Business Economics-I

Session 4
Dr. Durba Chakrabarty
ME
The Economic Concept of Elasticity

 Elasticity: the percentage change in one variable

relative to a percentage change in another.

percent change in A
Elasticity 
percent change in B
Elasticity of Demand

 Elasticityrefers to the measure of responsiveness

in the quantity demanded of a commodity to
changes in each of the forces that determine
demand.
Price Elasticity of Demand

 Price elasticity of demand (Ep) is given by the percentage

change in the quantity demanded of the commodity
divided by the percentage change in its price, holding
constant all the other variables in the demand function.

% Quantity
Ep 
% Price
Price Elasticity of Demand

 Point elasticity: elasticity measured at a given point of a

demand (or supply) curve. Instead of estimating over a
range of prices, it is the elasticity at a specific price. The
point elasticity of a linear demand function can be
expressed as:

Q / Q Q P
EP   
 P / P P Q
Price Elasticity of Demand
 Arc price elasticity: elasticity which is measured over a discrete interval of
the demand curve

Q2  Q1 P2  P1
Ep  
(Q1  Q2 ) / 2 ( P1  P2 ) / 2
Ep = arc price elasticity
Q1 = original quantity demanded
Q2 = new quantity demanded
P1 = original price
P2 = new price
Price Elasticity of Demand

Q2  Q1 P2  P1
Arc Definition EP  
P2  P1 Q2  Q1
Price Elasticity of Demand

 When demand is nonlinear, the calculation of ΔQ/ΔP is

somewhat more complicated because the slope of a curve
changes. This slope is obtained using the calculus concept
of derivative. In this instance,

Ed= dQ/dP * P1/Q1

 The derivative of Q with respect to P (i.e., dQ/dP) is

simply the instantaneous version of slope.
Price Elasticity of Demand
 An example of a nonlinear demand curves is
one with constant elasticity

• such a curve has a nonlinear equation:

Q = aP-b

• where –b is the elasticity coefficient

Price Elasticity of Demand

 Categories of elasticity
• Relative elasticity of demand: Ep > 1= elastic demand
• Relative inelasticity of demand: 0 < Ep < 1=inelastic
demand
• Unitary elasticity of demand: Ep = 1= unit elastic
demand
• Perfect elasticity : Ep = ∞ = perfectly elastic demand
• Perfect inelasticity: Ep = 0= perfectly inelastic
demand
Elastic Economic Relations

 When an elasticity is large (greater than 1 in absolute

value), we call the relation that it describes elastic.
 Elastic demand means that the quantity demanded is sensitive to
the price.
 Elastic supply means that the quantity supplied is sensitive to the
price.
Inelastic Economic Relations

 When an elasticity is small (between 0 and 1 in absolute

value), we call the relation that it describes inelastic.
 Inelastic demand means that the quantity demanded is not very
sensitive to the price.
 Inelastic supply means that the quantity supplied is not very
sensitive to the price.
Some Technical Definitions For Extreme
Elasticity Values
 Economists use the terms “perfectly elastic” and
“perfectly inelastic” to describe extreme values
of price elasticities.
 Perfectly elastic means the quantity (demanded
or supplied) is as price sensitive as possible.
 Perfectly
inelastic means that the quantity
(demanded or supplied) has no price sensitivity at
all.
Perfectly Elastic Demand
 We say that
demand is Price
perfectly elastic
when a 1%
change in the Perfectly Elastic Demand
(elasticity = ¥)
price would
result in an
infinite change in
quantity
demanded.

Quantity
Perfectly Inelastic Demand
 We say that
demand is Pric
e
perfectly
inelastic when a
1% change in the
Perfectly
price would Inelastic
result in no Demand
change in (elasticity =
0)
quantity
demanded.

Quantity
Determinants of Price Elasticity of
Demand
The demand for a commodity will be more price elastic if:
 It has more close substitutes
 More time is available for buyers to adjust to a price
change

The demand for a commodity will be less price elastic if:

 It has fewer substitutes
 Less time is available for buyers to adjust to a price
change
Cross-price Elasticity of Demand

 Cross-price elasticity of demand: the percentage

change in quantity consumed of one product as a
result of a 1 percent change in the price of a
related product
%QA
Ex 
%PB
Cross-price Elasticity of Demand

 Arccross-elasticity-relates the percentage change

in quantity to the percentage change in the price
of another product (either a substitute or a
complement).
Q2 A  Q1 A P2 B  P1B
EX  
(Q1 A  Q2 A ) / 2 ( P1B  P2 B ) / 2
Cross-price Elasticity of Demand

 The sign of cross-elasticity for substitutes is positive

 The sign of cross-elasticity for complements is negative.
 Two products are considered good substitutes or
complements when the coefficient is larger than 0.5 (in
absolute value).
Income Elasticity

 Income elasticity of demand: the percentage change in

quantity demanded caused by a 1 percent change in
income
% Q
EY 
%Y

(Y is shorthand for income)

Income Elasticity

 Categories of income
elasticity

 superior or luxury
goods:
EY > 1
 normal goods:
0 ≤ EY ≤ 1
 inferior goods:
EY < 0
Income Elasticity of Demand

 The elasticity of demand with respect to a consumer’s

income is called the income elasticity.
 When the income elasticity of demand is positive (normal good),
consumers increase their purchases of the good as their incomes rise
(e.g. automobiles, clothing).
 When the income elasticity of demand is greater than 1 (luxury
good), consumers increase their purchases of the good more than
proportionate to the income increase (e.g. ski vacations).
 When the income elasticity of demand is negative (inferior good),
consumers reduce their purchases of the good as their incomes rise
(e.g. potatoes).
Elasticity of Supply
 Priceelasticity of supply: the percentage
change in quantity supplied as a result of a 1
percent change in price
% Quantity Supplied
ES 
% Price

The coefficient of supply elasticity is a normally a positive

number
Elasticity of Supply

 When the supply curve is more elastic, the effect of a

change on quantity supplied will be greater than the
change in the price of the product , Es >1

 When the supply curve is less elastic, a change in supply

will have a greater effect on price than on quantity, Es <1