Elasticity

- The degree to which the curves react to the changes brought by changes in
various determinants.
Price Elasticity of Demand and Pricing Decisions
- Price Elasticity of Demand
o It’s the degree of responsiveness of quantity demanded to a change in
price.
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄
o Price Elasticity of Demand = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑄
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃
o When the resulting price elasticity of demand:
▪ = 1; Quantity Demanded is UNITARY ELASTIC
▪ > 1; The consumers’ sensitivity to changes in price is said to be
ELASTIC
▪ < 1; The quantity demand’s response to changes in price is said to
be INELASTIC
o Certain changes in demand curves occur as quantity demanded reacts to
changes in price.
▪ Elastic – The changes in price are relatively small, demand curves
tend to slope more horizontally
▪ Inelastic – Means there is a relatively large change in the price of
the commodity, tends to slope more vertically
- Total Revenue
o The total sale of products by the producer or seller
▪ TR = P x Q (TR: Total Revenue; P: Price; Q: Quantity)
o In comparing two TRs, whichever yields a higher TR, holding other things
constant, the price charged is the best price of the good, whether it is the
old price or the new price.
Income Elasticity of Demand
- It’s the degree of responsiveness of a percentage change in quantity demanded
with a percentage change in income
𝑄𝑑2−𝑄𝑑1
- Income Elasticity of Demand = 𝑄𝑑1+𝑄𝑑2 Qd = Quantity Demanded; Y = Income
𝑌2−𝑌1
𝑌1+𝑌2
2
- When the result of the income elasticity is:
o The product is called a NORMAL GOOD but is considered as LUXURY;
This happens when an increase in a consumer’s income has cause a
substantial increase in the demand for a product.
o When the income elasticity is a negative number, the good is said to be
INFERIOR
 o When the income elasticity is a negative number, the good is said to be
INFERIOR; A good becomes inferior when an increase in income brings
about a decrease in demand.
o A good is said to be UNITARY if income elasticity is equal to 1
o > 1; Luxury Good
o < 1; Necessity
o > 0; Normal Good
o < 0; Inferior Good
Cross Price Elasticity of Demand
- Is the degree of responsiveness of a percentage change in quantity of a good X
with a percentage change in the price of good Y. A positive cross elasticity
indicates that a good is a substitute of the other while a negative cross elasticity
means the goods are complementing each other
o = 0; X and Y are not related
o > 0, Positive; Substitutes
o < 0, Negative; Complements
- The percentage change in demand for the first good in response to the
percentage change in price of the second good is expressed in this mathematical
formula.
o % change in demand for product X = Qdx2 – Qdx1/Qdx1 + Qdx2/ 2
o % change in the price of product Y = Py2 – Py1/Py1 + Py2/2
***Factors that affect are price, income, price changes of other products
Price Elasticity of Supply
- Relationship of Quantity supplied and price
o Change in Q/Average Q/Change in P/Average P
- When Supply is elastic, producers are able to increase production even with an
increase in the cost of production. However, when the supply of a product
becomes inelastic, producers are hindered to produce more. In this respect,
when there is a considerable increase in price of goods being sold, supply
becomes elastic. However, when the change in price is insignificant, supply is
inelastic.
o = 1; Unitary Elastic
o > 1; Elastic
o < 1; Inelastic
Key Points to Remember
- Price elasticity of demand and pricing decisions are tools that aid sellers in their
pricing decisions that can increase their total revenue
- Price elasticity may be elastic, inelastic, or unitary
- When you increase price and Qd is inelastic, TR becomes higher. But when you
increase price and Qd is elastic, TR becomes lower.
- When you decrease price and Qd is elastic, TR becomes higher. A decrease in
price while Qd is inelastic makes TR lower.
- Income elasticity of demand can determine if a good is luxury, inferior, or basic.
This information helps sellers to know how consumers perceive what kind of
goods they sell.
- Cross elasticity of demand indicates the relationship between two goods. It is
important for a seller to know if his/her product is a complement of, or a
substitute for another good, especially if the other good is doing well in the
market.
- Price elasticity of supply can determine if quantity supplied can adjust to changes
in prices.