Elasticities of Demand and

Supply
Objectives:
At the end of this lesson, the students should be able to:
1. Reason effectively how a change in demand or supply or in both can affect
equilibrium price and equilibrium quantity;
2. Apply the principles of demand and supply to illustrate how prices of
commodities are determined; and
3. Distinguish between elastic and inelastic demand and supply.
 Elasticities of Demand and Supply
• We have learned how demand and supply respond to changes in their
determinants.
• Goods, however, differ in terms of how demand and supply respond to
changes to changes in these determinants. The degree of their response to a
change is referred to as elasticity.
• Elasticity is a measure of how much buyers and sellers respond to changes
in market conditions.
 What is Elasticity?

Elasticity is a measure of how much buyers and

sellers respond to changes in market conditions.
 Elasticities of Demand and Supply

• The coefficient of elasticity is the number obtained when

the percentage change in demand is divided by the
percentage change in the determinant.
• In terms of how responsive demand and supply are,
degrees of elasticity may either be:
1. Elastic Demand

• A change in a determinant will lead to a proportionately

greater change in demand or supply. The absolute value
of the coefficient of elasticity is greater than 1. If the
price of LPG increases by 10% and as a result the
quantity demanded goes down by 12%, then we say that
the demand for LPG is elastic.
2. Inelastic Demand

• A change in a determinant will lead to a proportionately

lesser change in demand or supply. The absolute value of
the coefficient of elasticity is less than 1. Suppose the
price of cell phone load goes up by 5% and the quantity
demanded goes down by 3%, then we can say that
demand for cell phone load is inelastic.
3. Unitary Elastic Demand

• A change in a determinant will lead to a proportionately

equal change in demand or supply. The absolute value of
the coefficient of elasticity is equal to 1. Let us say that
the price of string beans goes down by 6% also, we
describe the demand for string beans as unitary elastic.
 ELASTICITY OF DEMAND

• There are three types of elasticity of demand that

deal with the responses to a change in the price of
the good itself, in income, and in the price of a
related good, which is a substitute or a
complement.
 Price Elasticity of Demand

• This measures the responsiveness of demand to a

change in the price of the good. The concept of
elasticity is measured in percentage changes. The
value of price elasticity may be measured in two
ways:
1. Arc Elasticity
• The value of elasticity is computed by choosing two points on the
demand curve and comparing the percentage changes in the quantity and
the price on those two points.
• The computation of arc elasticity makes use of the following formula:
Ep = {(Q2-Q1)/(Q2+Q1/2)} ÷ {(P2-P1P)/(P2+P1/2)}
• Where: Q2= new quantity demanded Q1= original quantity demanded
P2 = new price of the good P1 = original price of the good
 Arc Elasticity
• Normally, coefficient of the price elasticity of demand has a negative sign
because it reflects the inverse relationship between price and the quantity
demanded.
• The size of the coefficient, regardless of the negative sign, will signify the
nature of the good involved.
• When price elasticity of demand is greater than 1, this signifies that the
demand is elastic since the percentage change in the quantity demanded is
greater than the percentage change in price
Arc Elasticity
• When price elasticity of demand is less than 1, this signifies that demand is
inelastic since the percentage change in quantity demanded is less than the
percentage change in price.
• Therefore, the good is essential since consumers will show a slight response
to a change in price.
• When the coefficient of price elasticity is equal to 1, the demand for the
product is unitary elastic, suggesting proportionate changes in quantity
demanded and the price of the good.
2. Point Elasticity
• It measures the degree of elasticity on a single point on the demand curve.
Changes on a single point are infinitesimally small. Ep = {(Q2-Q1)/Q1} ÷
{(P2-P1)/P1}
• Price elasticity is important to the seller since it gauges how far demand can
change relative to price. The price elasticity of demand measures how far
consumers are willing to buy a good especially when its price rises reflective
of the economic, social, and psychological forces shaping consumer
preference.
 Income Elasticity of Demand
• This measures how the quantity demanded changes as consumer income changes.
• Income Elasticity of Demand is equal to (% change in quantity demanded) / (%
change in income) A positive (+) sign for IE signifies that the good demanded is a
normal good, which is what a consumer tends to buy more when his income
increases.
• This is true for steak, pizzas, and luxury items. The negative (-) sign for IE indicates
the demand for inferior goods, which are goods that are bought when incomes are
low because low incomes prevent the consumers from buying higher priced goods.
 Cross Price Elasticity of Demand
• This measures how quantity demanded changes as the price of a related good changes.
• Cross elasticity (CE) measures the responsiveness of the demand for a good to the change
in the price of a substitute good or complement. Earlier in this chapter, we discussed what
substitute goods are and what complements are.
• A+ (positive) sign for CE signifies that the two goods involved are substitute goods which
means that as the price of the substitute good increases, the demand for the other good will
increase. This is true for rice and bread, which are substitute goods.
• If the price of bread go up, consumers will substitute rice for bread; thus, the demand for
rice increases. The – (negative) sign for CE indicates that the two goods are complements,
which means that the demand for a good will increase when the price of a complement
decreases. On the other hand, CE for cellphones and cellphone loads is negative.
 PRICE ELASTICITY OF SUPPLY

• With regard to supply, price elasticity of supply

determines whether the supply curve is steep or flat. A
steep curve signifies a high degree of elasticity or ability
to change, while a flat curve indicates an inability to
change in response to a change in the price of the good.
References
• Case, Karl E. and FAIR, Ray C. 2007. An Introduction to
Principles of Economics. Pearson 6th Edition, Education
International.
• Rosemary P. Dinio, PhD., and George A. Villasis. Applied
Economics, REX Book Store. First Edition
• Internet Sources: http://www.investopedia.com