Applied Economics

Quarter 3 – Module 4:
Market Pricing
Applied Economics
Quarter 3 – Module 4:
Market Pricing
 What I Need to Know

This module was designed to help you analyze and propose solution/s to the
economic problems using the principles of applied economics.

At the end of this module, you should be able to:

1. define elasticity;
2. compute for the demand elasticity and supply elasticity; and
3. analyze the implication of elasticity in price determination.

Lesson
Elasticity of Demand and
1 Supply
In the previous lesson about the law of supply and demand, we learned
that the price is the main determinant of the quantity demanded and quantity
supplied.

In making economic decision, both the seller and the buyer consider the
price of the goods that they will be buying or selling. As buyers, as mentioned in
the law of demand, most of the time we consider the selling price of an item before
deciding to buy it. For sellers, for sure, they want to produce more of their
products if the price is high to yield more profit, but they will also consider the
possibility of losing some customers because of setting higher price.

What if the price of the products/services listed in column 1 increase its price,
what will you do? Let us identify your responses. Based on what is listed in the
column 1, write what is your decision in the column 2 and in column 3 briefly
explain the reason in making such decision. Your decision could be:

1. Ikaw pa rin (if you still choose to buy or avail the product/service)
2. Buti pa siya. (if you choose to buy another product or an alternative)
3. Sige na nga. (if you have no choice but to buy the product)

4. Huwag na lang. (if you decide not to buy the product and not to find alternative)

YOUR REASON FOR YOUR

SITUATIONS
RESPONSE/DECISION DECISION
1. favorite milk tea
increases its price
by ₱10.00
2. favorite load promo
package for 7 days
reduces its validity
to 5 days at same
price
3. a variety of rice
increases by ₱5.00
per kilo
4. mother’s
maintenance
medicine increases
its price by 10 %
5. increase in price of
your favorite t-shirt
brand
 What is It

When we were in lower grade level, we encountered the

word “elastic, usually in our science subject. We define it as being
flexible or having the ability to be stretched but can go back to its original shape
or size like a rubber band.

In economics, the terms elasticity is used to define the change in behavior

of the sellers or buyers because of the change in price and/or other determinants
of supply and demand. It measures how the sellers or buyers respond to the
changes in determinants mainly the price.

Elasticity of Demand and Supply

The degree of elasticity of different products vary for several reasons. For
the customers and suppliers, the common determinant of the quantity demanded
and supplied is the price.

During the discussion of the law of demand and the law of supply, it was
discussed that as the price increase the quantity demanded by the customers
decrease and quantity supplied by the sellers increases. Do you think what is
stated in the law of demand and supply always applicable? If it is applicable, is
the change in quantity demanded for several products still the same? Does it
mean that if the price increase by 1 % the demand will decrease by 1 % and the
supply increases by 1 % also? To answer these questions, it is important to
understand the reactions of customers and sellers to the change in price of
different products. The reactions of the customers vary and so with the elasticity.
The higher the change in quantity demanded compared to the change in
determinants the more elastic is the product.

Price Elasticity of Demand and Supply

Price Elasticity of Demand

Price elasticity of demand measures the change in demand in response to

the change in price. For example, the price of pork increases by 5 % the price
elasticity will be determined by identifying the percentage of decrease or increase
in demand due to the change in price.
 To compute the price elasticity (ep) of demand the formula is:

Percentage change in quantity demanded

ep =

Percentage change in price

(Q2 – Q1)/Q1
=
(P2 – P1)/P1

Where:

Q1 = the original quantity demanded

Q2 = the new quantity demanded

P1 = the original price

P2 = the new price

To illustrate, let us have us have the following example.

Product A has the following demand schedule:

Situation Price Quantity demanded
1 ₱30.00 50
2 ₱40.00 45
3 ₱35.00 45
Example 1:

Let us first consider the Situation 1 and 2 where the price of product A
increases from 30 to 40 and the quantity demanded decreases from 50 to 45. To
compute for the elasticity coefficient let us use the given formula for price
elasticity of demand.
(45 – 50) /50
ep =
(40 – 30)/ 30

- 0.1
=
0.33
 ep = -0.3
Example 2:

To find out whether the product will be having the same elasticity at
different price, let us consider Situation 2 and 3 for another example.
(45 – 45) /45
ep =
(35 – 40)/ 40

0
=
-0.125

ep = 0

The two examples show that at different price and quantity combination
the price elasticity coefficient may not be the same, a proof that the customers’
reaction to price changes vary.

To understand the meaning of the elasticity coefficient, understanding the

types of elasticity can help us to analyze and interpret it.

Types of Elasticity

A. Elastic - The percentage change in quantity demanded is greater than the

percentage change in price. It has more than 1 elasticity coefficient.
It means that if the price will increase there is a greater possibility that the
consumer will not buy the product or may decrease the quantity of the
product to buy.
B. Inelastic - The percentage change in quantity demanded is lesser than the
percentage change in price. It has less than 1 elasticity coefficient. It
means that the decision of the consumer to buy the product is not that
affected by the increase or decrease in price. The seller cannot assume
that the consumer will buy more if they will decrease the price since the
change in quantity demanded is only minimal.
C. Unitary - The percentage change in price is equal to the percentage
change in quantity demanded. The elasticity coefficient is 1. It means that
if the price increase by 1 % the demand will decrease by 1 % also and vice
versa.
D. Perfectly elastic - When at the same price, the change of demand is
infinite.
It means that a small change in price may cause a huge change in demand.
E. Perfectly inelastic - When there is no change in demand despite of the
changes in price. Elasticity coefficient is zero. It means that the demand
 is not affected by price at all. The demand will still be the same even if
there is an increase or decrease in price.

Considering the two examples above let us interpret the elasticity coefficient
that we derive. In example 1, the price elasticity coefficient is -0.3. It is inelastic,
which means that for every 1 % change in price there will be 0.3 % change in
demand. The change in price cause a minimal change in demand. In example 2.
The price elasticity coefficient is 0. It is perfectly inelastic. The change in price
does not affect the demand. In interpreting the price elasticity coefficient, we
ignore the negative sign. It is negative because the price and demand is inversely
related.

Demand Curves and Their Elasticity

Figure 1: Elastic Demand Curve

3
2.5
2
1.5
1
0.5
0
0 2 4 6 8 10 12 14

Figure 1 is an example of an elastic demand curve showing that a small change

in price cause the demand to change more.

10 Figure 2. Inelastic Demand Curve

0
0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6
Figure 2 is an example of an inelastic demand curve showing that a change in
price cause a little change in demand.

Figure 3: Perpectly Inelastic Demand Curve

6
5
4
3
2
1
0
0 1 2 3 4 5 6

Figure 3 is an example of perfectly inelastic demand curve showing that the

quantity demanded is not affected by the change in price.

Figure 4: Perfectly Elastic Demand Curve

3

0
0 0.5 1 1.5 2 2.5 3 3.5

Figure 4 is an example of perfectly elastic demand curve. It shows a great change

in demand.

Figure 5: Unitary Demand Curve

6

0
0 1 2 3 4 5 6

Figure 5 is an example of unitary demand curve. It shows that the percentage of

change in price is the same with the percentage of change in demand.
Price Elasticity of Supply

Price is the main determinant of supply. Its elasticity describes how the
producer or seller reacts or respond to the change in price.

To compute the price elasticity (ep) of supply the formula is:

Percentage change in quantity supplied ep

=
Percentage change in price

(Qs2 – Qs1)/Qs1
=
(P2 – P1)/P1

Where:

Qs1 = the original quantity supplied

Qs2 = the new quantity supplied

P1 = the original price

P2 = the new price

To illustrate, let us consider the following example:

Price Quantity Supplied
₱150 300
₱175 350
Given the supply schedule above, let us compute for the price elasticity of
demand.

(350 – 300) /300

ep =
(175 – 150)/ 150

0.167
=
0.167
ep = 1

Interpretation: The price elasticity coefficient of 1 means unitary. It means that

for every 1 % change in price there will be 1 % change in quantity supplied.
Note: Interpretation is the same with how you interpret the price elasticity of
demand.
Supply Curves and Their Elasticity

Figure 6: Elastic Supply Curve

3
2.5

1.5

0.5

0
0 2 4 6 8 10 12 14

Figure 7: Inelastic Supply Curve

6

0
0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6

Figure 8: Perpectly Inelastic Supply Curve

(supply is fixed and zero elasticity)
10

0
0 1 2 3 4 5 6

Figure 9: Perfectly Elastic Supply Curve

(Infinitely Elastic)
2.5
2
1.5
1
0.5
0
0 0.5 1 1.5 2 2.5 3 3.5
 Income Elasticity and Cross Price Elasticity of Demand
Demand elasticity can also be determined by:

A. Income elasticity which measures the change in demand in response to the

change in income of the customers.

The formula for income elasticity (ey) is:

Percentage change in quantity demanded
ey =

Percentage change in income

(Q2 – Q1)/Q1
=
(Y2 – Y1)/Y1

Where:

Q1 = the original quantity demanded

Q2 = the new quantity demanded

Y1 = the original income

Y2 = the new income

For example:

An employee who earns P20,000 monthly can afford to buy his favorite milk
tea almost 3 times a week but because of the pandemic in which most of the
employees are affected, they are now reporting to their work 3 days a week only
instead of 5 days. His income is affected and so with their expenses. Instead of
their regular monthly salary, he receives P12,000 monthly. The purchase of his
favorite milk tea also reduced to once a week only.

To compute for its income elasticity, let us consider the following:

Q1 = 3 Q2 = 1
Y1 = 20,000 Y2 = 12,000

(1 – 3) /3
ey =
(12,000 – 20,000)/ 20,000
 -0.67
=
-0.4
ey = 1.675

For this example, the income elasticity coefficient shows that it is elastic. The
income really affects the demand for that particular product.

B. Cross price elasticity which measures the change in demand for a good in
response to the change in price of related (substitute or complementary)
goods.

The formula for cross price elasticity (ec) is:

Percentage change in quantity demanded of Good A
ec =
Percentage of change in price of Good B

(QD2 – QD1)/QD1
=
(P2 – P1)/P1

Note: For quantity demanded (QD) consider the quantity demanded for
Good A and for price, the change in price of another good (Good B).

Example:

The price of Product B increases from ₱35.00 to ₱42.00 which cause some
of its consumer to decide buying Product A, its substitute. The demand for
Product A increases from 500 units to 650 units.

Product A: QD1 = 500 units QD2 = 650 units

Product B: P1 = ₱35.00 P2 = ₱42.00
(650 – 500) /500
ec =
(42 – 35)/ 35

0.3
=
0.2

ec = 1.5
The cross elasticity of 1.5 shows that it is elastic. It means that a change
in price of a related good can cause a change in demand for another good.
 Assessment

Compute for the elasticity. Show your Solution. (5 points each)

1. Product A has an introductory price of ₱120.00. After 3 months of

business operation, the owner decided to increase the price by 8 % which
caused the demand to decrease from 495 to 450.

2. The price of pork increased from ₱240.00 to ₱280.00. Because of this,

Mrs. Cruz, a cafeteria owner, decided to offer more chicken dishes than
pork dishes. Her demand for chicken increases to 50 kilos per week from
35 kilos before the price increase of pork.

3. Like other children, Mr. Santos’ daughters also love ice cream. Mr. Santos
bought half gallon of ice cream for them every pay day (15 th and 30th of
the month). Last month, Mr. Santos got promoted in his job. With this, an
additional salary of ₱5,000.00 was added to his ₱20,000 basic salary.
Now, he can buy 2 half gallons of differently flavored ice cream every pay
day.

Additional Activities

Answer the following questions:

1. If you are the seller will you increase the price of your product instantly if
it is price elastic? Explain you answer briefly.
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2. What if the product is price inelastic, how will this affect your decision in
setting price?
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3. Is elasticity important in the analysis of the market? Why?
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