CHAPTER 3

ELASTICITY

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LEARNING OUTCOMES:-
At the end of this chapter, students should be able to:-
1. Explain the elasticity of demand and supply.
2. Explain 3 types of elasticity of demand

2
This chapter we have 2 part:

ELASTICITY ELASTICITY
OF DEMAND OF SUPPLY

3
1. ELASTICITY OF DEMAND
Definition
Measurements
Ed
Determinants
Relationship with TR
Elasticit Definition
y of DD Ey Measurement
Application
Definition
Exy Measurement
Application

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PRICE ELASTICITY OF DEMAND (Ed)
Definition:
Price elasticity of demand measures the percentage change in
quantity demanded caused by a percent change in price.

Ed = Percentage change in Quantity

How to Calculate

Percentage change in Price

=%∆Q
%∆P
 
Where Δ = changes
 
% ∆ Q = New Quantity – Original Quantity X 100
Original Quantity
 
% ∆ P = New Price – Original Price X 100
Original Price

5
EXAMPLE
Ben will buy 10 watermelons if the price is RM2.00 each. If price
increase to RM2.50, Ben will only buy 6 watermelons. Calculate
price elasticity of demand.
Ed = Q1 - Q0 / Q0
 So, we can say that… P1 - P 0 / P 0
   
Q1 = 6 Ed = 6 – 10
Q0 = 10 10
P1 = 2.50 = 2.5 – 2
2
P0 = 2
= - 0.4 / 0.25
= - 1.6

So, we can say that if price of watermelon increase by 1%, Quantity

demanded will reduce by 1.6%.

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MEASUREMENT AND
INTERPRETATION

1. Perfectly Inelastic
2. Inelastic
3. Unitary Elastic
4. Elastic
5. Perfectly Elastic

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1. PERFECTLY INELASTIC

Any changes in price will not

affect the quantity
demanded.
Price
DD
Ed = 0 2.0

1.5
E.g: Insulin for diabetic
person. Every diabetic
1.0
patient will want the insulin
regardless of price.
0.5

2 4 6 8 Quantity

8
2. INELASTIC
An increase in price causes a smaller % fall in demand.

%∆Q<%∆P

Price
0< Ed < 1
2.0
The curve will be steeper
1.5
E.g: Inferior goods of Goods
with few substitutes.
1.0
Petrol has few alternatives
because people with a car, 0.5
DD
need to buy petrol. If the
price of petrol goes up, 2 4 6 8 Quantity
demand proves very
inelastic

9
3. UNITARY ELASTIC
Unitary Elasticity is when there is an equally proportional change in
demand, following a change in price.

%∆Q=%∆P
Price
2.0
Ed = 1
1.5

E.g: Normal Good 1.0

0.5 DD

2 4 6 8 Quantity

10
4. ELASTIC
An increase in prices causes a bigger % fall in demand

%∆Q>%∆P

Price
Ed > 1 2.0

1.5
The curve will be flatter

1.0
E.g: Luxury good or goods
which has many substitutes DD
0.5
If price of a Porsche
increases, demand will fall 2 4 6 8 Quantity
more and demand proves
be elastic.

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5. PERFECTLY ELASTIC

The price will not affect as the

quantity demanded change

Ed = ∞ Price
2.0
E.g: Farmers selling corn in a
competitive marketplace. No 1.5 DD
farmer can sell for more than
the going price, since buyers 1.0
can easily buy from their
competitors. On the other
0.5
hand, no farmers are going to
sell for less, since they can sell
all that they have for the going 2 4 6 8 Quantity
rate.

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DETERMINANTS OF PRICE
ELASTICITY OF DEMAND

1. Necessity
2. Availability of close substitutes
3. Time horizon
4. Size of purchase from income
5. Uses of that goods

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1. NECESSITY

The more necessary a good is, the lower the elasticity, as people
will attempt to buy it no matter the price.

Luxury Goods Necessity Goods

Price Price

2.0 2.0

1.5 1.5

1.0 1.0

DD
0.5 0.5
DD

2 4 6 8 Quantity 2 4 6 8 Quantity

Elastic DD curve Inelastic DD curve

14
2. AVAILABILITY OF CLOSE
SUBSTITUTES
If there are close substitutes, buyers will move away from more
expensive items and demand will be elastic.

Many substitutes available Few substitutes available

Price Price

2.0 2.0

1.5 1.5

1.0 1.0

DD
0.5 0.5
DD

2 4 6 8 Quantity 2 4 6 8 Quantity

Elastic DD curve Inelastic DD curve

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3. TIME HORIZON
The longer the time available, the easier to find substitutes and the
more elastic the demand.

3 weeks 3 days
Price Price

2.0 2.0

1.5 1.5

1.0 1.0

DD
0.5 0.5
DD

2 4 6 8 Quantity 2 4 6 8 Quantity

Elastic DD curve Inelastic DD curve

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4. RELATIVE SIZE OF PURCHASE
FROM INCOME
Purchases which are a very small portion of total expenditure tend to
be more inelastic, because consumers are not worried about the extra
expenditure.
Large portion from income Small portion from income

Price Price

2.0 2.0

1.5 1.5

1.0 1.0

DD
0.5 0.5
DD

2 4 6 8 Quantity 2 4 6 8 Quantity

Elastic DD curve Inelastic DD curve

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5. USES OF THAT GOODS

If the goods have various functions, the demand will be inelastic

Limited Function Multi Function

Price Price

2.0 2.0

1.5 1.5

1.0 1.0

DD
0.5 0.5
DD

2 4 6 8 Quantity 2 4 6 8 Quantity

Elastic DD curve Inelastic DD curve

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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.

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 Price
 When Price ↑ from 2 to 3
P0 = 2, Q0 = 7 → TR = 2x7 =14 9
P1 = 3, Q1 = 6 → TR = 3x6 =18 8 Elastic Demand
7
So, as P ↑, TR ↑ 6 Unitary elastic Demand

5
Inelastic Demand
When Price ↑ from 6 to 7 4
P0 = 6, Q0 = 3 → TR = 6x3 =18 3
P1 = 7, Q1 = 2 → TR = 7x2 =14 2
1
DD

So, as P ↑, TR 0
1 2 3 4 5 6 7
Quantity

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INCOME ELASTICITY OF
DEMAND (EY)
Definition:
Income elasticity of demand measures the percentage change in
quantity demanded caused by a percent change in INCOME.

Ey = Percentage change in Quantity

How to Calculate

Percentage change in Income

=%∆Q
%∆Y
 
Where Δ = changes
 
% ∆ Q = New Quantity – Original Quantity X 100
Original Quantity
 
% ∆ Y = New Income – Original Income X 100
Original Income

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EXAMPLE
At Income level of RM2000, demand of Amir towards burger is 15 burgers.

However, when his incomes increase to RM4000, Amir demands burger 25

pieces. Ed = Q1 - Q0 / Q0
So, we can say that… Y1 - Y 0 / Y 0
 
 
  Q1 = 25 Ed = 25 - 15
Q0 = 15 15
Y1 = 4000 = 4000 - 2000
2000
Y0 = 2000
= 0.667

So, we can say that if Income of Amir increase by 1%, Quantity

demanded will increase by 0.667%.

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MEASUREMENT AND
INTERPRETATION

1. Zero Income Elasticity

2. Inelastic Income Elasticity
3. Elastic Income Elasticity
4. Negative Income elasticity

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1. ZERO INCOME ELASTICITY

Any changes in income will

not affect the quantity
demanded.
Income
DD
Ey = 0 2.0

1.5
Necessity Goods
1.0

0.5

2 4 6 8 Quantity

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2. INELASTIC INCOME ELASTICITY
An increase in Income causes a smaller % increase in
demand.

Income DD
0< Ey < 1
2.0

Normal goods 1.5

1.0

0.5

2 4 6 8 Quantity

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3. ELASTIC INCOME ELASTICITY
An increase in income causes a bigger % increase in
demand

Income

Ey > 1 2.0

1.5
DD
Luxury goods 1.0

0.5

2 4 6 8 Quantity

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4. NEGATIVE INCOME ELASTICITY

An increase in income causes

a decrease in demand

Ed < 0 Income
2.0
Inferior goods
1.5

1.0

0.5 DD

2 4 6 8 Quantity

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 CROSS ELASTICITY OF
DEMAND (EY)
Definition:
Cross elasticity of demand measures the percentage change in
quantity demanded of a particular good caused by a percent
change in the price of another good.

Exy = Percentage change in Quantity of X

How to Calculate

Percentage change in price of Y

= % ∆ Qx
% ∆ Py
 
Where Δ = changes
 
%∆Q = New Quantity of X – Original Quantity of X x100
Original Quantityof X
 
% ∆ Y = New Price of Y – Original Price of Y X 100
Original Price of Y

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EXAMPLE
When the price of Mc Donald burger increase from RM2 to RM 2.50,

quantity demanded for KFC burger will increase from 12 to 20 pieces.

Exy = Qx1 - Qx0 / Qx0
 
So, we can say that… Py1 - Py0 / Py0

 Qx1 = 20
Qx0 = 12
 
Exy = 20 - 12
12
Py1 = 2.5 = 2.5 - 2
2
Py0 = 2
= 2.668

So, we can say that if price of burger Mc Donald increase by 1%,

Quantity demanded for burger KFC will increase by 2.668%.

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MEASUREMENT AND
INTERPRETATION

1. Zero Cross Elasticity

2. Positive Cross Elasticity
3. Negative Cross elasticity

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1. ZERO CROSS ELASTICITY

Any changes in price of a

particular good will not affect
the quantity demanded.
Px
DD
Exy = 0 2.0

1.5
E.g: Coffe and car
1.0

0.5
Independent Goods
2 4 6 8 Qy

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2. POSITIVE CROSS ELASTICITY
An increase in price of a particular good causes an
increase in quantity demanded of another good.

Px DD
Exy > 0
2.0

E.g: Cofee and Tea 1.5

Substitute good
1.0

0.5

2 4 6 8 Qy

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3. NEGATIVE CROSS ELASTICITY
An increase in price of a particular good causes a decrease
in quantity demanded of another good.

Px

Exy < 0 2.0

1.5

E.g: coffee and milk 1.0

DD
0.5
Complementary goods
2 4 6 8 Qy

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2. SUPPLY

DEFINITION
DEFINITION

DETERMINANTS
DETERMINANTS
Measurements
Measurements
OF
OF ELASTICITY
ELASTICITY

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 ELASTICITY OF SUPPLY (Es)
Price elasticity of demand supply measures the percentage
change in quantity supplied caused by a percent change in price.

Es = Percentage change in Quantity

How to Calculate

Percentage change in Price

=%∆Q
%∆P
 
Where Δ = changes
 
% ∆ Q = New Quantity – Original Quantity X 100
Original Quantity
 
% ∆ P = New Price – Original Price X 100
Original Price

35
EXAMPLE
Company XYZ supplied 20 unit cups when the prices are RM 2. But when the price of cup increase to

RM 4, the company increase supply to 30 unit .

Es = Q1 - Q0 / Q0
So, we can say that… P1 - P 0 / P 0
 
Q1 = 30 Es = 30-20
Q0 = 20 20
P1 = 4 = 4–2
2
P0 = 2
= 0.5

So, we can say that if price of cup increase by 1%, Quantity

supplied will increase by 0.5%.

36
MEASUREMENT AND
INTERPRETATION

1. Perfectly Inelastic
2. Inelastic
3. Unitary Elastic
4. Elastic
5. Perfectly Elastic

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1. PERFECTLY INELASTIC

Any changes in price will not

affect the quantity supplied.

Es = 0 Price
SS
2.0

E.g: Monalisa Potret 1.5

1.0

0.5

2 4 6 8 Quantity

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2. INELASTIC
An increase in price causes a smaller % increase in supply.

%∆Q<%∆P

Price SS
0< Es < 1
2.0
The curve will be steeper
1.5
E.g: Agriculture Good
1.0

0.5

2 4 6 8 Quantity

39
3. UNITARY ELASTIC
Unitary Elasticity is when there is an equally proportional change in
supply, following a change in price.

%∆Q=%∆P
Price
SS
2.0
Es = 1
1.5

E.g: Normal Good 1.0

0.5

2 4 6 8 Quantity

40
4. ELASTIC
An increase in prices causes a bigger % increase in supply

%∆Q>%∆P

Price
Es > 1 2.0

1.5 SS
The curve will be flatter
1.0

E.g: Manufactured Good

0.5

2 4 6 8 Quantity

41
5. PERFECTLY ELASTIC

The price will not affect as the

quantity supplied change

Es = ∞ Price
2.0
E.g: Price Control
1.5 SS

1.0

0.5

2 4 6 8 Quantity

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DETERMINANTS OF PRICE
ELASTICITY OF SUPPLY

1. Number of producer
2. The existence of Spare capacity
3. Ease of storing stocks
4. Length of production period
5. Factor mobility

43
1. NUMBER OF PRODUCER

The more producers there are, the easier it should be for the
industry to increase output in response to a price increase.
Supply will thus be more elastic.

Large numbers of producers Small numbers of producers

Price Price
SS
2.0 2.0

1.5 1.5

SS
1.0 1.0

0.5 0.5

2 4 6 8 Quantity 2 4 6 8 Quantity

Elastic SS curve Inelastic SS curve

44
2. THE EXISTENCE OF SPARE
CAPACITY
The more capacity there is in the industry, the easier it should be
to increase output if price goes up. This makes supply more
elastic.
Large Capacity Small Capacity
Price Price
SS
2.0 2.0

1.5 1.5

SS
1.0 1.0

0.5 0.5

2 4 6 8 Quantity 2 4 6 8 Quantity

Elastic SS curve Inelastic SS curve

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3. EASE OF STORING STOCKS
If it is easy to stock goods, then if the price rises the firm can sell
these stocks and so supply is more elastic. In the case of goods
such as fresh products, it may not be easy to store them and so
the supply will not be very flexible.
Non perish product Perishable product

Price Price
SS
2.0 2.0

1.5 1.5

SS
1.0 1.0

0.5 0.5

2 4 6 8 Quantity 2 4 6 8 Quantity

Elastic SS curve Inelastic SS curve

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4. LENGTH OF PRODUCTION PERIOD

The quicker a good is to produce, the easier it will be to respond to a

change in price; supply in manufacturing is usually more price elastic
than agriculture.
Shorter production time Shorter production time

Price Price
SS
2.0 2.0

1.5 1.5

SS
1.0 1.0

0.5 0.5

2 4 6 8 Quantity 2 4 6 8 Quantity

Elastic SS curve Inelastic SS curve

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5. FACTOR MOBILITY

The easier it is for resources to move into the industry, the more
elastic supply will be.

High mobile resources Not mobile/specialized resources

Price Price
SS
2.0 2.0

1.5 1.5

SS
1.0 1.0

0.5 0.5

2 4 6 8 Quantity 2 4 6 8 Quantity

Elastic SS curve Inelastic SS curve

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