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Raising a new Generation of Leaders

Topic – Elasticity

ECN111
Introduction to Economics I (Micro)
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 Learning Objectives
• Understand the basic concepts of elasticities of demand
and supply

• Understand the types, features and determinants of

elasticity

• Apply the concept of elasticity to economic and business

related problems
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Elasticity

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Elasticity
The term ‘elasticity’ is an important concept in economics:

 It is defined as the percentage change in one variable (Y) resulting

from a 1-percent change in another variable (X).

 Specifically, it is a number that measures the sensitivity of one

variable to another.

 Elasticity (E) varies between 0 and ∞ (infinity); it can be positive or

negative.
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Substitutes….

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Complements….

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Determinants of Price Elasticity of Demand
1.Price of the commodity
 The response of demand for a commodity to an increase in price is a reflection of other factors relating to
that particular commodity e.g. the nature, availability of related products, taste of the consumer,
addiction and so on.
2.Nature of the commodity (normal and inferior goods)
 For normal goods that are necessities, elasticity of demand is positive and income inelastic or sometimes
zero, for luxury goods it is positive and income elastic while for inferior goods it is negative.
3.Prices and availability of related commodities
 Demand will be positive and elastic for goods with close substitutes, positive but inelastic for those
without close substitutes and negative for complements.
4.Income level
 Expensive goods (take large chunk of income) are demand elastic while demand for cheap ones are
inelastic. The greater the proportion of income spent on a good, the more elastic is the demand for the
product in relation to price.

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Determinants…..Contd.
5. Taste and preferences
 Commodities that are preferred are demand inelastic. This is because consumers will
always buy them regardless of price increase.
6. Time of adjustment
 Demand for goods over time becomes elastic as consumers identify substitutes. Demand is
price inelastic in the short-run.
7. Habits and addiction
 Goods that consumers are addicted to are demand inelastic. Quantity demanded does not
often respond to increase in price.
8. Production inputs
 Demand for production inputs are inelastic particularly if there are no alternatives. Since
raw materials are required for the production of other goods, manufacturers will buy them
regardless of increase in price.
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 Categories of Elasticity
Two main categories of ‘elasticity’:
1. Price Elasticity of demand

2. Price Elasticity of supply

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Price Elasticity of Demand

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Price Elasticity of Demand
Fig. 1
Elasticity of Demand

Income Elasticity of Cross-Price

Price Elasticity of Demand Elasticity of
Demand
Demand

Point Elasticity of Arc Elasticity of

Demand Demand

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Price Elasticity
of Demand

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Price Elasticity of Demand
Definition:
 The degree of responsiveness of demand for a commodity (X) to a
change in price of the commodity (Px).

 The percentage change in quantity demanded of a good resulting from

a 1-percent change in its price.

Ep .

(the symbol is the Greek capital letter delta; it means “the change in”)
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Price Elasticity of Demand……(2)
= change in quantity demanded of i.e. () A linear demand curve (LDC)
= change in price of i.e. () Fig. 2 is a straight line (Q = a - bP).

= initial quantity of
Price Ep = ∞ It has a constant slope ( and
as we move along the curve
the Ep changes.
= initial price of
Ep > 1
∆𝑷
∆𝑸 Ep = 1
Owing to the law of demand, Ep
is always negative. So, we focus on the P0 ----------------------------

•-------------------------
absolute value (│ │) of the elasticity
Ep < 1
coefficient to give a comment on the
degree of responsiveness of Q to changes in P. Ep = 0
Q0 Quantity

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Price Elasticity of Demand……(3)
Fig. 3 Price
Elasticity of Demand

Unitary Elastic
Elastic Demand Demand Perfectly Inelastic
(E>1) (E= 1) Demand
(E= 0)

Inelastic Demand Perfectly Elastic

(E< 1) Demand
(E=∞)

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 Demand for a product is
1. Elastic Demand price elastic if a change in
its price leads to a larger
Definition: The percentage change in the percentage change in
quantity demanded of a commodity is P Fig. 4 quantity demanded.

greater than the 1-percent change in

its price.
P1 ------------------------------

--
--------------------
P0 ------------------------------------------------------ D
In this case, the price elasticity of

----------------
demand is greater than 1 (i.e. Ep > 1).
Q1 Q0 Q
Some features of goods/services in this category are:
(a) luxuries (b) expensive and high-income goods (c) those with many substitutes
(d) those that are frequently bought or patronised and so on.
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2. Inelastic Demand
Definition: The percentage change in the
quantity demanded of a commodity is
Demand for a product is price
inelastic if a change in its price
leads to a smaller percentage
change in quantity demanded.
P D

smaller than the 1-percent change in Fig. 5

P1 --------------

------------------------------
its price.
P0 -------------------

-
--------------------
In this case, the price elasticity of
demand is less than 1 (i.e. Ep < 1).
Q1 Q0 Q
Some features of goods/services in this category are:
(a) necessities/essentials (b) those with few or no close substitutes (c) addictive
goods (d) goods not bought frequently
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 Quantity demanded
3. Unitary Elastic Demand responds in the exact
Fig. 6 proportion to change
Definition: The percentage change in in price.
quantity demanded of a commodity is P
equal to the 1-percent change in
its price.
P1 -------------------------------

--
--------------------
P0 --------------------------------------
This is a rare case in which the price

----------------
elasticity of demand is equal to 1 D

(i.e. Ep = 1). Q1 Q0 Q

Some features of goods/services in this category are those classified as essentials.

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4. Perfectly Elastic Demand A small rise in price
results in fall in demand
Definition: An infinitesimally small change Fig. 7 to zero; while a small fall
in price causes increase
in price results in an infinitely large change P in quantity demanded to
in quantity demanded. This exists when the infinity.

price is fixed, that is, an infinite range of

P0 D
quantities is associated with the same price.

-----------------------
-----------------------
-
----------------------
In this case, the price elasticity of demand is
infinity (i.e. Ep = ∞).
Q0 Q1 Q2 Q
This demand is applicable to perfectly competitive markets where there are homogenous
products e.g. a barbing salon, noodles, computers and so on.

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 A change in price results
5. Perfectly Inelastic Demand in no change in quantity
Definition: The percentage change in quantity demanded.
Fig. 8
demanded of a commodity is zero from the P D
1-percent change in its price. It means that a
P1 --------------------------
consumer will buy the good or service
regardless of its price movement. P0 --------------------------

In this case, the price elasticity of demand

is zero (i.e. Ep = 0).
Q0
Q
This demand is applicable to necessities (those with no close substitutes) and addicted
products e.g. salt, specific medications, cigarettes and so on.

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Categories of Price Elasticity of Demand
Elasticity Meaning

│εp│>1 • εp is high
•Demand is elastic in relation to price
•Change in price generates more than proportional change in quantity
demanded
│εp│<1 • εp is low
•Demand is inelastic in relation to price
•Change in price lead to less than proportional change in quantity
demanded
│εp│=1 • εp is of unitary elasticity
•Demand is unitary elastic in relation to price
•Change in price leads to a change of SAME proportion in quantity
demanded

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Categories of Price Elasticity of Demand…..(2)
Elasticity Meaning

│εp│→∞ • εp is with very large values

•Demand is perfectly elastic in relation to price
•An increase in price, not matter how small, will lead to a total
withdrawal of demand
•Quantity demanded will fall to zero when price increases even by a
very small amount
•Horizontal line
│εp│= 0 • εp is zero
•Demand is perfectly inelastic in relation to price
•Quantity demanded does not respond at all to changes in price; no
matter how high price rises, consumers will not cut back on the
quantity demanded; these applies to ‘necessities’
•Vertical line

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Price Elasticity of Demand….(5)
1. Point elasticity of demand:
 measures the responsiveness of demand to a very small
(infinitesimal) change in price.
Ep

2. Arc elasticity of demand:

 measures the responsiveness of demand to a large or
significant change in price.
Ep
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Income Elasticity of
Demand

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Income Elasticity of Demand
Defined as:

 The degree of responsiveness of demand for a commodity (x) to a

change in income of the consumer (M).

 The percentage change in quantity demanded resulting from a 1-

percent change in income.

EM .

(the demand for most goods rises when aggregate income rises)

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 Income Elasticity of Demand…..(2)
= change in quantity demanded of i.e. ()
= change in income i.e. (M M)
= initial quantity of Income
= initial income Fig. 9
Elasticity of Demand
Inferior goods @ high levels of income
Necessities @ intermediate levels of
Normal goods Inferior goods
income (E> 0) (E< 0)
Luxury goods @ low levels of income Positive elasticity Negative elasticity

Luxury goods Necessities

(E> 1) (0 <E< 1)
Demand is income-elastic Demand is income-inelastic

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 Income Elasticity of Demand…..(3)
1. Normal goods have a positive income elasticity of demand so as consumers'
income rises more is demanded at each price, that is, there is an outward shift
of the demand curve. These are classified into (a) luxuries and (b) necessities.

For luxury goods and services the percentage change Normal necessities have an income elasticity of
in quantity demanded is greater than the 1-percent demand of between 0 and 1. For example, if
change in income. Demand is income-elastic (> 1). income increases by 10% and the demand for
That is, demand rises more than proportionate to a bacon increases by 4% thus demand is rising less
change in income. For example, an increase in income than proportionately to income; or an increase in
might lead to a rise in the demand for new golf kits and
income will cause less demand for public transport
membership of a golf club while a decrease in income
system in preference for purchase of a car.
might lead to a cancellation of that membership or a
decrease in an ostentatious lifestyle. In this case,
demand is very income sensitive.

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Income Elasticity of Demand…..(3)
2. Inferior goods have a negative income elasticity of demand meaning that
demand falls as income rises. Typically, inferior goods or services exist where
superior goods are available and if the consumer has the means to afford it.
For inferior goods as income rises, demand declines and so too will the share of
income spent on inferior products. For instance, an increase in income will cause
a decrease in the demand for kerosene-cooking stoves in preference for
gas/electric cookers.

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Cross-Price Elasticity
of Demand

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Cross-Price Elasticity of Demand
Defined as:
 The degree of responsiveness of quantity demanded for a
commodity (x) to a change in the price of another commodity (y)

 The percentage change in quantity demanded of a good

resulting from a 1-percent change in the price of another
good.

E
.
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Cross-Price Elasticity of Demand…..(2)

Fig. 10

Cross-Price Elasticity of
Demand

Substitutes Complements Non-related

(E> 0) (E< 0) (E= 0)
Positive elasticity Negative elasticity Zero elasticity

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CPED – Substitutes (Close and Weak)
Close Substitutes (E.g.: Noodles) Weak Substitutes (E.g.: Airfares)
A small increase in the price of X leads to a A large rise in the price of Z leads to a small
large increase in the demand for Y increase in the demand for K
Price X Fig. 11a Price Z Fig. 11b
(N) Note: For substitutes, the cross- (N)
price elasticity of demand is
D 15’000 --------------------
positive. Increase in the price of

----------------------------
60 ------------------------- one will cause consumers to shift 10’000 ----------------
--------------------

--------------------
50 --------------- demand to the other. D
---------------

However, when consumers

become habitual purchasers of a
120 330
product, the cross price elasticity
Qty Y 4 7 Qty K
of demand against rival products
will decrease.

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CPED – Complements (Close and Weak)
Close Complements (E.g. Pop-Corn and Soft drinks) Weak Complements (E.g. Flour and Yeast)
A small decrease in the price of C (pop-corn) leads to a A large drop in the price of F (flour) causes
large increase in the demand for S (soft drinks) only a small increase in the demand for Y
(yeast)
Price C Fig. 12a Price F
(N) (N)
Fig. 12b
100 ----- 150 ------

-----------------------------
----------------------------

50 ------------------- 80 ---------
--------------------

--------------------
D Note: Complements are
in joint demand and CPED for
two (2) complements is D
negative. 3 5
4 12 Qty S Qty Y

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CPED – Non-related goods
• Non-related products have a zero cross elasticity.
 For example, the effect of a change in the price of tooth
gels on the demand for cooking oil. Since there is no
relation between the two commodities, the CPED is zero.

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 Price Elasticity Income Elasticity Cross - Price Elasticity

Ep> 1: Elastic demand EM> 0: Normal good E> 0: Substitutes

Ep< 1: Inelastic demand EM<0: Inferior good E< 0: Complementary

Ep = 1: Unitary demand EM> 1: Luxury good E= 0: Non-related

0 < EM< 1:Necessity

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Price Elasticity
of Supply

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Price Elasticity of Supply
Defined as:
 The percentage change in quantity supplied of a good resulting from a 1-
percent change in its price.

Es .

(The elasticity is usually positive because a higher market price gives suppliers
the incentive to increase output. However, for most manufactured goods, the
elasticity of supply with respect to prices of raw materials is negative).

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Price Elasticity of Supply.…(1)
Fig. 13
• Es = 0: no response in supply
Fig. 9
to change in price Price Es = 0

• Es < 1: % change in quantity supplied Es < 1 Es = 1

is less than % change in price

• Es = 1: % change in quantity
supplied is equal to % change in price P* Es = ∞

• Es > 1: % change in quantity supplied is Es > 1

greater than % change in price

• Es = ∞ : producers are willing to supply

as much as they can at a particular price Q* Quantity Supplied

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Determinants of Elasticity of Supply
1. Production inputs - Demand for production inputs are inelastic particularly if there
are no alternatives. Since raw materials are required for the production of other
goods, manufacturers will buy them regardless of increase in price.

2. Spare Capacity – A firm with more spare capacity has the ability to increase output
quickly without any rise in costs and therefore supply will be elastic

3. Stocks – A firm with high volume of stocks of raw materials and finished products
with respond to changes in demand quickly by supplying these stocks to the market
thus making supply to be elastic.

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Determinants……….
4. Ease of Factor Substitution - If capital and labour resources can
easily be switched (that is, mobile) then the elasticity of supply for a
product is likely to be elastic than if the factors of production are
immobile in response to changes in the pattern of demand for goods
and services.

5. Time Period – In the long-run, supply is likely to be more elastic and

inelastic in the short-run because of inability to change factor inputs.
For instance, in the agricultural sector the supply of products is fixed
and determined by planting decisions made months before, and
climatic conditions, which affect the production.
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Examples of Supply Elasticity
1. Petrol (gas) – The amount of petrol supplied would not change much
when the price of petrol changes, therefore it is inelastic.

2. Tickets (to a cinema/sports match) – Tickets are printed in a fixed

amount (there are only so many seats available), so no matter how
much the price changes, the amount supplied should always stay the
same. Tickets would be inelastic.

3. Clothing – If the market price of a certain clothing line drops, then the
production (and therefore supply) of those clothes will drop too. Thus,
clothings would be elastic.

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Examples of Supply Elasticity…..(2)
4. Electronic goods (games, cameras, etc.) – If the price of a certain
electronics, say, a games console drops, then production of the games
console would drop too. Electronics would be elastic.

5. Teaching – ceteris paribus, a teacher would teach the same number

of lecture hours regardless of whether there is an increase or
decrease in salary. Teaching would be perfectly inelastic.

6. Agri-produce switch – ceteris paribus, a producer’s ability to switch

between agricultural produce given the prevailing market price makes
production to be perfectly elastic.

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