Elasticity Cont’d

Price Elasticity of SUpply

Price Elasticity of SUpply(PES)

Measures the responsives (degree of responsiveness) of quantity supplied to a

change in price of a good.
Formula PES= Percentage Change in Quantity SUpplied/ Percentage Change in
Price
THe result of this formula is known as the PES coefficient . There are five categories
of Elasticity of SUpply based on the PES Coefficient
These categories are:

Elastic(fairly Elastic)- 1<PES < Infinity

Inelastic(Fairly Inelastic)- 0< PES < 1
Unitary Elastic-PES =1
Perfectly Elastic - PES= Infinity
Perfectly Inelastic - PES= 0(zero)
Note well.

Suppliers prefer to have an elastic PES value. Because this means

they are able to respond and satisfy any unexpected changes in the
market condition/changes in price.
.

The more time the producer has the greater the

amount of resources he would be able to put together
and the greater would be the quantity supplied, THis
means the higher the PES coefficient.
Elastic SUpply)Fairly Elastic)

This refers to a situation where a change in price will lead to

a more than proportionate change in quantity
supplied.Example Suppose there is an increase in price from
$40 to $60. This leads to an increase in quantity supplied
from 100 to 250.
PES 1<PEs<Infinity
Calculation
PES = %Change in QS / % CHange in Price
% CHange in QS= (New QS- OLD QS/ OLD QS ) x 100
= (250-100 / 100) x 100
= 150%
% Change in Price = (New Price- Old Price/ OLd Price) x100
= (60-40/40) x 100
= 50 %
PES = 150/50 = 3
Inelastic Supply

The change in quantity supplied is less than proportionate to the change in

price. THis suggests that firms are not able to respond to higher prices as they
would like to. 0 <PES<1
AN increase in Price from $40 to 60$ leads to an increase in quantity supplies
from 210 to 280 units .
Example of inelastic supply
Calculations
PES = %Change in QS / % CHange in Price
% CHange in QS= (New QS- OLD QS/ OLD QS ) x 100
= (280-210 / 210) x 100
= 33.3%
% Change in Price = (New Price- Old Price/ OLd Price) x100
= (60-40/40) x 100
= 50 %
PES = 33.3%/50% = 0.67
Observations
0<PES <1
UNitary Elastic SUpply

This means a change in price brings about a proportional change in

quantity supplied.

Example. If the price goes up by 50% quantity supplied will increase by

50% . In this case the PES coefficient is equal to one.
As shown below the change in price is equal to
change in QS
Perfectly Inelastic SUpply

WHen supply does not respond to a change in price it is known as

perfectly inelastic supply. In this case PES = 0.
Example. SUppose we have a farmer or a fisherman . The catch per day or
the farming output per yield is fixed ,hence even if price increase for the
day the suppliers are not able to match this increase in price simply
because they cannot. The vertical supply curve indicates totally inelastic
supply
.Inelastic
SUpply
.
Perfectly Elastic Supply

THis means that the quantity supplied is highly responsive to a change in price.
In this case price elasticity of supply is equal to infinity . ANd it is shown by a
horizontal supply curve.
This would mean , that this company is able to scale up production on a
tremendous scale if price increases.
Perfectly
Elastic
Factors affecting Price Elasticity of Supply

Time(production time)- Price elasticity of supply tends to

increase with time . Over a short time if the price of a good or
service the firm produces increases,the firm would be unable to
increase production(inelastic PES). This is because the producer
does not have enough time and resources(Labor,land ,capital
etc) needed to increase production. Similarly,the longer the
period producers have to respond ,greater the PES-elastic
Gestation Period (maturity period)

SOme products such as vintage wines, rums and even rubber has a special
gestation period before it can be refined and offered for sale. This means if the
price of these goods were to increase the quantity supplied would not increase
simply because the goods are not ready/mature. These goods have inelastic
supply
On the other hand if a product does not have any gestation period meaning it can
be assembled overnight ,this product would have a elastic supply. This is because
production can be ramped up on a short notice. Eg. Face masks,computer
Nature COnstraints
The nature world places constraint on supply .eg. some
plants take ;long to grow/bear and also agriculture is affected
by inclement weather. So it is not possible to increase the
supply of some goods over night hence it is inelastic.
Also when Drought and floods occur they negatively affect
farming yields making supply inelastic as well.
Nature of the Industry and SPare Capacity
Available
The spare capacity refers to the amount of machinery and productive
capability that is not fully utilized by some industry. IF an industry if
producing close to its maximum possible level (ON the PPF ) this means
that they cannot respond to an increase in prices. However if an industry is
producing well within the PPF and has alot of spare capacity
available,supply is likely to be more elastic since they will more likely be
able to fill this gap.
hw.

1.IF price increase from 100 to $150 quantity supplied increases

from 1200 to 1300 calculate PES
2. Supply falls from 500 to 200 due to a decrease in price from
5$ to 4$
PES = %Change in QS / % CHange in Price
% CHange in QS= (New QS- OLD QS/ OLD QS ) x 100
= (1300-1200/1200) x 100
= 8.3%
% Change in Price = (New Price- Old Price/ OLd Price) x100
= (150-100/100) x 100
=50 %
PES = 8.3%/50%=0.167.
Inelastic Supply
PES = %Change in QS / % CHange in Price
% CHange in QS= (New QS- OLD QS/ OLD QS ) x 100
= (200-500/500) x 100
= -60%
% Change in Price = (New Price- Old Price/ OLd Price) x100
= (4-5/5) x 100
=-20%
PES = -60%/-20%=3 (elastic)
Income Elasticity of Demand (YED)
Income elasticity of demand measures the responsiveness of quantity demanded to a
change in income. In other words it is how a consumer responds to a change in their
income;meaning will they buy more or less of a particular good.
YED = Percentage CHange in QD/ Percentage Change in Income

= % Δ Qd / % Δ Y
THe YED coefficient is the result of the calculation above.
IFincome increases from 100$ to $150 and the demand for cars increase from
2 to 4. Income elasticty will be :
eg
YYED= Percentage CHange in QD/ Percentage Change in Income
% Change In QD = (4-2/2) x 100 = 100%
% Change in Y= (150-100/100) x 100 = 50%
YED= 100%/50%
=2
Unlike before with PED and PES ,income elasticity may be either positive or
negative . Value derived may be greater than 1 or less than 1.
Interpretation of YED Values
When Income elasticity of demand is Positive these goods are called normal goods.
This means that demand for the good will increase if income rises.
A positive value(normal good ) may be further classified into Necessity goods and
luxury goods.
Necessity Goods - WHen YED is between 0 and 1 ,the good is a necessities. This
means that demand rises with income ,but less than proportionately . This is
because we have a limited need to consume additional quantities of necessity
goods( Toothpaste, newspapers, vegetables, meat)
0<YED<1
Luxury Good - These goods have an income elasticity that is both positive and
greater than 1. Therefore YED 1<YED< Infinity. This means that demand rises or
falls more than a proportional change in income .

Inferior Goods- These goods have a negative income elasticity of demand . THis
means that demand falls as income rises . Also as income decreases people buy
more.
YED = -
Summary SHowing how income affects the following good
Income Effect Normal Necessity Luxury Goods Inferior goods
Goods (Goods of
Ostentation/Ve
blen )

Income Rises QD increases QD QD Decrease

increases(Less increases(great
than prop er proportion
increase) increase)

Income QD decrease QD QD QD increases

decreases decreases(how decreases(at a
ever at a larger
smaller proportion than
proprtion) income)
Special Cases of good

Giffen Goods - a giffen good is a lnferior product for which demand increases
even as income falls / prices rise.

Eg In the Irish Potato famine the price of potatoes rose however impoverished
consumers had little money left for any alternative.
exercise
1. John income increase from 100,000 to 150,000 and as a result his
consumption of ramen decreases from 10 to 7 units . Calculate the yEd and
interpret this result
2. MAry income falls from 1000 usd to 950 usd and as a result she now
consumes 5 take out meals per month from the 6 she used to . Calculate the
YED value for these meals
3. Eduardo income increases from 500,000 to 1.000.000 and as result his
number of sports cars increased from 1 to 5 . Calculate the YED of sport cars
and interpret.
4. JEff consumes 4 loaves of bread when his income is 1000 , when his incomes
increases to $1500 the loaves of bread consumes increases to 7
 1. John income increase from 100,000 to 150,000 and as a result his consumption of ramen decreases
from 10 to 7 units . Calculate the yEd and interpret this result

YED= % Change in QD / % Chnage in income

% Change in QD = (7-10)/10 x 100

= -30%

% Change in Y = (150,000-10000)/100000 x100

= 50%

YED = -30%/ 50% = --0.6

The good is an inferior good. THis means that as income increases demand for the product
decreases. Eg of inferior goods, ramen, sardine, tinned food etc
 1. MAry income falls from 1000 usd to 950 usd and as a result she now consumes 5 take out meals per
month from the 6 she used to . Calculate the YED value for these meals

YED= % Change in QD / % Chnage in income

% Change in QD = ( 5-6)/6 x 100

= -17%

% Change in Y = (950-1000)/(1000) x 100

= -5%

YED = -17%/ -5% =3.4

3.4 indicates that the good is a luxury good

 1. Eduardo income increases from 500,000 to 1.000.000 and as result his number of sports cars increased
from 1 to 5 . Calculate the YED of sport cars and interpret.

YED= % Change in QD / % Chnage in income

% Change in QD = (5-1 ) / 1 x 100

= 400%

% Change in Y = 1000000-500000/500000 x 100

= 100%

YED = 400%/100%

= 4 luxury good
 1. Jeff consumes 4 loaves of bread when his income is 1000 , when his incomes increases to $1500 the
loaves of bread consumes increases to 7

YED= % Change in QD / % Chnage in income

% Change in QD = (7-4)/4 x 100

= 75%

% Change in Y = ( 1500-1000) / 1000 x 100

= 50%

YED = 75/50% = 1.5

Luxury good
Cross Elasticity of Demand (XED)
XED measures the responsiveness of the quantity demanded of one
good(Good A) to a change in the price of another good(Good B) .

In other words, it measures how sensitive/responsive are consumer purchases

of one product if the price of the other good changes

XED = Percentage change in QD of good A/ Percentage Change in Price of Good

B

= % Δ QdA / % Δ $ b
The XED concept allows us to quantify and more fully understand substitute and
complementary goods relationships.

Example.

When the price of guava jam increases from 6$ to $12, the quantity demanded for peanut
butter increases from 6 to 8. Calculate the XED

XED = % Δ QD Peanut Butter/% Δ Price Guava Jam

% Δ QD P Butter = (8-6/6) x 100 =33.33%

% Δ Price Guava jam = (12-6/6) x100 =100%

XED= 33%/100% =0.333

The price of bread increases from $5 to 6 $,and as a result the QD of cheese falls from 10 to 9.
Calculate the XED.

XED = % Δ QD Cheesw/% Δ Price bread

% Δ QD Butter = (9-10/10) x 100 =-10%

% Δ Price bread= (6-5/5) x100 = 20%

XED= -10%/20%

XED= -0.5
 Breaking Down the XED Coefficient - The XED value can range from POSITIVE OR
NEGATIVE
Substitute Good(positive PED Value) XED for substitute good is always positive because the demand
for one good increases when the price for another increases . A low positive(closer to 0) value means
that the goods are weak substitutes , while a higher positive value (closer to 1)indicates that they are
strong substitutes(rivals)

Eg. If the price of coffee increases , the quantity demanded for tea as a result also increases as
consumers switch to this new alternative.

Complementary Goods- Alternatively the XED for complementary good is negative (-) . This means as
the price of one item increases the consumption of the other item decreases . This is because the
items are associated(used together) . eg bread and cheese, cars and gasolene. The closer the value of
the XED to 0, the weaker complements the goods are. The closer the XED value to -1, the stronger the
complements are.

Nb. If the value is (-1) the goods are direct complements

If the value is +1 the goods are direct substitute

What happens when the value is Zero- Independent Goods-No relationship between price and
quantity of these products.
Question 1

Cross elasticity of demand = % Change in QD A/ % CHange in Price B

% Change in QD A = 0%

% CHange in Price B = (30000-20000)/ 20000 x 100

= 50%

XED= 0%/ 50%

=0

Independent Goods- their price and quantities are not correlated/related

Q2
Cross elasticity of demand = % Change in QD A/ % CHange in Price B

% Change in QD A = (15000-5000)/5000 x 100

= 10000/5000 x100

=200%

% CHange in Price B = (30000-20000)/ 20000 x 100

= 50%

XED= 200%/ 50%

XED = 4