CH-3

Elasticity & Its Applications

Prepared by: Dr. Amit A Rajdev,
Assistant Professor,
AITS.
 Chapter Plan..
1. Concept of Elasticity
2. Types of Elasticity of Demand
3. Price Elasticity of Demand
4. Degrees/Types of Price Elasticity of Demand
5. Determinants of Price Elasticity of Demand
6. Total Revenue and Price Elasticity of Demand
7. Elasticity of a Linear Demand Curve
8. Income Elasticity of Demand
9. Cross Elasticity of Demand
10. Elasticity of Supply
11. Application of Elasticity

Prepared by Mr. Amit A Rajdev, Assistant

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Professor, AITS.
 Concept of Elasticity
• The degree of responsiveness of demand to change its
determinants is called elasticity of demand.

• The important ones are the following:

1. Price Elasticity of Demand
2. Income Elasticity of Demand
3. Cross Elasticity of Demand
4. Promotional (advertisement) Elasticity of demand

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Professor, AITS.
 Price Elasticity of Demand
• It is defined as the responsiveness or sensitiveness of
demand for a commodity to the changes in price.

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Professor, AITS.
Example

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Professor, AITS.
Degrees of Price Elasticity of Demand
1. Perfectly Elastic Demand
2. Elastic Demand
3. Unitary Elastic Demand
4. Inelastic Demand
5. Perfectly Inelastic Demand

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Professor, AITS.
Figure 1 The Price Elasticity of Demand
(a) Perfectly Inelastic Demand: Elasticity Equals 0

Price
Demand

$5

4
1. An
increase
in price . . .

0 100 Quantity

2. . . . leaves the quantity demanded unchanged.

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Professor, AITS.
 Figure 1 The Price Elasticity of Demand

(b) Inelastic Demand: Elasticity Is Less Than 1

Price

$5

4
1. A 22% Demand
increase
in price . . .

0 90 100 Quantity

2. . . . leads to an 11% decrease in quantity demanded.

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Professor, AITS.
 Figure 1 The Price Elasticity of
Demand
(c) Unit Elastic Demand: Elasticity Equals 1
Price

$5

4
1. A 22% Demand
increase
in price . . .

0 80 100 Quantity

2. . . . leads to a 22% decrease in quantity demanded.

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Professor, AITS.
 Figure 1 The Price Elasticity of Demand

(d) Elastic Demand: Elasticity Is Greater Than 1

Price

$5

4 Demand
1. A 22%
increase
in price . . .

0 50 100 Quantity

2. . . . leads to a 67% decrease in quantity demanded.

Prepared by Mr. Amit A Rajdev, Assistant

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Professor, AITS.
 Figure 1 The Price Elasticity of Demand

(e) Perfectly Elastic Demand: Elasticity Equals Infinity

Price

1. At any price
above $4, quantity
demanded is zero.
$4 Demand

2. At exactly $4,
consumers will
buy any quantity.

0 Quantity
3. At a price below $4,
quantity demanded is infinite.
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Professor, AITS.
 Determinants of Price Elasticity of
Demand
• Availability of Substitutes
• Nature of Commodity (Necessities V/s Luxuries)
• Weightage in total consumption
• Time factor in adjustment of consumption pattern
(Time Horizon)
• Definition of Market and Range of commodity use

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Professor, AITS.
 Elasticity and Total Revenue
• When demand is inelastic (a price elasticity less than 1), price
and total revenue move in the same direction.
• When demand is elastic (a price elasticity greater than 1), price
and total revenue move in the opposite directions.
• If demand is unit elastic (a price elasticity equal to 1), total
revenue remains constant when the price changes.

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Professor, AITS.
Elasticity of a Linear Demand Curve

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Professor, AITS.
 Elasticity of a Linear Demand Curve

Total P2 + % Δ in % Δ in Q2 + % Δ in % Δ in Elasticit Elasticit Descripti

Price Qnt. Revenue P2 - P1 P1/2 Price Price Q2 - Q1 Q1/2 Qty Qty y y on
7 0 0
6 2 12 -1 6.5 -15.38 15 2 1 200.00 200 13.33 13 Elastic
5 4 20 -1 5.5 -18.18 18 2 3 66.66 67 3.72 3.7 Elastic
4 6 24 -1 4.5 -22.22 22 2 5 40.00 40 1.81 1.8 Elastic
Unit
3 8 24 -1 3.5 -28.57 29 2 7 28.57 29 1.00 1 Elastic
2 10 20 -1 2.5 -40.00 40 2 9 22.22 22 0.55 0.6 Inelastic
1 12 12 -1 1.5 -66.66 67 2 11 18.18 18 0.26 0.3 Inelastic
0 14 0 -1 0.5 -200.00 200 2 13 15.384 15 0.075 0.1 Inelastic

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Professor, AITS.
Elasticity of a Linear Demand Curve

13.0
3.70

1.80

1.00

0.60

0.30

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Professor, AITS.
Figure 4 Elasticity of a Linear Demand
Curve
When price increases from $4
Demand is elastic; demand
Price is responsive to changestoin$5, TR declines from $24 to
price. $20.
$7 Elasticity is > 1 in this range.
6

4
Elasticity is < is1inelastic;
Demand in this demand
range.is not
3
very responsive to changes in price.
2
When price increases from $2
to $3, TR increases from $20
1 to $24.

0 2 4 6 8 10 12 14
Quantity
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Professor, AITS.
 Income Elasticity
• It measures how the quantity demanded changes as consumer
income changes. It is calculated as the percentage change in
quantity demanded by percentage change in income.

Percentage Change in Quantity Demanded

Income Elasticity of Demand 
Percentage Change in Income

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Professor, AITS.
Cross Price Elasticity of Demand
– A measure of how much the quantity demanded of one good
responds to a change in the price of another good, computed
as the percentage change in quantity demanded of the first
good divided by the percentage change in the price of the
second good.

Percentage Change in Quantity Demanded of Good 1

CE p 
Percentage Change in Price of Good 2

Prepared by Mr. Amit A Rajdev, Assistant

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Professor, AITS.
 Elasticity of Supply
• It measures how the quantity supplied changes as price of
commodity changes. It is calculated as the percentage change in
quantity supplied by percentage change in price.

Percentage Change in Quantity Supplied

ES 
Percentage Change in Price

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Professor, AITS.
 Elasticity of Supply
1. Perfectly Elastic Supply
2. Elastic Supply
3. Unitary Supply
4. Inelastic Supply
5. Perfectly Inelastic Supply

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Professor, AITS.