CHAPTER 3

Elasticity

PREPARED BY: NORSILAWATI BINTI MOHD HASSAN

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 3.1.1 PRICE ELASTICITY OF DEMAND

DEFINITION:

Measures the
sensitivity/responsiveness of
the quantity demanded due to a
change in its price.

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 MEASUREMENT AND INTERPRETATION
(PERCENTAGE METHOD)

FORMULA:

d = %  Quantity Demanded
%  Price

d = Q 2 – Q1 x P1
Q1 P 2 – P1

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 DEGREE OF ELASTICITY (INTERPRETATION)

Perfectly Inelastic Demand

Price (RM) A conditionInelastic Demand
in which the quantity demanded does
d =0 not changeofas the price changes.
A large percentage change in the price of a good
d < 1 will only affect a small percentage of change in the
quantity demanded.
Elastic Demand
A small percentage of change in the
price of a Unitary Elastic
good will lead to larger
percentage of change in quantity
d =  Demand
demanded.
Perfectly Elastic
A condition in which
Demand
percentage changes in price
equals to percentage
A condition in which a small
changes in quantity
percentage of change in
demanded.
price leads to an infinite
d = 1 percentage of change in the
d > 1 quantity demanded.

Quantity Demanded

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 Degree Description Value of Slope of demand Example
coefficient curve
P Goods with high
subtitutes
Example: toopaste
Elastic %  Qd  %  P p > 1  P

Q
 Q
P Goods with low
substitutes
Example:
Inelastic %  Qd  %  P  P petrol,gasoline,
p  1 WATER
COMSUMPTION
Q BY JBA
Q
P

Unitary %  Qd = %  P
p = 1
 P

P
Q
-
- Very rare in
Horizontal real life.
Perfectly A small
elastic p =  P
percentage  in
the P leads to an
infinite percentage
 in the Qd. Q
Price is fixed  Q 
P Example: insulin
Vertical
consumption
Perfectly Any change in P 
inelastic will not change the p = 0
P
Qd. Qty 
demanded is fixed.
Q
Q
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 Proportion
Proportion of
of the
the
expenditure
expenditure on
on aa Nature
Nature of
of
Existence
Existence of
of product
product goods
goods
substitutes
substitutes

Frequently
Frequently Income
Income level
level
purchased
purchased
products
products

Time
Time
Complementary
Complementary dimension
dimension
goods
goods Habits
Habits

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 RELATIONSHIP BETWEEN PRICE ELASTICITY OF
DEMAND AND TOTAL REVENUE

Total Revenue (TR) = Price (P) x Quantity (Q)

The information on price elasticity of demand will be useful

Price
for the seller to adjust their selling price since it will affect
the total revenue.

RM30
DEMAND IS ELASTIC

Total Revenue
RM20 x 10 = RM200
RM20
If seller increases price to RM30
New Total Revenue
= RM30 x 5 = RM150
 TR =  RM50
D
RELATIONSHIP:
5 10 NEGATIVE
Quantity Demanded

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 RELATIONSHIP TO TOTAL REVENUE
(cont.)

Total Revenue (TR) = Price (P) x Quantity (Q)

Price
DEMAND IS INELASTIC

RM2 Total Revenue

RM1 x 15 = RM15
If seller increases price to RM2
RM1
New Total Revenue
= RM2 x 10 = RM20
 TR =  RM5
D
RELATIONSHIP:
POSITIVE
10 15
Quantity Demanded

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 RELATIONSHIP TO TOTAL REVENUE
(cont.)
Total Revenue (TR) = Price (P) x Quantity (Q)

DEMAND IS UNITARY ELASTIC

Price

Total Revenue

RM2 RM1 x 20 = RM20

If seller increases price to RM2
New Total Revenue
RM1 = RM2 x 10 = RM20
 TR =  0

D RELATIONSHIP: NO
RELATIONSHIP

10 20
Quantity Demanded

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 3.1.2 INCOME ELASTICITY OF DEMAND

DEFINITION:

Measures the sensitivity/responsiveness

of the quantity demanded due to a
change in income.

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 INCOME ELASTICITY OF DEMAND-
MEASUREMENT

FORMULA:

Y = %  Quantity Demanded
%  Income

y = Q 2 – Q1 x Y1
Q1 Y 2 – Y1

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 RESPONSES OF INCOME ELASTICITY/
TYPE OF GOODS (INTERPRETATION)

Elastic Income
-Type of good: Luxury goods such as antique
furniture and diamonds
Income
y =0
Inelastic Income
-Type of good: Normal goods such as food
and clothing

Negative Income Elasticity

-Type of good: Giffen/ Inferior goods such as
used car and low grade potatoes

0< y < 1 Zero Income Elasticity

-Type of good: Necessity Goods such as rice
and vegetables

y > 1 y< 0
Quantity Demanded

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 Type of goods

Value of Type Description Example

coefficient

Positive Luxury goods I  , big  in Qd

(elastic
income)
Y  1
Positive Normal goods I  , small  in Qd
(inelastic
income)
y 1
Zero Necessity goods I  , no change in Qd
y = 0

Negative Inferior / giffen I  , Qd 

y < 0 goods

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 3.1.3 CROSS ELASTICITY OF DEMAND

DEFINITION:

Measures the sensitivity/responsiveness of

the quantity demanded of one product due to
a change in the price of a related product.

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 CROSS ELASTICITY OF DEMAND-
MEASUREMENT

FORMULA:

X = %  Quantity Demanded of good X

%  Price of good Y

x = Qx2 – Qx1 x Py1

Qx1 Py2 – Py1

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 RESPONSES OF CROSS ELASTICITY/
RELATIONSHIP BETWEEN 2 GOODS
(INTERPRETATION)

Price of Good X Positive Cross Elasticity

x =0
-Good X and Y are substitute goods

Negative Cross Elasticity

-Good X and Y are complementary goods

Zero Cross Elasticity

-Good X and Y have no relationship

x > 0 x < 0

Quantity Demanded
of Good Y

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 Value of Relationship Description Example
coefficient

Positive cross Substitute Py  , Qy  ; Qx 

elasticity

Negative cross Complementary Py  , Qy  ; Qx 

elasticity

Zero cross Not related Py  , Qy  ; no change

elasticity in Qx

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 3.2 PRICE ELASTICITY OF SUPPLY

DEFINITION:

Measures the sensitivity/responsiveness of

the quantity supplied due to a change in the
price of a product or service.

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 PRICE ELASTICITY OF SUPPLY-
MEASUREMENT

FORMULA:

ss = %  Quantity Supplied

%  Price

SS = Q 2 – Q1 x P1
Q1 P 2 – P1

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 DEGREE OF ELASTICITY (INTERPRETATION)

Elastic Supply
A small percentage of change in the price of a good will lead to
larger percentage of change in the quantity supplied.

Inelastic Supply
Price (RM)
ss =0 A large percentage of change in the price of a good
ss = 1 will only affect a small percentage of change of the
quantity supplied.
ss < 1
Unitary Elastic Supply
Percentage change in price equals the percentage
change in the quantity supplied.

Perfectly Elastic Supply

An almost zero percentage of change in price brings
ss =  a very large percentage of change in the quantity
supplied.

Perfectly Inelastic Supply

ss > 1 A percentage of change in price has no effect on
the percentage of change in the quantity supplied.

Quantity Demanded

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 Time
Time Period
Period
Technology
Technology
improvements
improvements

Availability
Availability and
and
mobility
mobility ofof
factors
factors of
of
production
production

Nature
Nature of
of the
the
Perishability
Perishability market
market

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