Elasticity as a measure of

responsiveness

Y = Effect variable
X = Cause variable
Y=ƒ(X)
Y=α–βX

Where α & β are the coefficients

Summing UP
Introductory
Economic
Lecture 6
 Elasticity

Definitions
Computations
Recap
 Y = α – βX in Y-X space
Y E (elastic)

C
P
R
Q
A B IE (inelastic)

O X
β = slope = ∆Y / ∆X
CA / AB > PQ / QR
 Real world example
Qd
E ( elastic )

C
P
R
Q
A B IE ( inelastic )

P
Conventional representation
P
IE ( inelastic )
R
B
C
A
Q P E ( elastic )

Qd
 Slope of a demand curve

Slope of a demand curve = β

Higher slope = Inelastic demand curve

(Steep)

Lower slope = Elastic demand curve

(Flat)
 Price elasticity of other variables

Y=ƒ(X)

1. Y = Qd & X = Price Price elasticity

of demand.
2. Y = Qs & X = Price Price elasticity
of supply.
3. Y = Qd & X = Income Income
elasticity of demand.
4. Y = Qda & X = Priceb Cross
price elasticity of demand.
 Formal definition of the four
combinations
1. Price elasticity of demand

can be defined as

PЄd = Percentage change in Quantity Demanded

Percentage change in Price

Where Є = Epsilon; universal notation for

elasticity.
PЄd = Percentage change in Quantity Demanded
Percentage change in Price

Example
If, for example, a 20% increase in the price of a
product causes a 10% fall in the Quantity
demanded , the price elasticity of demand will be:

PЄd = - 10% = - 0.5

20%
 Formal definition of the four
combinations

2. Price elasticity of supply

can be defined as

PЄs = Percentage change in Quantity Supplied

Percentage change in Price
 PЄs = Percentage change in Quantity Supplied
Percentage change in Price

Example
If a 15% rise in the price of a product causes a
15% rise in the quantity supplied, the price
elasticity of supply will be:

PЄs = 15 % = 1
15 %
 Formal definition of the four
combinations

3. Income elasticity of demand

can be defined as

YЄd = Percentage change in Quantity Demanded

Percentage change in Income
YЄd = Percentage change in Quantity Demanded
Percentage change in Income

Example
If a 2% rise in the consumer’s incomes causes an
8% rise in product’s demand, then the income
elasticity of demand for the product will be :

YЄd = 8% = 4
2%
 Formal definition of the four
combinations

4. Cross price elasticity of demand

can be defined as

PbЄda = Percentage change in Demand for good a

Percentage change in Price of good b
PbЄda = Percentage change in Demand for good a
Percentage change in Price of good b

Example
If, for example, the demand for butter rose by
2% when the price of margarine rose by 8%,
then the cross price elasticity of demand of
butter with respect to the price of margarine will
be.

PbЄda = 2% = 0.25
8%
 PbЄda = Percentage change in Demand for good a
Percentage change in Price of good b

Example

If, on the other hand, the price of bread (a compliment)

rose, the demand for butter would fall. If a 4% rise in
the price of bread led to a 3% fall in the demand for
butter, the cross-price elasticity of demand for butter
with respect to bread would be :
PbЄda = - 3% = - 0.75
4%
 0 < |Є|< (for absolute values of elasticity)

8
Є=0
P
P Є<1
Qd P Є=1
Qd
P Є >1
Qd P Є=α
Qd

Inelastic Elastic Qd

Perfectly Inelastic Unit Elastic Perfectly Elastic

 Total revenue and elasticity

Firm A Firm B

O O

* Not perfect competition

 Firm A

P OAFD > OBTC

10 D F TR as P
Inelastic demand Curve
6C T

A B
O 90 100 Qd
 Firm B

P OVZU > OYUR

TR as P
Elastic demand curve
R U
7
U Z
6

Y V
O 40 100 Qd
 Numerical calculation of elasticity for
firm A
Є = percentage change in Qd
P percentage change in P

10 D F = 90 – 100 10 – 6
100 6

6C T = - 0.15

A B
O 90 100 Qd
 Numerical calculation of elasticity for
Firm B
Є = percentage change in Qd
percentage change in P
P
= 40 – 100 7–6
100 6
R U
7 =-3.6
U Z
6

Y V
O 40 100 Qd
 Elastic demand between 2 points

8 ЄKL = percentage change in Qd

K
percentage change in P
6 L
= 16– 8 ÷ 6–8
8 8
= -4

O 8 16 Qd

TR as the P
 Inelastic demand between 2 points

ЄGH = percentage change in Qd

P
percentage change in P
G = 36– 28 ÷ 1 – 3
3 28 3
H =-3
1 7

O 28 36 Qd

TR as the P
Overview of previous example
ЄKL = percentage change in Qd
percentage change in P
= 16– 8 ÷ 6 – 8
8 8
= -4
ЄLK = percentage change in Qd
percentage change in P
= 8 – 16 ÷ 8 – 6
16 6
= -3
2
 Concept of arc elasticity
As Є = ∆ Q ÷ ∆ P
Q P
To measure arc elasticity we take average values for Q and
P respectively.

ЄKL = 16– 8 ÷ 6–8 =-7

12 7 3

ЄLK = 8 – 16 ÷ 8 – 6 =-7

average elasticity12
along arc KL 7or LK is 3- 7/ 3
 Point elasticity

Є=∆Q ÷ ∆P
Q P

Є= ∆Q x P
∆P Q

d = infinitely small change in price

Є=dQ x P
dP Q

A straight line demand curve will have a different Є at

each point on it except Є = 0 or Є = α .
 Previous example
P
dP = -1
8 K dQ 4
L P at K = 8 = 1
6 Q 8
Є = - 4 x 1 = -4
Qd
O 8 16 P at L = 6 = -3
Q 16 8
Є=-4x3 =-3
8 2
 Qd = 60 – 15P + P2

P 60 - 15 P P2 Qd (000s)
0 60 0 0 60
1 60 -15 1 46
2 60 -30 4 34
3 60 -45 9 24
4 60 -60 16 16
5 60 -75 25 10
6 60 -90 36 6
 7 Qd (000s)
6
5
4
Price

3
2
1
0
0 20 40 60 80
Quantity demanded
 PЄd = d Q x P
dP Q

Differentiating the demand Equation

Given Qd = 60 – 15P + P2
then dQ/dP = -15 + 2P
Thus at a price of 3 for example,
dQ/dP = -15 + ( 2 x 3 ) = -9 Thus price Elasticity of
demand at Price 3 is - 9 x P/Q
= - 9 x 3 / 24 = - 9 / 8