PRINCIPLES OF ECONOMICS

Elasticity of
Demand and Supply

PowerPoint Slides
by Ambigah d/o Sandran

1
 Learning Objectives
Student will be able to learn:
The concept of price elasticity of demand.
To calculate the price elasticity of demand.
To differentiate the degree of price elasticity of demand.
To identify the determinants of price elasticity of demand.
To calculate income elasticity of demand.
The responses of income elasticity of demand.

2
 Learning Objectives
Student will be able to learn:
To define and calculate the cross elasticity of demand.
The responses of cross elasticity of demand.
To define price elasticity of supply.
To identify the degree of price elasticity of supply.
To calculate price elasticity of supply.
The determinants of price elasticity of supply.

3
 Learning Outcomes

At the end of the lesson, students should be able to:

Explain the concept of price elasticity of demand.
Calculate the price elasticity of demand.
Differentiate the degree of price elasticity of demand.
Identify the determinants of price elasticity of demand.
Calculate income elasticity of demand.
Explain the responses of income elasticity of demand.

4
 Learning Outcomes

At the end of the lesson, students should be able to:

Define and calculate the cross elasticity of demand.
Explain the responses of cross elasticity of demand.
Define price elasticity of supply.
Identify the degree of price elasticity of supply.
Calculate price elasticity of supply.
Explain the determinants of price elasticity of supply.

5
 Introduction

Elasticity can be defined as the rate of change of the quantity

demanded or quantity supplied due to a change in a variable.

A variable is a factor or determinant that affect the quantity

demanded quantity supplied, consumers income or the price
of other goods with the assumption of ceteris paribus.

6
 Price Elasticity of Demand (Ed)

Measure sensitivity / responsiveness of the quantity demanded

due to a change in its price

Formula:
Price elasticity of demand
= (% change quantity demanded) / (% change in price)
= [ (Q/Q) * 100 ] / [ P/P * 100 ]
= (Q / Q) * (P / P)
7
 Price Elasticity of Demand (Ed)

d = [ (Q2-Q1)/Q1 ] * [ P1 / (P2-P1) ]

8
 Example: Price elasticity of demand (Ed)
Question:
If the price of nail polish decrease from RM5 to RM3 and the
quantity for nail polish increase from 40 to 50 units, calculate the
Ed?
Solution:
Q1=40 Q2= 50
P1=RM5 P2=RM3
d = [ (Q2-Q1)/Q1 ] * [ P1 / (P2-P1) ]
Ed = [ (50 - 40) / 40 ] * [ 5 / (3 - 5) ]
Ed = [ 10/40 ] * [ 5 / (-2) ]
Ed = - 0.625
Ed= 0.625 #
9
 Degree of Price Elasticity of demand
(Ed)
1. Elastic demand, Ed > 1
Small percentage change in the price of the product
Will lead to a larger percentage change in the quantity demanded

Example: price increase 5%,quantity fall 10% (high substitutes)

% P < % Q
Price

P= 5% D

Quantity
0
10 Q =10%
 Degree of Price Elasticity of demand
(Ed)
2. Inelastic demand, Ed < 1
Larger percentage change in the price of the product
will lead only to a small percentage change in the quantity demanded

Example: price increase 10%,quantity fall 2% (low substitutes)

% P > % Q
Price

P=
10% D

Quantity
11 0
Q = 2%
 Degree of Price Elasticity of demand
(Ed)
3. Unitary Elastic demand, Ed = 1

percentage change in = percentage change in

the price of the product the quantity demanded

Example: price increase 5%,quantity fall 5%

% P = % Q
Price

P= 5%
D

Quantity
0
12 Q = 5%
 Degree of Price Elasticity of demand
(Ed)
4. Perfectly Inelastic demand, Ed = 0
change in the price of the product
will not lead to change in the quantity demanded
Example: price increase 10%, quantity demand remain the same

% P ; % Q = 0
Price
D

P=
10%

Quantity
13 0
Q = 0%
 Degree of Price Elasticity of demand
(Ed)
5. Perfectly elastic demand, Ed =
Small change in the price of the product
will lead to infinite percentage change in the quantity demanded
Example: price increase 10%, quantity demand remain the same

% P = 0 ; % Q
Price

10 D

Quantity
14 0
5
 Determinants of
Price Elasticity of Demand (Ed)

1. Existence of
5. Time dimensions
substitutes

2. Proportion of the 6. Habits

expenditure on a product

3. Nature of goods 7. Complementary

4. Income level 8. Frequently Purchased

Products
15
 Income Elasticity of Demand (Ey)

Measure the responsive or sensitivity of changes quantity demand

for a product due to a change in income.
Consumers incomes will affect the demand for different
products.

16
 Income Elasticity of Demand (Ey)
Income elasticity of demand (Ey)
= [ (% change in quantity demanded) / (% change in income) ]
= [ (Q/Q) * 100 ] / [ (Y/Y) * 100 ]
= (Q/Q) * (Y/Y)

Ey= [ (Q2-Q1)/Q1 * ( Y1/ (Y2-Y1) ]

17
 Income Elasticity of Demand (Ey)
1. Inelasticity income
0 < Ey < 1

Income
Y : Qd
Although Y faster than
they Qd
Ey
e.g. normal goods
= food, clothing
Curve upward sloping
0
Quantity
18
 Income Elasticity of Demand (Ey)

2. Elasticity income Ey > 1

Y : Qd
Income
Although Y subsequently at
fast rate
e.g. luxury goods
Ey = gold, luxury cars, antique
furniture
Curve upward sloping

0
Quantity

19
 Income Elasticity of Demand (Ey)

3. Negative income elasticity of demand

Ey < 0
Income
Y : Qd
e.g. giffen / inferior goods
= used cars, salted fish,
Curve downward sloping
Ey

0
Quantity
20
 Income Elasticity of Demand (Ey)

4. Zero income elasticity of demand

Ey = 0
Income
Y : Qd constant

Ey e.g. necessity goods

=rice, vegetables
Curve vertical

0
Quantity
21
 Cross Elasticity of Demand (Ex)

Measure the responsive or sensitivity of quantity demanded for

one product (Qdx) due to a change in the price of related
product (Py)

22
 Cross Elasticity of Demand (Ex)
Cross Elasticity of Demand Ex
= [ (% in quantity demanded of goods X) / (% in price of goods Y) ]
= [ (Qx / Qx) * 100 ] / [ (Py / Py) * 100 ]
= (Qx / Qx) * (Py / Py)

Ex= [ (Qx2 - Qx1) / Qx1 * ( Py1 / (Py2 - Py1) ]

23
 Cross Elasticity of Demand (Ex)

1. Positive Cross Elasticity

Price of X Ex > 0
Px : Qy
Ex

Substitute goods

0
Quantity of Y
24
 Cross Elasticity of Demand (Ex)

2. Negative Cross Elasticity

Price of X Ex < 0
Px : Qy

Complementary goods

Ex

0
Quantity of Y

25
 Cross Elasticity of Demand (Ex)

3. Zero Cross Elasticity

Price of X
Ex = 0

Ex Px : Qy constant

No relationship goods

0
Quantity of Y
26
 Elasticity of Supply (Es)
Price elasticity of supply measures the sensitivity or
responsiveness of the quantity supplied due to a change in the
price of a product or service.

Price elasticity of S
= Es
= [ (% change in Qs) / (% change in price) ]
= [ (Qs / Qs)*100 ] / [ (P / P)*100 ]
= (Qs / Qs) * (P / P)

27
 Elasticity of Supply (Es)

Es = [ (Q2 - Q1) / Q1 ] * [ P1 / ( P2 - P1) ]

28
 Degree of Elasticity of Supply (Es)

Es > 1
Elastic S

Es =
Es < 1
Perfectly
Inelastic S
Elastic S
Degree
of Es

Es = 0
Es = 1
Perfectly
Unitary
Inelastic
Elastic S
S
29
 Degree of Elasticity of Supply (Es)
1. Elastic supply, Es > 1
Small percentage change in the price of the product
will lead to a larger percentage change in the quantity supplied
Example: price increase 1%, quantity increases 10%

Price
S % P < % Q

P= 1%

Quantity
0
30 Q =10%
 Degree of Elasticity of Supply (Es)
2. Inelastic supply, Es < 1
Larger percentage change in the price of the product
will lead only affect a small percentage of the quantity supplied
Example: price increase 5%, quantity increase 1%

% P > % Q
Price S

P= 5%

Quantity
0
31
Q = 1%
 Degree of Elasticity of Supply (Es)
3. Unitary Elastic supply, Es = 1

percentage change in = percentage change in the

the price of the product quantity supplied

Example: price increase 10%, quantity increases 10%

% P = % Q
Price S

P=
10%

45
Quantity
0
32 Q = 10%
 Degree of Elasticity of Supply (Es)
4. Perfectly Inelastic supply, Es = 0
change in the price of the product will has
no effect on the percentage change in quantity supplied
Example: price increase 10%, quantity supplied remain the same

Price % P ; % Q = 0

P=
10%

Quantity
0
Q = 0%
33
 Degree of Elasticity of Supply (Es)
5. Perfectly elastic supply, Es =
An almost zero percentage change in price brings a very large
percentage change in the quantity supplied
Example: price increase 10%, quantity demand remain the same

% P = 0 ; % Q
Price

P S

Quantity
0
Q1 Q2
34
 Determinants of Elasticity of Supply
Determinants of Es

1. Technology
2. Time period
improvements

3. Availability and mobility

4. Nature of the market
of factors of production

5. Perishability

35
 Summary
Price elasticity of demand (Ed) is a measure of the degree of

responsiveness of change in the quantity demanded of a good to

a change in its price, with the assumption of ceteris paribus.

Price elasticity of demand is determined by several factors, such

as availability of substitutes, number of uses, importance,

consumer habits, time period, and proportion of expense from
income.

The demand for a good is said to be elastic towards a change in

price if the good has many substitutes, has many uses, is less
important to consumers, and involves a high proportion of

36
expense from income.
 Summary
The demand for a good is said to be elastic towards a change in
price if the good does not have many substitutes, does not have
many uses, is very important to consumers, has brand loyalty,
and involves a small proportion of expense from income.
The demand for a good is inelastic if a decrease in its price
results in decreased total income, or if an increase in price
results in increased total income. There is a positives
relationship between the price and the total income.
The demand for a good is unity elastic if total income is not
affected by any increase or decrease in price.

37
 Summary
Income elasticity of demand (Ey) is a measure of the reactivity of

change in quantity demanded of a good due to a change in consumers

income.

Cross elasticity of demand (Exy) is a measure of the reactivity of the

quantity demanded of a good to change in the price of another good.

Price elasticity of supply (Es) is a measure of the degree of reactivity of

the change in quantity supplied of a good to a change in its price.

The main determinants of price elasticity of supply are production costs,

availability and mobility of factors of production, time period, number of

firms in an industry, and production time.
38
 Key terms:
Term Definition
A condition in which a small percentage change in
Elastic demand the price of a product will lead to a larger
percentage change in the quantity demanded.
Compare a present ratio with past or expected
Inelastic ratios for the organization to determine if there
demand has been an improvement or deterioration or no
change over time.
A condition in which a percentage change in price
Unitary elastic
equals a percentage change in quantity
demand
demanded.
Perfectly
A condition in which the quantity demanded does
inelastic
not change even though the price changes.
demand
39
 Key terms:
Term Definition
A condition in which a small percentage change in
Perfectly elastic
price leads to an infinite percentage change in
demand
quantity demanded.
Measures the responsiveness or sensitivity of
Income
changes in quantity demanded of a product due
elasticity
to a change in income.
Measures the responsiveness of quantity
Cross elasticity
demanded of a product due to a change in the
of demand
price of related product.

Price elasticity Measures the sensitivity of the quantity supplied

of supply due to a change in its price.

40