity constant slope

ε =∞

ε=c ε =1

ε=0
Q
1/2 1/2
 WHY IS THAT REMARKABLE?
p p
Consider the effect of the A producer who can set the
same price fall on different price would never sell on the
sections of the demand inelastic section of the demand
–Δ p loss
surplus

gain

loss –Δ p
surplus gain
Q
ICOME ELASTICITY
How does the demand change is the budget changes?
INCOME ELASTICITY
• Measures the responsiveness of the demand as the
income changes
• Income elasticity is usually positive
• Normal goods: Consumption grows if income grows
• If the income changes one per cent, how many per
cent does the demanded quantity change?
• It follows from the income-consumption curve (ICC)
 INCOME-CONSUMPTION CURVE
y U0 U1 U2
Both x and y are normal goods,
since their optimal consumption
grows as income grows.

C
B
A

x
m0 m1 m2
 SPECIAL CASES
• Luxury goods vs. necessity goods
• Depends on income elasticity: necessity < εm = 1 < luxury
• Inferior goods
• The demand decreases as the income increases
• Income elasticity is negative
• Engel-curve ➝ 𝑥 𝑝$ , 𝑝% , 𝑚
∼ Low-end products
• Giffen goods (~very special case)
• The demand decreases as the prices decreases