CHAPTER 5

Unitary Elastic Demand (E = 1): Changes in price do not affect

ELASTICITY-measures how responsive one variable is to total expenditure. The percentage change in quantity demanded is
changes in another variable. It quantifies the sensitivity of demand or equal to the percentage change in price.
supply to factors like price changes or income levels.

A. PRICE ELASTICITY OF DEMAND C. INCOME ELASTICITY OF DEMAND

-is a measure used to show how the quantity demanded of a product
-measures how much the quantity demanded of a good changes in
or service changes when consumers' income changes. IED indicates
response to a price change. If the elasticity is greater than 1, demand
the sensitivity of demand to changes in income.
is elastic, meaning consumers are sensitive to price changes. If it’s
less than 1, demand is inelastic, indicating consumers are less
responsive. For example, luxury items tend to have elastic demand,
CATEGORIES OF INCOME ELASTICITY:
while necessities like food and medicine often have inelastic demand 1. Normal Goods: - IED > 0: Demand increases as income rises.
2. Inferior Goods: - IED < 0: Demand decreases as income increases.
3. Necessities: - IED < 1: Demand increases but not as quickly as
B. FORECASTING CHANGES IN TOTAL income rises.
EXPENDITURE AND REVENUE WHEN PRICES 4. Luxuries: - IED > 1: Demand increases faster than income rises.
CHANGE
When analyzing how changes in price affect total expenditure (or
revenue), the relationship between price elasticity of demand and D. CROSS ELASTICITY OF DEMAND
expenditure is crucial: -measures the responsiveness of the quantity demanded for one
good when the price of another good changes. It is particularly
Elastic Demand (E > 1): If the price decreases, total expenditure useful for understanding the relationship between two products,
increases. Consumers buy significantly more due to the price drop. If whether they are substitutes or complements.
the price increases, total expenditure decreases. Consumers buy
significantly less CATEGORIES OF CROSS ELASTICITY
1. Substitutes: - XED > 0: If the price of Good B increases, the
Inelastic Demand (E < 1): If the price decreases, total expenditure quantity demanded for Good A also increases. This indicates that the
decreases. The increase in quantity demanded is not enough to two goods are substitutes. For example, if the price of coffee rises,
offset the lower price. If the price increases, total expenditure the demand for tea may increase.
increases. Consumers continue buying despite the higher price.
2. Complements: - XED < 0: If the price of Good B increases, the 5. Perfectly Elastic Supply (PES = infinite): If PES is infinite, any
quantity demanded for Good A decreases. This indicates that the two change in price will result in an infinite change in the
goods are complements. For example, if the price of printers rises, quantity supplied.
the demand for ink cartridges may decrease.

3. Unrelated Goods: - XED = 0: If changes in the price of Good B have

no effect on the quantity demanded of Good A, the goods are F. TAX SHIFTING
considered unrelated. -refers to the process by which the burden of a tax is transferred
from one party to another, usually from producers to consumers,
depending on the elasticities of demand and supply.
E. PRICE ELASTICITY OF SUPPLY
-measures the responsiveness of the quantity supplied of a good or KEY CONCEPTS IN TAX SHIFTING
service to a change in its price. In other words, it shows how much
the quantity supplied changes in response to a percentage change in • Inelastic Demand: If demand is inelastic, the producer can
price. pass most of the tax onto the consumer in the form of higher
prices.
TYPES OF PRICE ELASTICITY OF SUPPLY • Elastic Demand: If demand is elastic, producers bear a larger
1. Elastic Supply (PES > 1): If PES is greater than 1, the quantity share of the tax because they cannot raise prices significantly
supplied is highly responsive to price changes. Even a small without losing customers.
price increase can result in a large increase in the quantity • Inelastic Supply: When supply is inelastic, the supplier bears
supplied. most of the tax.
2. Inelastic Supply (PES < 1): If PES is less than 1, the quantity • Elastic Supply: If supply is elastic, the tax burden shifts more
supplied is not very responsive to price changes. Even to the consumer, as suppliers cannot afford to bear the tax
significant price changes lead to only a small change in the and will raise prices.
quantity supplied.
3. Unitary Elastic Supply (PES = 1): If PES equals 1, the
percentage change in quantity supplied is exactly equal to
the percentage change in price.
4. Perfectly Inelastic Supply (PES = 0): When PES is 0, the
quantity supplied remains the same regardless of price
changes (e.g., supply of fixed goods like land).