Chapter Five

Elasticity's of Demand
and Supply
1. Price Elasticity of Demand
 Price elasticity of demand is a measure of the
responsiveness of the quantity demanded to a price
change, other things being equal.
 Price elasticity of demand is the percentage change in
quantity demanded due to a 1% increase in price.
 The price elasticity of demand answers the following
question:
By what percent would the quantity demanded of the good
changes if the price of the good increases by 1%?
A) Calculating the Price Elasticity of
Demand:
 The price elasticity of demand is calculated as
 The elasticity formula always yields a negative value because
price and quantity move in opposite directions (demand law).

 But it is the magnitude, or absolute value, of the price

elasticity of demand that reveals how responsive the quantity
demanded is to a price change.

 Therefore, since we already know the sign of the price

elasticity of demand, we ignore it and consider only the
absolute value.

 In determining the elasticity of demand, we consider only the

absolute value of price elasticity of demand, not the true
negative value.
 B) Different Cases of Price Elasticity of
Demand
Cases of Elasticity Elasticity The shape of the Demand Curve

1. Demand is elastic Relatively

(i.e. if a percentage change in price Flat
leads to a greater percentage
change in quantity demanded).

2. Demand is inelastic Steep

(i.e. a percentage change in price
leads to a smaller percentage
change in quantity demanded).

3. Unit-Elastic Demand Flat

(i.e. a percentage change in price
leads to an equal percentage change
in quantity demanded.
 Cases of Elasticity Elasticity The shape of the
Demand Curve
4. Perfectly-Elastic Demand Horizontal
(i.e. a very small change in price
leads to an infinite percentage
change in quantity demanded).

5. Perfectly-Inelastic Demand Vertical

(i.e. any increase or decrease in
price leads to no change in quantity
demanded).
Examples (1):
If the price of pizza is $4, the quantity demanded of pizza is
60 slices. When the price of pizza drops to $2, the quantity
demanded of pizza is 80 slices. Calculate the price elasticity
of demand.
Solution:
Ed = = ÷ = -0.66

Therefore, since , demand is price-inelastic

C) Total Revenue and Price Elasticity of
Demand
The total revenue from the sale of good or service
equals the price of the good multiplied by the
quantity sold.

But a rise in price doesn’t always increase total

revenue. This is because a rise in price leads to a
decrease in quantity demanded (sold). The increase
in price would increase total revenue, but the
decrease in quantity sold would decrease total
revenue.
Therefore,
 Ifthe percentage increase in price is greater than
the percentage decrease in quantity sold (i.e.
demand is inelastic), total revenue would
increase.
 Ifthe percentage increase in price is smaller than
the percentage decrease in quantity sold (i.e.
demand is elastic), total revenue would decrease.
 Ifthe percentage increase in price is equal to the
percentage decrease in quantity sold (i.e.
demand is unit elastic), total revenue would not
change.
2. Income Elasticity of Demand

Income elasticity of demand measures the

responsiveness of quantity demanded of a good to a
change in consumers’ income.
The income elasticity of demand answers the
following question:
By what percent would the quantity demanded of
the good changes if consumers’ income increases by
1%?
It is computed
as:
The sign of the income elasticity of demand
determines whether the good is normal or inferior.
 If the sign of is positive, the good is normal.
 If the sign of is negative, the good is inferior.
Example:
 Following an increase in income from £40,000 to
£50,000, an individual consumer buys 40 DVD films
per year, instead of 20.Calculate income elasticity
of demand. What type of goods are DVD films?
Ei= = ÷ = ÷ = 4
Since is positive and greater than one, DVD movies are
normal.
3. Cross-Price Elasticity of Demand

 The cross-price elasticity of demand is a measure

of the responsiveness of demand for a good to a
change in the price of another good, other things
remaining the same.
 The cross-price elasticity of demand for good X
relative to good Y is the percentage change in the
quantity demanded of X due to a one-percent
increase in the price of good Y.
 The cross-price elasticity of demand for X relative to
Y answers the following question:
By what percent would the quantity demanded of good
X changes if the price of good Y increases by 1%?
 The formula for calculating the cross-price
elasticity is:
 The sign of the cross-price elasticity of demand
determines the relationship between the two goods, X
& Y.
 If is positive, the two goods are substitutes.
 If is negative, the two goods are complements.
 If is zero, the two goods are unrelated.
Example (1):
If the price of X changes from L.E 6 to L.E 7 per unit
and as a result the consumer's demand for Y changes
from 60 to 80 units, calculate the cross-price
elasticity of demand for Y. what is the relationship
between the two goods?
Solution
EC

Since , then X and Y are substitutes.

Example (2)
You are given market data that says when the
price of pizza is $4, the quantity demanded of
pizza is 60 slices and the quantity demanded of
cheese bread is 100 pieces. When the price of
pizza is $2, the quantity demanded of pizza is 80
slices and the quantity demanded of cheese
bread is 70 pieces. Calculate cross-price
elasticity of demand for cheese bread relative to
pizza.
Example (2)
 Last year the price of corn was $3 per bushel and the
quantity of corn supplied was 8 million bushels. This year
the price of corn is $4 per bushel and the quantity of corn
supplied is 10 million bushels. what is the price elasticity
of supply of corn ?