Topic 5

Concept of Elasticity
Definition of elasticity
Price Elasticity of Demand (PED)
Relationship Between PED and Total

Revenue (TR)
Income Elasticity of Demand
Cross Elasticity of Demand
Elasticity of Supply

Definition of Elasticity
General definition : Measurement of the magnitude of responsiveness of

variable (eg. Qd or Qs) to the change in one of the determinants factor (eg.
Price and income)

General Formula :

Types of Elasticity :-

% Q

Price Elasticity of Demand

Def : measure how much the

quantity demanded of a good

responds to a change in price of
that good.
Formula :

~ Qd0 = original quantity

demanded
~Qd1 = new quantity demanded
~P0 = original price level
~P1 = new price level
~ -ve sign indicates the negative
(inverse) relationship between
price level & quantity
demanded of the goods.

Price Elasticity of Demand

Degree of Price Elasticity
Elastic ( p 1 )
Shows that % changes in quantity is larger than % changes in price (Qd P)
Eg: Goods with high substitutes (toothpaste & clothing)

Example : Given price of Scrabble increase from RM85.00 to RM95.00 with the quantity
demand decrease from 105 boxes to 95 boxes. Calculate the price elasticity of demand for
this good.

Continue....

Price Elasticity of Demand

p 1 )
Shows that % changes in price is
larger than % changes in quantity
demanded (Qd P)
Low substitution goods eg. Petrol &
cigarettes
Inelastic (

Unitary Elastic ( p 1 )
Shows that % changes in quantity is

equal as % changes in price (Qd P)

Continue....

Price Elasticity of Demand

Perfectly Inelastic ( p 0)
Shows that any % changes in P will

have no effect on the %changes in Qd.

Coefficient = 0
Eg goods: insulin for diabetic patients

Perfectly elastic (p

A condition when at fixed price

consumer will buy any quantity.

Decrease in P will cause Qd
increase by infinite amount. But at
any above price P0, quantity
demand will be zero.

Continue....

Price Elasticity of Demand

Determinants

Exercise

Availability of Substitutes or

1. Given, the price of Book is increase

from RM1.50 to RM2.00 with the
quantity fall from 27 to 10 unit.
Calculate the price elasticity of
demand for this good.

Substitutability
Proportion of Consumers Income
Spent on a Good
Nature of goods
Time Dimension
Income Level
Habits

2. Given, the price of motorcycle

decreasing by 30% from RM4,500
with quantity demanded increase to
150 units from 120 units. Calculate
the price elasticity of demand and
interpret the coefficient.

Continue....

Relationship between PED & TR

Relationship between P

Elasticity of Demand & TR

the concept of elasticity always
associate with total revenue
Total revenue (TR) the amount
paid by buyers & received by
sellers of a good.
The formula : TR = P x Q

DD is unitary elastic
P increase -> TR is same

(%change in Qd =% change in P)

Price (RM)

* P x Q = RM500
(revenue)
P0=10, P1=15
Q0=15, Q1=10
TR0=150, TR1=150

TR
0

. P Q TRsame
100

Quantity

Continue....

Relationship between PED & TR

DD is elastic
P increase -> decrease in TR

(%change in Qd >% change in P)

P0=10, P1=12
Q0=15, Q1=10
TR0=150, TR1=120

P Q TR

DD is inelastic
P increase -> TR increase

P0=6 P1=12
Q0=20, Q1=18
TR0=120, TR1=144

. P Q TRincrease

Income Elasticity of Demand

Def : measure how much the

Sign of the coefficient

quantity demanded of a good

responds to a change in consumer
income.
Formula : y %Qd

Positive

%Y

Qd 1 Qd 0
Y0
y
X

Qd 0
Y 1 Y 0

Q
Y
y
X 0
Qd 0
Y

~ Qd0 = original quantity demanded

~Qd1 = new quantity demanded
~Y0 = original income level
~Y1 = new income level

Normal goods, luxury goods &

necessities goods
in Y will in Qd for this goods.
+ve & greater than 1 luxury
+ve & between 0 and 1 normal
+ve & = o
necessity goods
Negative
Inferior goods
in Y will in Qd for this goods & vv

Continue...

Income Elasticity of Demand

Cooeficient
of EY

Degree of
Elasticity

Types of
Good

EY = 0

Perfectly
inelastic

Necessity
goods

EY > 1

Elastic

Luxury
Goods

0<EY< 1

Inelastic

Normal
goods

0<EY< 1

-ve elastic

Inferior

Responses of Income Elasticity

Perfectly Inelastic

also known as zero income elasticity

of demand
Condition in which Qd of a product
does not change even though Y
Example of goods : rice, vegetables,
salt

Continue...

Income Elasticity of Demand

Elastic

Negative Elastic

Condition in which Y , Qd
(grater then increasing in Y)
Example of goods : antique
furniture, luxury cars, gold &
jewelry.

Inelastic

Condition in which as Qd as Y
although increasing in Y more
faster than Qd.
Example of goods : food & clothing

Condition in which Qd
as Y
Example of goods : Giffen goods or
inferior goods such as used cars,
salted fish & low grade potatoes.

Cross Price Elasticity of Demand

Def : measure how much the

Sign of the coefficient

quantity demanded of a good

responds to a change in the price of
another good. (% Qdx / % Py)
Formula :

Positive

%Qdx

%Py

Qdx1 Qdx0
Py 0
X

Qdx0
Py1 Py 0

Qx
Py 0
X

Py Qdx0

~ Qdx0= original quantity demanded

of good X
~Qdx1 = new quantity demanded of
good X.
~ Py0 = original Price level of good Y
~Py1 = new Price level of good Y

The 2 goods (X & Y) are substitute to

each other.
Increase in Py will cause increase in
Qdx.
Example : Vico & Milo, Nissan &
Perdana
Negative
Implies this 2 goods are

complimentary goods.
Increase in Py will cause decrease in
Qdx.
Example : Tennis rackets & tennis
ball.

Continue...

Cross Price Elasticity of Demand

Equal to 0
Implies this 2 goods are

independent or unrelated goods.

Example : Tennis rackets & petrol.
Sign of
Elasticity

Exercise
a. The following table shows the price of good X
and quantity demanded for goods X and Y.

Types of Goods

(+ve sign) Goods X & Y, substitute goods

(-ve sign)

Goods X & Y, complimentary

goods

Exy=0

Goods X & Y, not related goods

Price of Good
X (RM/Unit)

Quantity of
Good X
Demanded
(units)

Quantity of
Good Y
Demanded
(units)

10

10

10

i. Calculate the price elasticity of demand for good

X when price increases from RM4 per unit to
RM6 per unit.
ii. Calculate the cross elasticity of demand for good
Y when the price of good X decreases from RM8
per unit to RM6 per unit.
ii. What is the relationship between goods X and Y

Price Elasticity of Supply

Def : measure how much the

Degree of Price Elasticity of

quantity supplied of a good

responds to a change in price of
that good.
Formula :

Supplied
Elastic (s 1)
Shows that small % change in P will
lead to a large % change in Qs.(Qs P)

~ Qs0 = original quantity supplied

~Qs1 = new quantity demanded
~P0 = original price level
~P1 = new price level

Continue....
Inelastic (

Price Elasticity of Supply

s 1 )

Shows that large % changes in P

will only affect a small % of the Qs.

(Qs P)

Unitary Elastic ( s

1 )

Shows that % changes in P equals

the % change in Qs.

(Qs P)

Continue....
Perfectly Inelastic (

Price Elasticity of Supply

s 0 )

Shows that % changes in P have no

effect on the %changes in Qs.

Perfectly Elastic (

)
s

Shows an almost zero % in P brings a

very large % change in Qs.

Continue....

Price Elasticity of Supply

Determinants

Technology method of

The time factor involved in making

production
Perishable

adjustment to supply
- very short run
- short run
- long run
Change in the cost of factor of
production small changes in cost of
FOP, the supply will be less
elastic/inelastic ; large changes in
cost of FOP, the supply will be elastic
Pattern usage for factor of
production limited or specific
usage of FOP, the supply is inelastic ;
normal or easily usage of FOP, the
supply is elastic