CHAPTER 6: ELASTICITY

INTRODUCTION

In previous chapters, we looked at supply and demand. In this chapter we focus on the responsiveness
of the quantity demanded and the quantity supplied to changes in price and other determinants of
the quantity demanded and the quantity supplied. In other words, how sensitive are consumers and
producers to price changes.

9.1 INTRODUCTION

ELASTICITY

Elasticity is a measure of sensitivity. When two variables are related, one often wants to know how
sensitive the first is to changes in the second.

In econmics there are four types of elasticities, which include:

E pD Price elasticity of demand
EYD Income elasticity of demand
D
E xp
Cross-price elasticity of demand
E pS
Price elasticity of supply

6.2 PRICE ELASTICITY OF DEMAND (PED) AND SUPPLY (6.4)

DEMAND

PED is the % ▲ in the Qd if the price of the product ▲ by 1 %

%Q

%P

When calculating PED, you will have to categorise your answer into one of the categories above.

LECTURER NOTES | ECON 112 CHAPTER 6

SUPPLY

Price elasticity of supply measures producer’s reaction to price changes

PES is the % ▲ in the Qs if the price of the product ▲ by 1 %

%QS Elastic

Ep 
S ∞

%P
Relative elastic
(>1)
Relative
inelastic (0-1)
Inelastic
(0)
Unitary elastic
(1)

When calculating PED, you will have to categorise your answer into one of the categories above.

Categories of elasticity

Please note that the same categories are used for the price elasticity of supply. The only
difference is we use a supply curve and not a demand curve.
Perfectly elastic

Any Q at one P
E = I∞I

Consumers are
extremely sensitive
to price changes. A
small change in price
will result in quantity
dropping to zero.

LECTURER NOTES | ECON 112 CHAPTER 6

 Perfectly inelastic

Any P at one Q
E=0

Consumers are not

sensitive to price
changes. It does not
matter what the
price is, they will still
buy.

Unitary elastic

Same % change in
P&Q
%Q = %P
E=I1I

Relatively elastic

Q changes MORE
than P
%Q > %P
E>I1I

%Q

%P
2%P, 4%Q
4/2 = 2
Relatively inelastic

Q changes LESS than

P
%Q < %P
E<I1I

LECTURER NOTES | ECON 112 CHAPTER 6

Formulas to calculate elasticity:

Point formula

Q P
E 
P Q

1 P
E  Confused about how to calculate
slope Q
elasticity?

Have a look at the video in Chapter

Arc formula 6 on how to calculate elasticity.

Q  P
E 
P  Q

E
1

P
slope  Q

Price elasticity of demand and revenue

Ever wondered if producers should ask a lower price to sell more

and therefore make a bigger profit? Or should they ask a higher
price, sell less and therefore make a bigger profit? It all depends.
It depends on whether your producers or consumers are
sensitive to price changes.

Price elasticity of demand – The ratio of the percentage changes

in the quantity demanded of a good to the percentage change in
the price of that good, ceteris paribus.

Total revenue (or expenditure) – The price (P) of a good or service

multiplied by the quantity (Q) of that good or service sold. TR =
PQ.

Have a look at the following table regarding what price strategies

producers should implement.

LECTURER NOTES | ECON 112 CHAPTER 6

 Category Meaning Effect on total revenue
TR changes with P in the same
Q does not change when P direction as P; there is
Perfectly inelastic
changes therefore an incentive for
suppliers to raise prices.
TR changes in the same
direction as change in P; there
Relative inelastic %ΔQ<%ΔP
is therefore an incentive for
suppliers to raise prices.

Unitary elastic %ΔQ=%ΔP TR remains unchanged.

TR changes in the opposite

direction to change in P; There
Relatively elastic %ΔQ>%ΔP
is therefore an incentive for
suppliers to lower prices.
Indeterminate quantity
When P increases, Q falls to
demanded a given price;
Perfect elastic zero; TR therefore also falls to
nothing demanded a
zero.
fractionally higher price.

Want to see how the graph works? Have a look at the videos in Chapter 6.

Determinants of the price elasticity of demand

• Substitution possibilities
• The degree of complementarity of the product
• The type of want satisfied by the product
• The time period under consideration
• The proportion of income spent on the product
• Other possible determinants of price elasticity of demand
The definition of the product
Advertising
Durability
Number of uses of the product
Addiction
• The combined effect of the determinants

LECTURER NOTES | ECON 112 CHAPTER 6

The determinants of the price elasticity of supply
• The time period under consideration
• Price expectations
• Possibility of stockpiling the product
• Existence of excess capacity
• Availability of inputs

6.3 OTHER ELASTICITIES

Income elasticity

Income elasticity of demand is concerned with the sensitivity of the quantity demanded if the income
of consumers changes. As consumers’ incomes rise, the quantity demanded usually increases. The
question is, by how much will the quantity demanded change relative to the change in income.

Income elasticity measurers the responsiveness of the quantity demanded to changes in income.

Confused about how to calculate

income elasticity?
% change in Q demanded of product %QD
EY   Have a look at the video in Chapter
% change in consumer's income %Y
6 on how to calculate income
elasticity.

After you calculate income elasticity, it is important to categorise your answer; see flow diagram
below.

Income  Q
Income  Q

Essential good: 0 < e < 1

y
e >0 Normal good e < Inferior good
y y
Luxury good: e > 1
y
0
Income  Q
Income  Q

LECTURER NOTES | ECON 112 CHAPTER 6

Cross-price elasticity

The responsiveness of the quantity demanded of a particular good to changes in the price of a related
good. The ratio between the percentage change in quantity demanded of a product (the dependent
variable) and the percentage change in the price of a related product (the independent variable): ec =
percentage change in quantity demanded of product A / percentage change in the price of product B.
For unrelated goods, the cross-elasticity of demand is zero. For substitutes, the cross-elasticity of
demand is positive (if the price of one good changes, the quantity demanded of the substitute will
change in the same direction). For complements, the cross-elasticity of demand is negative (if the price
of one good changes, the quantity demanded of the complement will change in the opposite
direction).

Confused about how to

calculate cross-price elasticity?
% change in the Q demanded of product A %QAD
E 
D
 Have a look at the video in
%PB
xp
% change in the P of product B
Chapter 6 on how to calculate
cross-price elasticity.

Substitutes: A substitute is a good that can be used instead of another particular good in order to
satisfy a specific want (for example, jam is a substitute good for golden syrup). An increase in the price
of a substitute will result in an increase in demand for the other good, ceteris paribus. Similarly, a
decrease in the price of a substitute will lead to a decrease in demand for the good concerned.

Complements: A good that is used jointly or in conjunction with another good (such as bread and
margarine). These goods are related in such a way that a change in the price of the one good will result
in a change in the demand of the other good. For example, a reduction in the price of one good will
increase demand for that good, and so also increase the demand for the other complementary good
(for example, a car and petrol). Similarly, an increase in the price of the one good will result in a
decrease in demand for the other good.

Price of related
good  Q Price of related Q
good 

E <0 Complements
E > Substitutes xp
xp
0
Price of related
Price of related Q Q
good 
good 

LECTURER NOTES | ECON 112 CHAPTER 6

6.5 SUMMARY

LECTURER NOTES | ECON 112 CHAPTER 6