Libyan International University’

Faculty of Business Administration

Elasticity of Demand
&
Its Applications
Lecture 4

Dr. Mariam Alkwafi

 Intended Learning Outcomes ILOs

• Understanding types of elasticity

• To calculate elasticity of demand
• To calculate elasticity of income
• To calculate cross-elasticity of demand

2 Dr. Mariam Alkwafi

 Elasticity

• Elasticity is a general concept that can

be used to quantify the response in one
variable when another variable
changes.

% A
elasticity o f A w ith resp ect to B 
% B
 Price Elasticity of Demand
 Price elasticity of demand is the percentage
change in quantity demanded given a percent
change in the price.

 It is a measure of how much the quantity

demanded of a good responds to a change in
the price of that good.
Computing the Price Elasticity of Demand

The price elasticity of demand is computed as

the percentage change in the quantity
demanded divided by the percentage change in
price.

Price Elasticity = Percentage Change in Qd

Of Demand Percentage Change in Price

 Computing the Price Elasticity of Demand

Percentage change in quatity demanded

Price elasticity of demand 
Percentage change in price
Example: If the price of an ice cream cone increases
from $2.00 to $2.20 and the amount you buy falls from
10 to 8 cones then your elasticity of demand would be
calculated as:
(8  10)
 100
10  20 percent
  2
(2.20  2.00) 10 percent
 100
2.00
 Price Elasticity of Demand

• A popular measure of elasticity is price

elasticity of demand measures how
responsive consumers are to changes
in the price of a product.

% ch an g e in q u an tity d em and ed
p rice elasticity of d em and 
% ch an ge in p rice
• The value of demand elasticity is always
negative, but it is stated in absolute
terms.
 Slope and Elasticity

• The value of the slope of the

demand curve and the value
of elasticity are not the same.
• Unlike the value of the slope,
the value of elasticity is a
useful measure of
responsiveness.

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 Slope and Elasticity
23 1 23 1
slope   slope  
10  5 5 160  80 80

• Changing the units of measure yields a very different

value of the slope, yet the behavior of buyers in both
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diagrams is identical.
 Types of Elasticity

Hypothetical Demand Elasticities for Four Products

% CHANGE % CHANGE IN
ELASTICITY
IN PRICE QUANTITY DEMANDED
PRODUCT (%DP) (%DQD) (%DQD
/ %DP)
Insulin +10% 0% 0.0 Perfectly inelastic
Basic telephone service +10% -1% -0.1 Inelastic
Beef +10% -10% -1.0 Unitarily elastic
Bananas +10% -30% -3.0 Elastic
 Perfectly Elastic and
Perfectly Inelastic Demand Curves

• When demand does not • Demand is perfectly elastic

respond at all to a change in when quantity demanded
price, demand is perfectly drops to zero at the slightest
inelastic. increase in price.
Calculating Elasticities

:Calculating percentage changes •

P2  P1
% ch an g e in p rice  x 100%
P1
Calculating Elasticities

• Elasticity is a ratio of
percentages.
• Using the values on the
graph to compute
elasticity, using
percentage changes
yields the following
result:
 100%
p rice elasticity o f d em an d    3 .0
 3 3 .3 %
 Calculating Elasticities
• A more accurate way of
computing elasticity than
percentage changes is the
midpoint formula:
Q 2  Q1
x 1 00 %
%  Q d ( Q1  Q 2 ) / 2

% P P2  P1
x 10 0 %
( P1  P2 ) / 2
10  5 5
x 1 00 % x 100%
% Qd (5  1 0 ) / 2 7 .5 6 6 .7 %
  =   1.6 7
% P 2  3 -1 -4 0.0 %
x 100% x 100%
(3  2) / 2 2 .5
 Calculating Elasticities
Here is how to interpret two different values of
elasticity:
• When e = 0.2, a 10% increase in price leads to
a 2% decrease in quantity demanded.
• When e = 2.0, a 10% increase in price leads to
a 20% decrease in quantity demanded.
 Elasticity Changes along a
Straight-Line Demand Curve

Price elasticity of •
demand decreases as
we move downward
along a straight line
.demand curve
Demand is elastic in •
the upper range and
inelastic in the lower
.range of the line
 Elasticity Changes along a
Straight-Line Demand Curve

- 6.4 Along the elastic •

range, elasticity values
.are greater than one

- .29 • Along the inelastic

range, elasticity values
are less than one.
 Elasticity and Total Revenue
TR  P  Q
Effect of an
Change in quantity increase in Effect of a
Type of versus change in price on total decrease in price
demand Value of Ed price revenue on total revenue
Elastic Greater than Larger percentage change Total revenue Total revenue
1.0 in quantity decreases increases
Inelastic Less than 1.0 Smaller percentage Total revenue Total revenue
change in quantity increases decreases
Unitary Equal to 1.0 Same percentage change Total revenue Total revenue does
elastic in quantity and price does not change not change

• When demand is inelastic, price and total revenues are directly

related. Price increases generate higher revenues.
• When demand is elastic, price and total revenues are indirectly
related. Price increases generate lower revenues.
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 The Determinants of
Demand Elasticity
• Availability of substitutes -- demand is more
elastic when there are more substitutes for
the product.
• Importance of the item in the budget --
demand is more elastic when the item is a
more significant portion of the consumer’s
budget.
• Time dimension -- demand becomes more
elastic over time.

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 Other Important Elasticities

• Income elasticity of demand –

measures the responsiveness of
demand to changes in income.
% ch an g e in q u an tity d em and ed
in co m e ela sticity of d em an d 
% ch an g e in inco m e

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 Income Elasticity
- - Types of Goods
 Normal Goods
 Income Elasticity is positive.
 Inferior Goods
 Income Elasticity is negative.
 Higher income raises the quantity demanded for
normal goods but lowers the quantity demanded for
inferior goods.
 Other Important Elasticities
• Cross-price elasticity of demand: A measure
of the response of the quantity of one good
demanded to a change in the price of another
good.
% ch an g e in qu an tity o f Y d em an d ed
cro ss - p rice elasticity o f d em an d 
% ch an g e in p rice o f X

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 Cross Price Elasticity of Demand
• Elasticity measure that looks at the impact a
change in the price of one good has on the
demand of another good.
• % change in demand QA/% change in price of
QB.
• Positive-Substitutes
• Negative-Complements.
 Other Important Elasticities
• Elasticity of supply: A measure of the
response of quantity of a good supplied to a
change in price of that good. Likely to be
positive in output markets.

% ch an g e in q uan tity su p p lied

elasticity of su pp ly 
% ch an g e in p rice

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 Elasticity of supply
• A measure of the response of quantity of a
good supplied to a change in price of that
good.
• Always Positive. WHY?