Elasticity

Chapter 4
 What is Elasticity?
Elasticity is a measure of a variable’s sensitivity to a
change in another value.
In economics, it refers to the degree to which
individuals, consumers or producers change their
demand or the amount supplied in response to the
price or income changes.
 Demand Elasticity
It refers to how sensitive the demand for a good is to
changes in other economic variables, such as price
and consumer income.
 Price Elasticity of Demand
It is an economic measure that is used to measure
the degree of responsiveness of the quantity
demanded of a good to a change in its price, when
all of the other factors are held constant.
 Price Elasticity of Demand
Formula
It is calculated by dividing the percentage change in
quantity demanded by the percentage change in
price.
 Categories of Elasticity of
Demand
If Ed is < 1 the demand curve is inelastic
If Ed is >1, the demand curve is elastic
If Ed is = 1, the demand curve is unitary elastic
If Ed is = 0, the demand curve is perfectly inelastic
If Ed is undetermined (infinity) the demand curve is
perfectly elastic
 Elastic Demand
Consumers are responsive to changes in price of
goods.
The goods has a lot of substitutes.
The demand curve is flatter.
 Inelastic Demand
Consumers are not very responsive to changes in
price of the goods.
Consumer has few substitutes
Demand Curve is steeper.
 Perfectly Elastic Demand
Any price increase would cause the demand to fall to
zero.
Consumers are completely and totally sensitive to
price
If the company changes its price, no consumers will
buy the product.
A very small change in price leads to huge change to
quantity demanded
There are infinite substitute goods
Perfectly Inelastic Demand
The quantity demanded remains the same regardless
of the change in price.
Completely insensitive to price
An increase in price has no effect on the quantity
demanded
The product has no substitute
Examples (prohibited drugs, insulin)
Examples of Elastic Goods
Cars
Furnitures
Vacations
 Examples of Inelastic
Goods
Medicine
Gas
Food
FMCG’s
 Factors that Influence the
Elasticity of Demand
Availability and Closeness of Substitutes- when a
large number of substitutes are available,consumers
respond to a higher price of goods by buying more
of the substitute goods
The importance or degree of necessity of the goods-
the more essential or necessary the goods or services
are, the more inelastic the demand will be. On the
other hand, goods and services that are not very
important tend to have an elastic demand.
 PRICE ELASTICITY OF
SUPPLY
It measures the responsiveness of quantity supplied
in response to a percentage change in the price of
goods.
Elastic Supply- a change in price leads to a greater
change in quantity supplied. It shows that suppliers
are sensitive at any change in price. Goods that can
be produced immediately by manufacturing firm are
of this type pf elasticity.
Inelastic Supply- a change in price leads to a lesser
change in quantity supplied. This manifests that
suppliers are weak in response to any price changes.
This is very common to agricultural products which
take time to be produced.
Unitary Elastic Supply- a change in the price leads
to an equal change in quantity supplied.
Perfectly Elastic Supply- this occurs when there is
no change in price and there is an infinite change in
quantity supplied.
Perfectly Inelastic Supply- this happens when a
change in price has no effect on quantity supplied.
 Determinants of Elasticity
of Supply
Monetary or Intermediate- In this period, supply will
be inelastic and the supply is fixed.
Short-run- in this state, supply is inelastic. The
output of production can increase even if equipment
is fixed.
Long-run - in this period, supply is elastic. New
firms are expected to enter or the old one may leave
the industry.
 Income Elasticity of
Demand
The responsiveness of quantity demanded in
response to the change in income of the consumers.
The income elasticity coefficient is obtained by
dividing the percentage change in the quantity
demanded by the percentage change in income.
 Classification of Goods
Normal, Luxury Goods
Normal, Necessity Goods
Inferior Goods
 Inferior Goods
As the income increases, the demand for these goods
decreases.
Inferior goods has negative Income Elasticity
coefficient
 Normal Goods
As the income increases, the quantity demanded for
these goods also increases
Normal goods has positive income elasticity
coefficient.
Normal, luxury goods has a positive income
elasticity coefficient greater than 1
Normal, necessity goods has a positive income
elasticity coefficient less than 1
Good P (Before) Qd (Before) P (After) Qd (After)

x 1000 35 1200 25
Y 1000 35 950 45
 Cross Price Elasticity of
Demand
It measures the responsiveness of quantity
demanded of a good to a change in price of another
good
This is calculated by taking the percentage change in
the quantity demanded of one good and dividing it
by the percentage change in the price of the other
good.
 Usefulness of Cross
elasticity of Demand
Establishment of market price
Goods classification as to whether it is substitute
goods or complementary goods
 Substitute Goods
Goods which can be used in place of another
Example: coffee and tea, rice and bread, product
brands
As the price of one good increases, the demand for
other good increases
 Complimentary Goods
Goods that “go together” and complement each
other
Examples: car and gasoline, printer and ink
As the price of one good increases, the quantity
demanded for other good decreases