CHAPTER 3

ELASTICITY

At the end of the chapter the student should be able to:

1. Measure the magnitude of market responses;
2. Understand the responsiveness of consumers and producers in markets to price changes;
3. Compute and clearly relate elasticities on the operations of supply and demand in the
market on maximizing revenues;

In the previous chapter, we were familiarized with the concept of demand and supply and
how these two forces operate in determining price over a perfectly competitive market, which
brought the existence of demand and supply curve. With the application of ceteris
paribusrule (meaning other things remain constant), we know that if the price of certain goods
and services will increase, lesser quantity of goods and services will be purchased. Similarly, if the
price of goods and services decline, more goods and services will be purchased. But the question
is, “by how much will be the extent of change?”
This chapter will tackle the different types of elasticity and its determinants, as well as
the classification of goods.

ELASTICITY

In economics, the concept of elasticity measurestheresponsivenessofonevariabletoa

certainchangeofanothervariable. Also, it is the proportionalmeasureorpercentagechangein
thevariablesandmeasurestheresponsivenessofconsumersandproducers.
The basic formula used to determine elasticity is:

Percentage Change in Variable Y

𝐄𝐥𝐚𝐚𝐭 =
Percentage Change in Variable X

%∆
Using the mathematical symbol, =
%∆

Where:
ε = Greek letter epsilonused as symbol for elasticity
∆ = letter delta,means “change”
% = percentage

DEMAND ELASTICITY

There are several factors affecting the consumers in deciding how many of the
commodity will be bought. Any change (increase or decrease) in these factors will result to a
reaction on the part of the consumer. An increase in the price (while the other factors are held
constant) will lead to a decrease in the quantity to be purchased. An increase in income of the
consumer (while other factors are held constant) will mean more quantity to be demanded for
normal commodity. Thedegreeoftheconsumer’sresponsivenessorreactiontochangesinthe
factorsaffectingdemandisknownasthedemandelasticity.

Price Elasticity of Demand

The price elasticity of demand measures the responsiveness of quantity demanded with
respect to its price. Considering that an increase in the price of a good or service would result to
a decline in quantity demanded, it is expected that the price elasticity of demand is negative
because the relationship between price and quantity demanded in inversely related. However,it
istheabsolutevaluethatisusuallytakenandthenegativesignisomitted. The basic
formula used:

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 𝐏 𝐄𝐥𝐚𝐚𝐭 𝐨 𝐦 () = PercentagePercentageChangeChangein Quanityin PriceDemanded = %
%∆∆𝐦
When calculating the price elasticity of demand, there are two possible ways:

1. Pointelasticityofdemandtakes the elasticity of demand at a particular point on a

demand curve (or between two points).
∆𝐦 ∆𝐦

= %%∆∆𝐦 = 𝐦∆ 𝟏𝟏 = 𝐦∆ = ∆∆𝐦 𝐦 = 𝐦 −−𝐦 𝐦

2. Arcelasticityofdemandmeasures the elasticity of demand at the midpoint between

the two selected points on a demand curve.

%∆𝐦 𝐦− 𝐦 +
Ɛ = = %∆ − 𝐦 + 𝐦

However, using the pointelasticityformularesults to different answers when dealing

with large changes in price. Using the initial values of price (P 1) and quantity (Q1) creates a
problem in the calculation. As the difference between the two prices or quantities increases, the
accuracy of the price elasticity of demand given decreases, it can be varied at different points
along the demand curve due to its percentage nature.
To get out the irregularity problem of having a price elasticity of demand depending on
which of the two given points on a demand curve is chosen as the “original” point and which as
the “new” one, compute the percentage change in P and Q relative to the averageof the two
prices and the averageof the two quantities. Thus, arcelasticityformulamust be used.

Example: Using the demand schedule for notebook in Chapter 2 (Table 2.1). Let us compute the
demand elasticity for notebook using point elasticity and arc elasticity from points
A to E and E to A.
Point Price per unit Quantity Demanded per Week
A 10 120
B 15 105
C 25 75
D 30 60
E 35 45
Solution:
Point Elasticity Arc Elasticity
Qd2 − Qd1 P1 Qd2 − Qd1 P 2 + P1
εD = x εD = x
P 2 − P1 Qd1 P 2 − P1 Qd2 + Qd1
Point A to E 45 − 120 10 −75 10 45 − 120 35 + 10 −75 45
εD = x = x εD = x = x
35 − 10 120 25 35 − 10 45 + 120 25 165 ε D =

120 εD = =│− = │ − 0.82│ = .

0.25│ = . 𝟐
Point E to A 120 − 45 35 75 35 120 − 45 10 + 35 75 45
εD = x = x εD = x = x
10 − 35 45 −25 45 εD = 10 − 35 120 + 45 −25 165 εD =

= │ − 2.33│ = . = │ − 0.82│ = .
Classification of Price Elasticity of Demand:
1. Elastic demand (εD > 1) - when the percentage change in quantity demanded is -
greater than the percentage change in price or (%∆Qd >%∆P).
P

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 D

Qd
2. Inelastic demand (εD < 1) – when the percentage change in quantity is less than the
percentage change in price or (%∆Qd < %∆P).
P

D
Qd

3. Unitary elastic demand (εD = 1) – when the percentage change in quantity is equal to
the percentage change in price or (%∆Qd = %∆P)
P

D
Qd

4. Perfectly elastic demand (εD =∞) – without change in price will have an infinite
change on quantity demanded.
P

Qd

5. Perfectly inelastic demand (εD = 0) – any change in price will have no effect on
quantity demanded.
P D

Determinants of Qd Price Elasticity of Demand:

1. The importance or degree of necessity of
the goods.
2. Number of available substitutes
3. The proportion of income in price changes
4. Time period

Effect on Total Revenue

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 If there is a price change, it is imperative for a firm to understand what effect of such
change in price will do on total revenue.
Any change in price will create two effects:
1. The priceeffect. This refers to an increase in price that will result to a positive effect on
revenue, and vice versa.
2. The quantityeffect.This pertains to an increase in price that will result to less quantity
sold, and vice versa.
Table 3.1 Summary of the Effects of Price Changes to the Total Revenue and Price Elasticity of
Demand
Demand Elasticities Change/s in Price Effects on Total Revenue
(TR)
Inelastic Demand increase increase
Elastic Demand increase decrease
Elastic Demand decrease increase
Inelastic Demand decrease decrease
Elasticity in the demand curve

Income Elasticity of Demand

Quantity demanded may also change if the consumer’s income changes. Income elasticity
measures the responsiveness of quantity demanded to a change in the consumers’ income. The
basic formula used is:

𝐄𝐥𝐚𝐚𝐭 𝐨 𝐦 () = PercentagePercentage ChangeChange inin

QuanityConsumersDemanded'Income = %%∆∆𝐦

Mathematically, this must be computed in two ways as:

1. Pointelasticityofdemand

%∆Qd Qd2 − Qd1 Y1

εY = = x
%∆Y Y2 − Y1 Qd1

2. Arcelasticityofdemand

%∆Qd Qd2 − Qd1 Y2 + Y1

ƐY = = x %∆Y Y2 − Y1 Qd2 + Qd1

When the income elasticity of demand assumes a positive value, quantity demanded of
the goods increase as income increases and the good being studied is known as normalgood. A
normal good may also be classified as “luxuries” or “necessities” depending on their demand
elasticities. If the income elasticity of demand is greater than 1, the good may be considered a
luxury while if income elasticity of demand is less than 1, the good may be considered a
necessity.
On the other hand, if the quantity of a good falls as income increases, the income
elasticity takes a negative value and the good is called inferiorgood.

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 Table 3.2 Summary of Income Elasticity Coefficient
Type of Good Income Elasticity Coefficient
Normal good Positive elasticity (εY>0)
Inferior good Negative Elasticity (εY<0)
Normal, Luxury good Positive Elasticity greater than one (εY>1)
Normal, Necessity good Positive Elasticity less than one (εY<1)
Example: April earns a monthly salary of P15,000 and she consumes P1,000 worth of beef per
month. When her income increased by P2,500/month, she started to consume
P2,000/month. Is April’s demand for beef meat normal necessity, or normal luxury,
inferior?

Let: Y1 =15,000 Qd1 = 1,000

Y2 = 17,500 Qd2= 2,000

Qd2 − Qd1 Y2 + Y1 2,000 − 1,000

ƐY = x= x
= x =.
Y2 − Y1 Qd2 + Qd1 17,500 − 15,000

Therefore,April’sdemandforbeefmeatisanormal,luxurygood.

Cross Price Elasticity of Demand

Measures the responsiveness of quantity demanded of a good to a change in the price of
another good. The basic formula used is:

Percentage Change in Quanity Demanded for Good X %∆𝐦

𝐏𝐥 𝐏 𝐄𝐥𝐚𝐚𝐭 𝐨 𝐦 () = =
Percentage Change in the Price for Good Y %∆

Mathematically, this must be computed in two ways as:

1. Pointelasticityofdemand

%∆Qd QdX2 − QdX1 PY1

εXY = = x
%∆P PY2 − PY1 QdX1

2. Arcelasticityofdemand

%∆Qd QdX2 − QdX1 PY2 + PY1

εXY = = x
%∆P PY2 − PY1 QdX2 + QdX1

A good is considered as a complementarygood when the result of cross price

elasticity of demand is negative (ƐXY < 0) while, a good is considered as a substitutegood when
the result of cross price elasticity of demand is positive (ƐXY > 0).

Example:

Table 3.3 Cross Price Elasticity of Substitute Good

Commodity Before After

Price Quantity Price Quantity

Beef (X) 150 15 150 25

Chicken (Y) 120 20 140 40

QdX2 − QdX1 PY2 + PY1 25 − 15 140 + 120 10 260

εXY = x = x = x =.𝟐
PY2 − PY1 QdX2 + QdX1 140 − 120 25 + 15 20 40

Therefore,beefandchickenarebothsubstitutegoods.
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 Table 3.4 Cross Price Elasticity of Complementary Good
Commodity Before After

Price Quantity Price Quantity

Computer (Y) 6,000 450 10,000 300

CD-ROM (X) 1,500 140 1,500 100

QdX2 − QdX1 PY2 + PY1 100 − 140 10,000 + 6,000 −40 16,000
εXY = x = x = x =− . 𝟔
PY2 − PY1 QdX2 + QdX1 10,000 − 6,000 100 + 140 4,000 240

Therefore,computerandCD-ROMarebothcomplementarygoods.
SUPPLY ELASTICITY Price Elasticity of Supply
Measures the responsiveness of quantity supplied in response to a percentage change in
the price of a good. The basic formula used is:

Percentage Change in Quanity Supplied %∆𝐥 𝐏

𝐄𝐥𝐚𝐚𝐭 𝐨 𝐒𝐄 () = Percentage Change in Price = %∆

When calculating price elasticity of supply, there are two possible ways:

1. Pointelasticityofsupplytakes the elasticity of supply at a particular point on a supply

curve (or between two points).
∆𝐥 ∆𝐥

= %%∆∆𝐥 = 𝐥∆ 𝟏𝟏 = ∆𝐥 = ∆∆𝐥 𝐥 = 𝐥 −−𝐥 𝐥

2. Arcelasticityofsupplymeasures the elasticity of supply at the midpoint between the

two selected points on a supply curve.

∆𝐥
𝐥+ 𝐥 𝟏 ∆𝐥

Ɛ = %%∆∆𝐥 = ∆ 𝟏 = 𝐥∆+𝐥 = ∆∆𝐥 𝐥 ++ 𝐥 = 𝐥 −− 𝐥 𝐥 ++ 𝐥

+ +

Example: Using the supply schedule for notebook in Chapter 2 (Table 2.2). Let us compute the
supply elasticity for notebook using point elasticity and arc elasticity from points A to
E and E to A.
Point Price per unit Quantity Supplied per Week
A 10 60
B 15 65
C 25 75
D 30 80
E 35 85
Solution:
Point Elasticity Arc Elasticity
Qs2 − Qs1 P1 Qs2 − Qs1 P 2 + P1
εS = x εS = x
P 2 − P1 Qs1 P 2 − P1 Qs2 + Qs1
Point A to E 85 − 60 10 25 10 85 − 60 35 + 10 25 45
εD = x = x εD = x = x
35 − 10 60 25 60 εD = 35 − 10 85 + 60 25 145 ε D =

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 =.𝟔 =.
Point E to A 60 − 85 35 −25 35 60 − 85 10 + 35 −25 45
εD = x = x εD = x = x
10 − 35 85 −25 85 εD = 10 − 35 60 − 85 −25 165

=. εD = =.
Classification of Price Elasticity of Supply:
1. Elastic supply (εS >1) - a percentage change in quantity supplied is greater than the
percentage change in price.
P

Qs
2. Inelastic supply (εS<1) – a percentage change in quantity supplied is less than the
percentage change in price.
P
S

Qs

3. Unitary elastic supply (εS=1) – a percentage change in price is equal to a percentage

change in quantity supplied.
P

Qs

4. Perfectly elastic supply (εS=∞) – without change in price, an infinite change occurs
in quantity supplied.
P

Qs

5. Perfectly inelastic demand (ε=0) – any change in price creates no change in quantity
supplied.
P
S

Qs

Determinants of Price Elasticity of Supply

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 1. Monetary or intermediate – in this period supply will be perfectly inelastic and supply
is fixed.
2. Short-run – in this state supply in inelastic. The output of production can increase even
if equipment is fixed.
3. Long-run – in this period, supply is elastic. New firms are expected to enter or the old
one may leave the industry.

References

Bello, Amelia L. et al. 2009. Economics. C and E Publishing, Inc.

Case, Karl E.; Fair, Ray C. 2005. 7TH Edition. Principles and Foundations of Economics. Pearson
Education, Inc.

Gabay, Bon Kristoffer G. et al. 2007. 1st Edition. Economics: Its Concepts and Principles (with Agrarian
Reform and Taxation). Rex Book Store.

Sexton, Robert L. 2005. 3rd Edition. Exploring Economics. South-Western, Thompson Corporation.

Silon, Elsa T. et al. 2009. Manual for Economics with Work Exercises.

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