THE PRICE

ELASTICITY
CONCEPT
GROUP 2
ELASTICITY

◦is a measure of how much buyers and

sellers respond to changes in market
conditions.

◦allows us to analyze supply and

demand with greater precision.
 The price elasticity of demand is a
measure of how much the quantity
demanded of a good responds to a
change in the price of that good.
measures how factors such as price
THE and income affect the demand for a
product
PRICE
When we talk about elasticity, that
ELASTICI responsiveness is always measured in
percentage terms.
TY OF
DEMAND Specifically, the price elasticity of
demand is the percentage change in
quantity demanded due to a
percentage change in the price.
 Factors Affecting Price Elasticity of
Demand
1. Substitutes- If there is a greater availability of substitutes, then the
good is likely to be more elastic. For example, if the price of one soda
brand goes up, people can turn to other brands. So, a small change in
price is likely to cause a greater fall in quantity demanded.
2. Necessities- If a good is a necessity, then the demand tends to be
inelastic. For example, if the price for drinking water rises, then there
is unlikely to be a huge drop in the quantity demanded since drinking
water is a necessity.
3. Time- Over time, a good tends to become more elastic because
consumers and businesses have more time to find alternatives or
substitutes. For example, if the price of gasoline goes up, over time
people will adjust for the change, i.e., they may drive less or use
public transportation
4. Habit- The demand orforform carpools.
addictive or habitual products is usually
inelastic. This is because the consumer has no choice but no pay
whatever the producer is demanding. For example, if the price for a
pack of cigarettes goes up, it will likely not have any effect on
demand.
Price Elasticity of Demand Formula

%∆ in Q = Percentage Change in Quantity Demanded. The Percentage Change in Quantity

d

Demanded is the New Quantity Demanded minus the Old Quantity Demanded divided by
the Old Quantity Demanded.
%∆ in P = Percentage Change in Price. This is the New Price minus the Old Price divided by
the Old Price.
PED = %∆ in Q / %∆ in P
d

The value of Price Elasticity of Demand (PED) is always negative, i.e. price and demand have
an inverse relationship. This is because the ratio of changes of the two variables is in
opposite directions, so if the price goes up, demand goes down and the change will end up
negative.
◦For our examples of price elasticity of demand, we will use the
price elasticity of demand formula.
◦Widget Inc. decides to reduce the price of its product, Widget 1.0
from 100 to 75. The company predicts that the sales of Widget 1.0
will increase from 10,000 units a month to 20,000 units a month.
◦To calculate the price elasticity of demand, first, we will need to
calculate the percentage change in quantity demanded and
percentage change in price.
◦% Change in Price = (75-100)/(100)= -25%
◦% Change in Demand = (20,000-10,000)/(10,000) = +100%
◦Therefore, the Price Elasticity of Demand = 100%/-25% = -4.
◦This means the demand is relatively elastic.
5 Types of Price Elasticity of Demand

◦Inelastic Demand
◦Quantity demanded does not respond strongly to price changes.
◦Price elasticity of demand is less than one.
◦Elastic Demand
◦Quantity demanded responds strongly to changes in price.
◦Price elasticity of demand is greater than one.
◦Perfectly Inelastic
◦Quantity demanded does not respond to price changes.
◦Perfectly Elastic
◦Quantity demanded changes infinitely with any change in price.
◦Unit Elastic
◦Quantity demanded changes by the same percentage as the price.
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.

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.

Figure 1 The Price Elasticity of
Demand Price
(c) Unit Elastic Demand: Elasticity Equals 1

$5

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

0 80 100 Quantity

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

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.

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.
Total Revenue and the Price Elasticity of
Demand
◦Total revenue is the amount paid by
buyers and received by sellers of a
good.
◦Computed as the price of the good
times the quantity sold.
TR  P  Q
Figure 2 Total Revenue
Price

When the price is $4,

consumers will demand 100
units, and spend $400 on
this good.

$4

P × Q = $400
P
(revenue) Demand

0 100 Quantity

Q
Elasticity and Total Revenue along
a Linear Demand Curve
◦With an inelastic demand curve, an increase
in price leads to a decrease in quantity that is
proportionately smaller. Thus, total revenue
increases.
Figure 3 How Total Revenue Changes
When Price Changes: Inelastic Demand
Price Price
An Increase in price … leads to an Increase
from $1 in total revenue from
to $3 … $100 to $240

$3

Revenue = $240
$1
Revenue = $100 Demand Demand

0 100 Quantity 0 80 Quantity

Elasticity and Total Revenue along a Linear
Demand Curve

◦With an elastic demand curve, an increase in

the price leads to a decrease in quantity
demanded that is proportionately larger. Thus,
total revenue decreases.
Figure 3 How Total Revenue Changes When Price
Changes: Elastic Demand
Price Price

An Increase in price … leads to an decrease

from $4 in total revenue from
to $5 … $200 to $100

$5

$4

Demand
Demand

Revenue = $200 Revenue = $100

0 50 Quantity 0 20 Quantity
Note that with each price increase, the Law of Demand still holds
– an increase in price leads to a decrease in the quantity
demanded. It is the change in TR that varies!
Elasticity of a Linear Demand
Curve
Figure 4 Elasticity of a Linear
Demand
Price
Curve
Demand is elastic; When price increases
from $4 to $5, TR
demand is responsive
$
7
Elasticity is > 1declines
to changes in price.
in
$20.
from $24 to
this
6
range.
5

4
Elasticity is < 1 in this
3 Demand is inelastic;
range.
demand is not very
2 responsive
Whentoprice
changes in
increases
1
price. from $2 to $3, TR
increases from $20 to
$24.
0 2 4 6 8 1 1 1
0 2 4 Quantity
INCOME ELASTICTY OF
DEMAND
Income Elasticty of Demand
◦Income Elasticity of Demand (YED)
is defined as the responsiveness of
demand when a consumer’s income
changes.
FORMULA OF INCOME
ELASTICTY OF DEMAND
TYPES OF GOODS
◦Normal goods – Goods whose demand is directly
proportional to the income of the consumers are
known as normal goods. The income elasticity of
these goods is always positive.
◦Inferior goods – Goods whose demand is inversely
proportional to the income of the consumers are
known as inferior goods. The income elasticity of
these goods is always negative.
EXAMPLES
◦Suppose that when people's income
increases by 20%, they buy 10% less
fast food. In this situation, what type
of good would fast food be?

- 10%

20%

The answer is – 0.5.

◦Suppose we knew that when people's
income increased by 5% in a country,
the demand for healthcare increased
by 10%. What kind of good do people
consider healthcare: Normal or
inferior?

10%

5%

The answer is 2.
ENGEL CURVE
Types of Income Elasticity of Demand
◦There are five types of income elasticity of
demand:
High: A rise in income comes with bigger
increases in the quantity demanded.
Unitary: The rise in income is proportionate to
the increase in the quantity demanded. 
Low: A jump in income is less than
proportionate than the increase in the quantity
demanded. 
Zero: The quantity bought/demanded is the
same even if income changes
Some important uses of 
income elasticity of demand  are as follows:

◦Useful to know about stage of trade cycle.

◦Useful for forecasting demand
◦Useful for classification of normal & inferior
goods
◦Useful for making marketing strategy
CROSS ELASTICITY OF
DEMAND
Cross Elasticity of Demand
◦It is an economic concept that measures
the responsiveness in the quantity
demanded of one good when the price
for another.
Substitute Goods

◦These are the products that can be used

for the same purpose by the same
consumer.

◦Note:
◦ the answer is always positive
Complementary Goods

◦Goods causes an interplay between the

consumer need for the second product as
the price of the first product fluctuates.

Note: the answer is always negative

Fluctuates- to shift back and forth
FORMULA:

percentage change in quantity

demand (x)
percentage change in price of
good (y)
Examples:
PRICE ELASTICITY
OF SUPPLY
DEFINITION
◦Measures the responsiveness and
sensitivity of producers to changes in the
price of the goods
◦Measures the relationship between
change in quantity supplied and a
change in price
 Formula to calculate PES
percentage change in
Price elasticity of
supply = quantity supplied
percentage change in price
 ELASTICITY OF SUPPLY

ELASTIC SUPPLY

• E>1
• A slight change in
price results in a
large change in
quantity supplied,
implying elastic
supply.
 INELASTIC SUPPLY

• E< 1
• the change in supply is
relatively less than the change
in price
UNIT-ELASTIC SUPPLY

• E=1
• The percent in
price is the same
as the percent
change in
quantity supplied.
 PERFECTLY ELASTIC
AND
PERFECTLY INELASTIC SUPPLY

• E=0, it is perfectly
inelastic
• E= infinity, perfectly
inelastic at constant
costs.
◦if supply is elastic, then producers can
increase their output without a rise in cost or
a time delay

◦if supply is inelastic, then firms find it hard to

change production in a given time period
FACTORS AFFECT THE
ELASTICITY OF SUPPLY
Production Time

Mobility of the factors of production

Response time

Spare Capacity

Inventories/ Stock levels

PROJECTING THE
FUTURE