Introduction to economics

(Elasticity)
Norbert Szijártó, PhD
Department of World Economy
28-09-2022
Price elasticity
• Price elasticity of demand = (% change in quantity demanded) / (% change in price)

• Example:
• Suppose that a 10 percent increase in the price of an ice-cream cone causes the
amount of ice cream you buy to fall by 20 percent. We calculate your elasticity of
demand as

• Price elasticity of demand = (20 percent) / (10 percent) = 2

• In this example, the elasticity is 2, reflecting that the change in the quantity
demanded is proportionately twice as large as the change in the price.
Income elasticity
• Income elasticity denotes the percentage change in quantity demanded divided by
the percentage change in income, holding other things, such as prices, constant.

• Income elasticity = (% change in quantity of demand) / (% change in income)

• In general…
• High income elasticities, such as those for airline travel or yachts, indicate that the demand for these
goods rises rapidly as income increases.
• Low income elasticities, such as for potatoes or used furniture, denote a weak response of demand to
increases in income.
Income and substitution effects
• Income and substitution effects combine to determine the major characteristics of demand
curves of different commodities.
• Review of key concepts:
• The substitution effect occurs when a higher price leads to substitution of other goods for the
good whose price has risen.
• The income effect is the change in the quantity demanded of a good because the change in its
price has the effect of changing a consumer’s real income.
• Income elasticity is the percentage change in quantity demanded of a good divided by the
percentage change in income.
• Goods are substitutes if an increase in the price of one increases the demand for the other.
• Goods are complements if an increase in the price of one decreases the demand for the other.
• Goods are independent if a price change for one has no effect on the demand for the other
Empirical estimates of price and income
elasticities
Elasticity of supply
• The law of supply states that higher prices raise the quantity supplied.
• Definition for price elasticity of supply:
• A measure of how much the quantity supplied of a good responds to a change
in the price of that good, computed as the percentage change in quantity
supplied divided by the percentage change in price
• Supply of a good is said to be elastic if the quantity supplied responds
substantially to changes in the price.
• Supply is said to be inelastic if the quantity supplied responds only
slightly to changes in the price.
Computing the price elasticity of supply
• Price elasticity of supply = (percentage change in quantity supplied) / (percentage change in price)

• For example, suppose that an increase in the price of milk from $2.85 to $3.15 a gallon raises the
amount that dairy farmers produce from 9,000 to 11,000 gallons per month.

• The midpoint method

• Percentage change in price = (3.15 – 2.85)/(3) * 100% = 10%
• 3 = (3.15 + 2.85)/2

• Percentage change in quantity supplied = (11,000 - 9,000)/10,000 * 100% = 20%

• 10,000 = (11,000 + 9,000)/2

• Price elasticity = 20% / 10 % = 2

Problem 1 (price elasticity of demand)
• If the price of petrol has decreased from 408 to 400 and as a
consequence of this decrease the daily sales have increased from
21600 litres to 21910 litres.

• 1) Calculate the price elasticity of demand! Interpret the results!

Solution 1
• Price elasticity of demand
ε(P) = (% change in quantity demanded) / (% change in price)
BUT WHAT IS OUR REFERENCE POINT? The old price or the new price?
 application of the midpoint formula instead of differential calculus
• ε(P) = ((Q2 – Q1)/(P2 – P1)) * ((P1 + P2)/(Q1 + Q2))

• I -0.72 I < 1  inelastic demand

Thank you for your attention!