Ch.

6 Elasticity
Based on:
Microeconomics 13th ed, R.A. Arnold
Economics: Principles & Applications 6th ed, Hall & Lieberman

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 Elasticity
In microeconomics, the concept of elasticity is applied
in situations where we are interested to study the
responsiveness of a (dependent) variable to changes
in another (independent) variable, ceteris paribus.
%∆ 𝒅𝒆𝒑𝒆𝒏𝒅𝒆𝒏𝒕 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒
Formula:
%∆ 𝒊𝒏𝒅𝒆𝒑𝒆𝒏𝒅𝒆𝒏𝒕 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒

E.g., law of demand states: if P ↑ , then Qd ↓

and if P ↓ , then Qd ↑

Here, Qd responds to changes in P. Hence, we may want to

measure the responsiveness of Qd to changes in P.
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 Price Elasticity of Demand
Price elasticity of demand (Symbol: |Ed|): Measures
the responsiveness of quantity demanded to changes
in price, ceteris paribus.
%∆𝑄𝑑
It is calculated using the formula:|𝐸𝑑 | = | |
%∆𝑃
𝑛𝑒𝑤−𝑜𝑙𝑑
Usually, we calculate: %∆= × 100 *
𝑜𝑙𝑑
𝑛𝑒𝑤−𝑜𝑙𝑑
In elasticity, we also use: %∆= 𝑛𝑒𝑤+𝑜𝑙𝑑 × 100 **
2
*If we use the first formula, the elasticity is called
point elasticity of demand.
**If we use the second formula, the elasticity is called
arc elasticity of demand.
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 Continued from last slide

E.g., in NSU cafeteria, previously, when the price of

coffee was 10 tk (Pold), buyers wanted 1500 cups
(Qd old). Now, the price is 20 tk (Pnew) & buyers want
1000 cups (Qd new). Find the |Ed|.
𝑄𝑑 𝑛𝑒𝑤 −𝑄𝑑 𝑜𝑙𝑑
Here, %∆𝑄𝑑 = 𝑄𝑛𝑒𝑤 +𝑄𝑜𝑙𝑑 × 100
2
1000−1500
Therefore, %∆𝑄𝑑 = 1000+1500 × 100 = −40
2
𝑃𝑑 𝑛𝑒𝑤 −𝑃𝑑 𝑜𝑙𝑑 20−10
And,%∆𝑃 = 𝑃𝑛𝑒𝑤 +𝑃𝑜𝑙𝑑 × 100 = 20+10 × 100 = 66.7
2 2
40
Now, |𝐸𝑑 | = − = −0.6 = 0.6
66.7
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 Continued from last slide

We found, |Ed| = 0.6

Now, we can obtain (extract) information from this
number (i.e., interpret the number):
If P increases by 1 % , then Qd decreases by 0.6% *
Or, if P decreases by 1% , then Qd increases by 0.6% *
(*approximately in the given price range 10tk to 20tk)
We can use this interpretation to analyze changes in
Total Revenue (TR). We know, TR = P x Q
Therefore, if P ↑ 1 % and Q ↓ 0.6 % , then TR ↑
So, if NSU cafe increases price of coffee, the total
revenue is likely to increase.
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 Continued from last slide

We can also say, the quantity demanded of

coffee does not respond much to changes in
price. That is, the demand for coffee is inelastic.
Generally, if |Ed|< 1 , then we say the demand
of the product is inelastic.
If, |Ed|> 1 , we say the demand is elastic
If, |Ed|= 1 , the demand is unit elastic
There are two other situations/possibilities. They are
discussed in the next slide.

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Price changes by a very small amount and the
quantity demanded changes by a very large amount
Therefore, Ed → ∞ (or a very large number)
Here the demand is perfectly elastic.

The demand is perfectly inelastic when a change in

price does not affect the quantity demanded (e.g.,
medicines). Hence, % ∆ Qd = 0. Therefore, Ed = 0.
The next slide summarizes the above discussions.

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In the next slide, we see how the price elasticities (above) affect the
slope and shape of the demand curve.

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 Determinants of Price Elasticity of Demand (Ed)
(Here, we look at the factors that affect the value of Ed)

1. Number of substitutes: If a good has many substitutes

then Ed will be more as compared to a good which has
fewer substitutes. Why? If there are many substitutes,
buyers can easily shift to them when the price of a
product increases. Hence, Qd decreases by a larger %
and hence value of Ed will be larger (demand more
elastic).
2. Necessities versus luxuries: If a good is a necessity (e.g.
water), Ed will be less as compared to a good which is a
luxury (e.g. grape juice). If the price of a necessity
increases then Qd will fall by a smaller % . Hence, Ed is
smaller and demand less elastic.

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 Continued from last slide

Time: As more time passes after the price change, the

higher will be the Ed. Since consumers can find other
substitutes, change their preferences, lifestyle and
habit.

E.g., if the price of cigarettes increase suddenly, then buyers

cannot reduce consumption of cigarette drastically within
a period of short-time and hence demand for cigarette is
likely to be inelastic. However, as more time passes,
people can quit cigarettes and the quantity demanded
falls by a larger amount and hence the demand becomes
more elastic with time.

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 Other Elasticity Concepts
Cross Price Elasticity of Demand (Ec): A measure of the
responsiveness in quantity demanded of one good to changes in
price of another related good (substitute or complement).

E.g., we may want to know how much does the quantity demanded
of Pepsi respond to changes in price of Coke.

To find the answer to the above question we can use the following
formula:
%∆𝑄𝑑 𝑜𝑓 𝑃𝑒𝑝𝑠𝑖
𝐸𝑐 =
%∆𝑃 𝑜𝑓 𝐶𝑜𝑘𝑒

Let’s assume, using market data, we find that:

%∆𝑄𝑑 𝑜𝑓 𝑝𝑒𝑝𝑠𝑖
𝐸𝑐 = = + 𝟎. 𝟓
%∆𝑃 𝑜𝑓 𝑐𝑜𝑘𝑒
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Continued
Let’s try to interpret the number. The + indicates
that P of Coke and Qd of Pepsi are positively
related. That is, if price of Coke increases, buyers
buy more Pepsi, ceteris paribus. Hence, Coke and
Pepsi are substitutes.

Therefore, we can conclude that if 𝐸𝑐 > 0 , then the

goods under consideration are substitutes.

Overall: + 0.5 indicates that if price of Coke

increases by 1%, then quantity demanded of Pepsi
increases by 0.5% (on average in the given range).

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Continued
Now, let’s say, we want to find out how much does the quantity demanded of
burger responds to changes in price of coke.

In this case, we can use the following formula and find:

%∆𝑄𝑑 𝑜𝑓 𝐵𝑢𝑟𝑔𝑒𝑟
𝐸𝑐 = = −𝟏. 𝟓
%∆𝑃 𝑜𝑓 𝐶𝑜𝑘𝑒

The − sign indicates that P of Coke and Qd of burger are negatively related.
That is, if price of Coke increases, buyers buy less burgers, ceteris paribus.
This means Coke and burgers are complements; they are consumed together.

Therefore, we can conclude that if 𝐸𝑐 < 0 , then the goods under

consideration are complements.

Overall: − 𝟏. 𝟓 indicates that if price of Coke increases by 1%, then quantity

demanded of burger decreases by 1.5% (on average in the given range).

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 Income Elasticity of Demand
In Ch 3, we learned that income affects demand.
Income Elasticity of Demand (𝐸𝑌 ): measures the
responsiveness of quantity demanded to changes in
income (Y).
%∆𝑄𝑑
𝐸𝑌 =
%∆𝑌
If 𝐸𝑌 > 0 , then income and quantity demanded are
positively related. Hence, the good under consideration
is a normal good. E.g., if our income increases, we may
buy more ice-cream and hence 𝐸𝑌 > 0.
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 Continued
If 𝐸𝑌 < 0 , then income and quantity demanded
are negatively related. Hence, the good under
consideration is an inferior good. E.g., if our
income increases, we may take less local bus
rides (negative relation).

If 𝐸𝑌 = 0 , then changes in income doesn’t

affect the quantity demanded. Hence, the good
under consideration is a neutral good. E.g.,
medicines can be a neutral good.
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Price Elasticity of Supply

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The Relationship Between Taxes and Elasticity

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In figure, Gov is taxing $1 per DVD sold.
Remember: If the demand is less elastic (more
inelastic) the D curve will become steeper (more
vertical). You should do the graphical analysis as an
exercise. You will see that the consumer ends up paying
more of the tax.
When demand is perfectly
Inelastic, the consumer or
buyer pays all of the tax.

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