ELASTICITY OF

DEMAND,SUPPLY AND INCOME

SESSION 3
By Elvira Hernández Benito
SESSION PLANING

Explanation of: Elasticity of Demand, Supply and Income.

Questions.
Exercises.
Questions.

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
ELASTICITY OF DEMAND, SUPPLY AND
INCOME.
Definition:

The elasticity (as used in economics) is the ratio of percentage change in the quantity demanded (or
supplied) to a percentage change in an economic variable, such as Price, Income, etc. Elasticity (we denoted it by
epsilon symbol) may be used to predict the responsiveness of demand (and supply) to change in such economic
variables.

The three types of elasticity we are going to study are:

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
•A)  Price elasticity of demand: measures the responsiveness of quantity demanded to changes in the
good´s own price. And it is represented by the formula:

Ɛd = =

which simplifies to:

Ɛd = *

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
•and  taking into account that for the linear demand function (P = a - bQ) the slope -b= , so if we invert
the fraction: = getting the “point of elasticity demand” as:

 
Ɛd = * =

Note: if Ɛd < -1 demand is elastic and if -1 < Ɛd < 0 demand is inelastic.

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
•B) Price elasticity of supply: follows the same idea as the elasticity of demand. But in this cases, as the
supply function is positively sloped, the coefficient of price elasticity of supply will be positive. And so:

Ɛs = =

 
Ɛs = *

Note: if Ɛs > 1 supply is elastic and if Ɛs < 1 supply is inelastic.

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
C) Income elasticity of demand: measures the responsiveness of demand for a particular good to changes in consumer
income and it is represented by a similar formula as seen before for demand and supply:

 
Ɛy = =

Note: if Ɛy > 1 the good is a luxury good, if 0 < Ɛ y < 1 the good is a normal good and if Ɛy < 0 the good is an
inferior good.

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
EXERCISE 1
Given the demand function Q=250-5P, where Q is the number of children´s watches demanded at €P
each:

a. Derive an expression for the point elasticity of demand in terms of P only.

b. Calculate the point elasticity at each of the following prices: P=20, P=25 and P=30.

c. Describe the effect of price changes (expressed as % changes) on demand at each of these prices.

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
SOLUTION
•   Q = 250 – 5P
a)

then P = 50 – 0,2Q (being a=50 and b=0,2)

We know that –b = and -=

Given that Ɛd = *
Ɛd = * =

As (–b*Q) = (P – a) then Ɛd =

In our case:   Ɛd =

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
• 
b)
P = 20
In this case:
Ɛd =
Ɛd = -0,67 > -1 then the demand is inelastic

P = 25
In this case:
Ɛd =
Ɛd = -1 then the demand is unit elastic

P = 30
In this case:
Ɛd =
Ɛd = -1,5 < -1 then the demand is elastic
Applied Business Mathematics
Elvira Hernández Benito
Academic Year 20-21
c)

For P = 20

An increase of 10% in price causes a 6,7% decrease in demand.

For P = 25

An increase of 10% in price causes a 10% decrease in demand.

For P = 30

An increase of 10% in price causes a 15% decrease in demand.

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
EXERCISE 2
The demand function for laptop bags is given by the equation

P = 3000 - 0.6Q

a) Plot the demand function.

b) Calculate the price elasticity of demand for Q = 1500 to Q = 4500 at intervals of 500.

c) Hence state the value of Q for which this product has unit elastic demand.

d) State the range of values for Q for which demand is elastic and inelastic.

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
SOLUTION
P = 3000 - 0.6Q

a)
Demand function P = 3000 - 0.6Q

2500

2000

1500
P

1000

500

0
1000 1500 2000 2500 3000 3500 4000 4500 5000

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
•  Given that Ɛd =
b)

For Q = 1500, P = 2100

then Ɛd = Ɛd = -2,33

For Q = 2000, P = 1800

then Ɛd = Ɛd = -1,5

For Q = 2500, P = 1500

then Ɛd = Ɛd = -1

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
• 
For Q = 3000, P = 1200
then Ɛd = Ɛd = -0,67

For Q = 3500, P = 900

then Ɛd = Ɛd = -0,43

For Q = 4000, P = 600

then Ɛd = Ɛd = -0,25

For Q = 4500, P = 300

then Ɛd = Ɛd = -0,11

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
c) Ɛd = -1

As we could see previously, this value for elasticity takes place when

Q = 2500 and P = 1500

That means that “demand is unit elastic when the price is €1500”

d) Seen that, we can conclude that:

- From Q=1500 until Q<2500, Ɛd < -1 then “demand is elastic”

- From Q>2500 until Q=4500, Ɛd > -1 then “demand is inelastic”

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
EXERCISE 3
The demand and supply functions for a good are:

Pd = 52 – 2Q

Ps = 10 + 4Q

a) Find the equilibrium point and graph the functions.

b) Find the point elasticity of supply and the point elasticity of demand where P=35 and give
an interpretation of the results in terms of percentage changes.

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
Pd = 52 – 2Q

Ps = 10 + 4Q

a) Equilibrium point:

It happens when Pd = Ps
That means that:
52 – 2Q = 10 + 4Q
52 – 10 = 4Q + 2Q
42 = 6Q
then: Q = 7
and P = 38

Equilibrium point: (7, 38)

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
Graphically:
First, we set a table of values for P and Q:

Q 0 1 2 3 4 5 6 7 8 9 10
Ps =10 + 4*Q 52 50 48 46 44 42 40 38 36 34 32
Pd =52 - 2*Q 10 14 18 22 26 30 34 38 42 46 50

as we can see, the common value of Q for Pd and Ps is Q=7

Plotting the graphs:

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
•P  = 52 – 2Q
d

Ps = 10 + 4Q

b) Point elasticity of supply and demand when P=35

- Point elasticity of supply:

Ɛs = *

given that :

= (the inverse of he slope) P=35 and Q= =6.25

then:

Ɛs =

Ɛs = 1.4 (when prices increase 10% the quantity supplied increases 14%)

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21
•d  = 52 – 2Q
P

Ps = 10 + 4Q

- Point elasticity of demand:

Ɛd = *

given that :

= (the inverse of the slope) P=35 and Q= =8.5

then:

Ɛd = -

Ɛd = -2.06 (when prices increase 10% the quantity demanded decreases 20.6%)

Applied Business Mathematics

Elvira Hernández Benito
Academic Year 20-21