CHAPTER 3

CHAPTER 3
Elasticity
Dr. Nurul Nadia Abd Aziz
Copyright © 2020 Dr. Nurul Nadia Abd Aziz 1

Learning Outcomes
i. Students are able to discuss the concepts of
elasticity of demand.
ii. Students are able to distinguish between price
elasticity of demand, cross elasticity of
demand and income elasticity of demand.
iii. Students are able to explain price elasticity of
supply.
iv. Students are able to discuss the determinants
of price elasticity of demand and supply.

Elasticity of Demand
Price Cross Price Income

elasticity elasticity elasticity
of demand of demand of demand

Price Elasticity of Demand
It measures the sensitivity or
responsiveness of quantity demanded
due to a change in the price of the
product.

Formula of Ed
%Q
d 
%P
Q1  Q0 P0
d  
P1  P0 Q0 Where;
Q0 = Original quantity
Q1 = New Quantity
P0 = Original price
P1 = New price

Degree of Price
Elasticity of Demand

Elastic demand (Єd > 1)
• The demand is elastic when the
coefficient is more than 1. P
• It means the percentage change
in quantity demanded is greater
than percentage change in price.
• This type of demand basically P1
P0 Dd
related to products that have
many substitutes.
• Examples: Toyota, Honda, Nissan,
Q
Ford, Proton, Mitsubishi, BMW, Q1 Q0
Mercedes

Inelastic demand (Єd < 1)
• The demand is inelastic when the

coefficient is less than 1. P
• It means the percentage change
in price is greater than P1
percentage change in quantity
demanded.
P0
• Good that has no substitutes has
inelastic demand. Dd
Q
• Examples: Electricity and water Q1 Q0

Unitary elastic demand (Єd = 1)
• The demand is unitary P

when the coefficient is
equal to 1.
• It means the percentage P1
change in price is equal

to the percentage change P0
in quantity demanded. Dd
• No such product for this Q
demand. Q1 Q0

Perfectly inelastic demand
(Єd = 0)
• The demand is perfectly P
inelastic when the coefficient
is 0. Dd
• It means quantity P1
demanded does not change
as the price change. P0
• Examples: Drug for drug
addicts; insulin for diabetic Q
Q0
patients.

Perfectly elastic demand
(Єd = ∞)
• The demand is perfectly
elastic when the coefficient is P
an infinite number.
• It means a small percentage
change in price leads to an P0 Dd
infinite percentage change in
quantity demanded.
• Examples: Control price items
Q
such as sugar, oil, rice, flour, Q0 Q1
petrol.

Status of goods
Proportion
G Time
of income
Horizon
level I T
S C
Number of Consumer
Substitute Habit
Determinants
of Price
Elasticity of
Demand
12
Copyright © 2020 Dr. Nurul Nadia Abd Aziz
1. Number of Substitute
• Generally, the large number of substitute
goods that are available, the greater the
elasticity of demand.
• For example, Toyota, Honda, Ford and
many others became perfect substitute
for Proton. So the demand for Proton
must be elastic.
• For good that has no close substitute
such as electricity, the demand is highly
inelastic.

2. Proportion of income level
• Demand sometimes depends on the value of a product, that is
whether it is cheaper or more expensive.
• For cheaper products, like clothes, if the price increased by 10%,
consumer will be less sensitive to the price change because only
a small proportion of their income is spent on it. So the demand
will be inelastic.
• For expensive products, like houses, a 10% increase will give

significant impact on people’s income and budget. So, the
demand will be elastic.
3. Status of goods
• Electricity is consider necessities. The effect of price changes for
necessity goods is insignificant to the consumers because the
goods are basic needs and important to the consumers. A price
increase will not significantly reduce the amount of power used
by people. Its demand is inelastic.
• On the other hand, Rolex is considered luxury good. The effect

of price change for luxury goods is significant to the consumers
because the goods are not basic needs of the consumers. An
increase in price will cause the demand will decrease, therefore,
the demand is elastic.
4. Time Horizon
• Generally, the longer the time period under
consideration, the demand will be more elastic.
• In the long run, the demand is elastic because the
consumer has more information on the availability of
substitute goods.
• In the short run, the demand is inelastic because the

consumer has not enough time to look for substitute
and buyer respond less to these price change.
5. Consumer Habits
• Heavy smokers and heavy drinkers tend to have inelastic
demand for cigarettes and liquor respectively due to
their habit.
• Almost every year, Malaysian government increased the

tax on cigarette and liquor, consequently increased on
the price of the items, but the demand for these goods
were still high.
• The smokers have an inelastic demand for cigarettes
because cigarettes have become their necessities due to
their habit.
Elasticity and Total Revenue
• Raising the price will have two effects:
1. More revenue per unit sold
2. Fewer units sold.
• In order to increase total revenue, we must decide
which of the two effects is greater.
• Demand is inelastic, total revenue is more influenced
by the higher price increases as price increases.
• Demand is elastic, total revenue is more influenced
by the lower quantity and decreases as price
increases.

Relationship between Total
Revenue and Price Elasticity of
Demand
Degree of Effects on Price and Quantity Effects on Total
Elasticity Revenue
Elastic Demand i. Price ↑, Quantity Demand ↓ Total Revenue ↓

ii. Price ↓, Quantity Demand ↑ Total Revenue ↑
Inelastic Demand i. Price ↑, Quantity Demand ↓ Total Revenue ↑

ii. Price ↓, Quantity Demand ↑ Total Revenue ↓
Thus, when
Unitaryseller
Elastic wants to maximize
i. Price ↑, Quantityprofit
Demandfrom
↓ selling goods↔
Total Revenue that have
elastic demand, he ii. should
Price ↓,lower
Quantitythe
Demand ↑ ButTotal
price. Revenue
if the goods↔have
inelastic demand, he should increase the price .
Price
When Price ↑ from 2 to 3
P0 = 2, Q0 = 7 → TR = 2x7 =14 9
8
P1 = 3, Q1 = 6 → TR = 3x6 =18 Elastic Demand
7
Unitary elastic Demand
6
So, as P ↑, TR ↑ 5
Inelastic Demand
4
When Price ↑ from 6 to 7 3
P0 = 6, Q0 = 3 → TR = 6x3 =18 2
DD
1
P1 = 7, Q1 = 2 → TR = 7x2 =14
0
1 2 3 4 5 6 7
So, as P ↑, TR Quantity

Cross Price Elasticity of Demand
It measures the sensitivity of quantity
demanded of good X when the price
of good Y changes.

Formula of Exy
%QX
 XY 
%PY
QX 1  QX 0 PY 0
 XY   Where;
PY 1  PY 0 QX 0
QX0 = Original quantity
QX1 = New Quantity
PY0 = Original price
PY1 = New price

Exy = Positive
• An increase in price of a P (Toyota) DD

particular good causes an 2.0
increase in quantity
demanded of another 1.5
good.
1.0
• Exy > 0
• Substitute good 0.5
• Examples: Toyota and 2 4 6 8 Q (Honda)

Honda

Exy = Negative
• An increase in price of P Car
a particular good 2.0
causes a decrease in
quantity demanded of 1.5
another good. 1.0

• Exy < 0
DD
• Complementary goods 0.5
• Example: Car and 2 4 6 8 Q (Petrol)

petrol

Exy = Zero
P (Tomatoes)
• Any changes in price of DD
2.0
a particular good will
not affect the quantity
demanded. 1.5
• Exy = 0
1.0
• Independent Goods
• Example: Cars and 0.5
Tomatoes
2 4 6 8 Q (cars)

Coefficient of
Cross Elasticity of Demand
Positive Negative Zero

(Exy = positive) (Exy = negative) (Exy = 0)
• The relationship • The relationship • The two goods are
between two between two unrelated to each
goods is goods is other.
substitute. complement. • Example: Car and
• Example: Toyota • Example: Car and Tomatoes
and Honda Petrol.

Income Elasticity of Demand
responsiveness of quantity demanded of
a good when the consumer’s income
changes.

Formula of EY
%Q
Y 
% Y
Q1  Q0 Y0
Y  
Y1  Y0 Q0 Where;
Q1 = New Quantity
Y0 = Original income
Y1 = New income

0 < Ey < 1
• An increase in Income Income DD

causes a smaller % 2.0
increase in demand.
1.5
• 0< Ey < 1
1.0
• Normal goods
0.5
• Examples: Television,
book, computer. 2 4 6 8 Quantity

Ey = Positive
Income
• An increase in income 2.0
causes a bigger %
1.5
increase in demand DD
• Ey >= 1 1.0
• Luxury goods
0.5
• Examples: Luxury car,
jewelry. 2 4 6 8 Quantity

Ey = Negative
• An increase in income Income
causes a decrease in 2.
demand 0
1.
• Ed < 0 5
• Inferior goods 1.
0
• Examples: Salted fish, 0.
5
DD
broken rice, used car 2 4 6 8 Quantity

Ey = Zero
• Any changes in income
Income
will not affect the DD
2.0
quantity demanded.
• Ey = 0 1.5
• Necessity Goods 1.0
• Examples: Electricity, 0.5

water.
2 4 6 8 Quantity

0 < EY <1 EY = Zero (0)
The good is a The good is a
normal good. necessity good.
4 4 E.g.: Electricity,
E.g.: Television,
computer, water.
books Coefficient of
Income Elasticity
of Demand
1 1 3 3
Positive (EY > 1) 2 EY= Negative

The good is a 2
The good is a inferior
luxury good.
good.
E.g.: Luxury car,
E.g.: Salted fish,
jewelry.
broken rice, used car
Price Elasticity of Supply
responsiveness of quantity supplied due
to a change in its price.

Formula of Es
%Q
S 
%P
Q1  Q0 P0
S  
P1  P0 Q0 Where;
Q1 = New Quantity
P0 = Original price
P1 = New price

Degree of
Price Elasticity of Supply

Elastic Supply (Єs > 1)
• The supply is elastic when P

the coefficient is more
than 1. Ss
P1
• It means the percentage
P0
change in quantity
supplied is greater than
percentage change in
price. Q
• Example: Manufactured Q0 Q1
goods

Inelastic Supply (Єs < 1)
• The supply is inelastic
P
when the coefficient is Ss
less than 1.
change in price is greater

than percentage change P0
in quantity supplied.
• Example: Agricultural Q0 Q1
Q
products

Unitary Elastic Supply (Єs = 1)
• The supply is unitary

when the coefficient is P
equal to 1. Ss
change in price is equal
to the percentage P0
change in quantity
supplied. Q
• Example: Normal goods Q0 Q1

Perfectly Inelastic Supply (Єs = 0)
P
• The supply is perfectly
inelastic when the Ss
coefficient is 0. P1
• It means quantity
supplied does not change P0
as the price change.
• Example: Monalisa Potret Q
Q0

Perfectly Elastic Supply (Єs = ∞)
• The supply is perfectly
elastic when the coefficient P
is an infinite number.
• It means a small
percentage change in price
P0 Ss
leads to an infinite
percentage change in
quantity supplied.
• Example: Control price Q0 Q1
Q
items

Determinants of Price
Elasticity of Supply
C Change in cost due to the change in supply
G Gestation period
S Substitute availability of input used
T Time period / adjustment period
Perishability
P
Change in Cost
• Any change in supply requires a small change in
production cost (like roti canai) the supply is
elastic.
• If the change in supply requires big change in cost

(like houses) the supply will be inelastic.

Gestation period
• If the time taken to produce a good is short (example: Thin
Crisp Waffles + Ice Cream), the supply is elastic because the
producer is able to supply a larger amount of goods to
meet the changed in price.
• If the time taken to produce a good is long (like agricultural

products), the supply is inelastic because the producer is
able to supply only a small amount of goods to meet the
changed in price.

Substitute Availability of
Input Used
• If the firm can use any kind of materials for its
input (easily available type of input), supply of its
product elastic.
• If the firm uses very specialized inputs or

production factors (not easily available type of
input, supply of its product inelastic.
Time period or adjustment period
• In the short run, the producers and the industry is still
have limited way to increase production and supply
because they have insufficient time to adjust, then the
supply is inelastic.
• In the long run, the producers have sufficient time to

adjust, then the supply curve is elastic. Example, in the
long run the firm can expand its factory, farmer can
acquire additional land, equipment and machinery.
Perishability
• If the product is less perishable like manufactured
products, the supply is elastic because it is durable
for a long time.
• If the product is perishable like agricultural

products, the supply is inelastic because it is easily
rotten.
TUTORIAL

Ed Exy Ey Es
Definition
Formula
Coefficient

You have completed
the topic!!
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Dr. Nurul Nadia Abd Aziz

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Price Cross Price Income

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• The demand is inelastic when the

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• The demand is unitary P

change in price is equal

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• For expensive products, like houses, a 10% increase will give

• On the other hand, Rolex is considered luxury good. The effect

• In the short run, the demand is inelastic because the

• Almost every year, Malaysian government increased the

Copyright © 2020 Dr. Nurul Nadia Abd Aziz 1818

Elastic Demand i. Price ↑, Quantity Demand ↓ Total Revenue ↓

Inelastic Demand i. Price ↑, Quantity Demand ↓ Total Revenue ↑

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• An increase in price of a P (Toyota) DD

• Examples: Toyota and 2 4 6 8 Q (Honda)

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another good. 1.0

• Example: Car and 2 4 6 8 Q (Petrol)

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Positive Negative Zero

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• An increase in Income Income DD

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broken rice, used car 2 4 6 8 Quantity

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• Necessity Goods 1.0

• Examples: Electricity, 0.5

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Positive (EY > 1) 2 EY= Negative

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• The supply is elastic when P

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change in price is greater

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• The supply is unitary

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C Change in cost due to the change in supply

S Substitute availability of input used

T Time period / adjustment period

• If the change in supply requires big change in cost

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