LECTURE NOTES ON ECONOMICS: ELASTICITY

Topic: Elasticity of Demand and Supply

Elasticity – is the percentage change in one variable resulting from 1-percent increase/decrease in
another.

- Measures the sensitivity of one variable to another

PRICE ELASTICITY OF DEMAND

𝒑𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 ∆𝑸 𝑷

Review: ∈𝑫,𝑷 = ∈𝑫,𝑷 = .
𝒑𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑷𝒓𝒊𝒄𝒆 ∆𝑷 𝑸

Interpretation/Meaning

Note: Price Elasticity of demand will always be negative in value given the fact of inverse relationship between price and quantity.
Because of this, we interpret the absolute value.

If ∈𝑫,𝑷 is greater than 1, the demand is relatively ELASTIC , which means quantity demand is
relatively sensitive to price change that even a small change in price
would result to a greater change in quantity.

If ∈𝑫,𝑷 is equal to 1, the demand is UNIT ELASTIC, which means quantity demand has a uniform
change with the price change.

If ∈𝑫,𝑷 is less than 1, the demand is relatively INELASTIC, which means quantity demand is
relatively insensitive to price change.

Linear Demand Curve: Q=a-bP

1 ∆P
Slope ≠ elasticity, which b = to which slope is since Price is in the Y-axis and Q is in the X-axis.
slope ∆Q

∆𝑸 𝑷 ∆Q
On the other hand, ∈𝑫,𝑷 = . Therefore, b =
∆𝑷 𝑸 ∆P

➢ The slope is constant along the straight demand curve (for linear demand curve) but elasticity value
changes along the curve

Example:

𝑷
The demand curve equation is Q= 8 – 2P, since b= -2, then ∈𝑫,𝑷 = −𝟐 ( 𝑸 )

In which at Price = 2 & Q = 4 the elasticity is

unitary elastic

1
LECTURE NOTES ON ECONOMICS: ELASTICITY

Polar Extremes

There are polar extremes, where the price elasticities are infinite or zero, or completely elastic or
complete inelastic.

Perfectly Elastic or Infinitely Elastic – consumers will buy as much as they can at a single price. But,
smallest increase in price above this level, the quantity demanded drops to zero, and for
any decrease in price, the quantity demanded increase without limit.

Perfectly Inelastic or Infinitely Inelastic – consumers will buy a fixed qty no matter what the price.

INCOME ELASTICITY OF DEMAND

Note: Income is represented with I and for some books M.

𝒑𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 ∆𝑸 𝑰

Review: ∈𝑫,𝑰 = ∈𝑫,𝑷 = .
𝒑𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑰𝒏𝒄𝒐𝒎𝒆 ∆𝑰 𝑸

Interpretation/Meaning

If ∈𝑫,𝑰 is NEGATIVE, the demand is relatively ELASTIC , which means the good is an INFERIOR
GOOD to which as income increase quantity demanded decreases.

If ∈𝑫,𝑰 is POSITIVE between 0 to 1 (decimal), the demand is relatively INELASTIC, which means
the good is a NORMAL GOOD specifically a Necessity Good to which
as income increases quantity demanded increases but as income
decreases the quantity consumption declines. These are the goods
consumers need in order to survive.

If ∈𝑫,𝑰 is POSITIVE greater than 1, the demand is relatively ELASTIC, which means the good is a
NORMAL GOOD specifically Luxury Good to which as income increases
consumer now can afford to buy the said good. These are the WANTS in
which, with or without it consumer can still survive to live.

2
LECTURE NOTES ON ECONOMICS: ELASTICITY

CROSS PRICE ELASTICITY OF DEMAND

Goal: TO know the percentage change in Quantity demanded for one good as a result to a 1-percent
change of the other good’s price.

Set Up: 2 Goods = Good A and Good B to which we would like to know the % change in Quantity for good
A as a result of the percentage Price change of Good B

𝒑𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒇𝒐𝒓 𝑮𝒐𝒐𝒅 𝑨

Review: ∈𝑫,𝑸𝒈𝒐𝒐𝒅 𝑨𝑷 𝒈𝒐𝒐𝒅 𝑩 = 𝒑𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑷𝒓𝒊𝒄𝒆 𝒐𝒇 𝑮𝒐𝒐𝒅 𝑩

∆ 𝑸𝑨 𝑷𝑩𝑰𝒏𝒊𝒕𝒊𝒂𝒍
∈𝑫,𝑸𝒈𝒐𝒐𝒅 𝑨𝑷 𝒈𝒐𝒐𝒅 𝑩 = .
∆ 𝑷𝑩 𝑸𝑨𝑰𝒏𝒊𝒕𝒊𝒂𝒍

Interpretation/Meaning

If ∈𝑫,𝑸𝒈𝒐𝒐𝒅 𝑨𝑷 𝒈𝒐𝒐𝒅 𝑩 is NEGATIVE, the two good are COMPLEMETS, which means a price increase for
Good B will result to a decrease in Qty consumption for Good B so as for
Good A even if there is no change with Good A’s price, given the fact
that Good A and Good B are consumed together which in the absence of
one the other good is useless. On the other hand, a price decrease
would result to an increase in demand for Good B so as to Good A
Example: Car and Gasoline

If ∈𝑫,𝑸𝒈𝒐𝒐𝒅 𝑨𝑷 𝒈𝒐𝒐𝒅 𝑩 is POSITIVE, the two goods are SUBSTITUTE, which a price increase for
Good B would result to a decrease in Qty consumption for Good B, but it
would increase the demand for Good A since the consumers whom use
to consume Good B may now transfer their consumption for Good A.
The consumer may choose either Good A or Good B given that they are
close substitute. Example: Coke and Pepsi

If ∈𝑫,𝑸𝒈𝒐𝒐𝒅 𝑨𝑷 𝒈𝒐𝒐𝒅 𝑩 is equal to ZERO, the two goods are NOT RELATED, which a price increase
or decrease of the price for Good B has nothing to do with consumers
consumption for Good A. Example: Eskinol Facial Cleanser and cellular
phone

POINT VS ARC ELASTICITY OF DEMAND

Point Price Elasticity – price elasticity of demand is Arc Price Elasticity – the price elasticity of demand is
at a particular point on the over a range of prices
demand curve.

∆𝐐 𝐏 ∆𝑸 𝑷
∈𝐃,𝐏 = . ∈𝑫,𝑷 = .
∆𝐏 𝐐 ∆𝑷 𝑸
where, % ∆ of Q is Qfinal𝑄𝑖𝑛𝑖𝑡𝑖𝑎𝑙
− Qinitial
𝑥 100 where, % ∆ of Q is
Qfinal − Qinitial
Qfinal + Qinitial 𝑥100
2

And, % ∆ of P is
Pfinal − Pinitial
𝑃𝑖𝑛𝑖𝑡𝑖𝑎𝑙
𝑋 100 And, % ∆ of P Pfinal − Pinitial
Pfinal + Pinitial 𝑥 100
2
Therefore,

P is the average price and Q is the average quantity

3
LECTURE NOTES ON ECONOMICS: ELASTICITY

PRICE ELASTICITY OF SUPPLY

𝒑𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 ∆𝑸 𝑷

Review: ∈𝑺,𝑷 = ∈𝑺,𝑷 = .
𝒑𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑷𝒓𝒊𝒄𝒆 ∆𝑷 𝑸

Interpretation/Meaning

Note: Price Elasticity of supply will always be positive in value given the fact of direct relationship between price and quantity.
Because of this, we interpret the absolute value.

If ∈𝑺,𝑷 is greater than 1, the supply is relatively ELASTIC , which means quantity supply is
relatively sensitive to price change that even a small change in price
would result to a greater change in quantity.

If ∈𝑺,𝑷 is equal to 1, the demand is UNIT ELASTIC, which means quantity supply has a uniform
change with the price change.

If ∈𝑺,𝑷 is less than 1, the demand is relatively INELASTIC, which means quantity supply is
relatively insensitive to price change.

Linear Supply Curve: Q=c + dP

1 ∆P
Slope ≠ elasticity, which d = to which slope is since Price is in the Y-axis and Q is in the X-axis.
slope ∆Q

∆𝑸 𝑷 ∆Q
On the other hand, ∈𝑺,𝑷 = . therefore, d =
∆𝑷 𝑸 ∆P

➢ The slope is constant along the straight demand curve (for linear supply curve) but elasticity value
changes along the curve

Example:

𝑷
The demand curve equation is Q= 20 + 5P, since d=5, then ∈𝑺,𝑷 = 𝟓 ( 𝑸 )

SHORT-RUN vs. LONG RUN ELASTICITES

- Flexibility of decision making

- Some goods are elastic in the short-run than in the long-run but for some it’s the other way
around.
Example:

GASOLINE: it takes CAR: If price increase,

time for the car initially consumers
owners to change may defer buying new
car which are fuel cars. But, in time old
efficient or plan a cars wear out and
new mechanism to must be replaced.
reduce the cost if
price increases Short-Run: relatively
elastic
Short-Run: relatively
inelastic Long-Run: relatively
inelastic
Long-Run: relatively
elastic

4
LECTURE NOTES ON ECONOMICS: ELASTICITY

“BACK OF THE ENVELOPE” – understanding and predicting the effects of changing market conditions.

Suppose the long-run price elasticity of supply for coffee is 1.5 and the long-run elasticity of
demand is -0.5. The equilibrium price is Php 3.00 and Equilibrium Quantity is 18. Using the back of the
envelope derive the demand and supply curve.

Recall: Demand Curve: Q = a-bP & Supply Curve: Q=c+dP