Elasticity of Demand and Supply

• What Is Elasticity?
Elasticity is a measure of a variable's sensitivity to a
change in another variable. In business and economics,
elasticity refers the degree to which individuals,
consumers or producers change their demand or the
amount supplied in response to price or income changes.
It is predominantly used to assess the change in
consumer demand as a result of a change in a good or
service's price.
Elasticity of Demand and Supply
Elasticity is an economic concept used to measure the
change in the aggregate quantity demanded for a good or
service in relation to price movements of that good or
service. A product is considered to be elastic if the
quantity demand of the product changes drastically when
its price increases or decreases. Conversely, a product is
considered to be inelastic if the quantity demand of the
product changes very little when its price fluctuates.
Elasticity Example
• For example, insulin is a product that is highly inelastic.
For diabetics who need insulin, the demand is so great
that price increases have very little effect on the quantity
demanded. Price decreases also do not affect the quantity
demanded; most of those who need insulin aren't holding
out for a lower price and are already making purchases.
• On the other side of the equation There are highly elastic
products. Bouncy balls, for example, are highly elastic in
that they aren't a necessary good, and consumers will
only decide to make a purchase if the price is low.
Therefore, if the price of bouncy balls increases, the
quantity demanded will greatly decrease, and if the price
decreases, the quantity demanded will increase.
Types of elasticity
There are four types of elasticity, each one measuring the relationship
between two significant economic variables. They are:
• Price elasticity of demand (PED), which measures the
responsiveness of the quantity demanded to a change in price. PED
can be measured over a price range, called arc elasticity, or at one
point, called point elasticity.
• Price elasticity of supply (PES), which measures the responsiveness
of the quantity supplied to a change in price.
• Cross elasticity of demand (XED), which measures the
responsiveness of the quantity demanded of one good, good X, to a
change in the price of another good, good Y.
• Income elasticity of demand (YED), which measures the
responsiveness of the quantity demanded to a change in
consumer incomes.
What is Price Elasticity of Demand?
Price elasticity of demand is an economic measure of the change in
the quantity demanded or purchased of a product in relation to its
price change. Expressed mathematically, it is:
Price Elasticity of Demand = % Change in Quantity Demanded /
% Change in Price
(Percentage change in quantity demanded divided by the
percentage change in price)

• PED=
Elasticity of Demand & Supply
The price elasticity of demand is the percentage
change in the quantity demanded of a good or service
divided by the percentage change in the price. The price
elasticity of supply is the percentage change in quantity
supplied divided by the percentage change in price.
Elasticity of Demand & Supply
• Elasticities can be usefully divided into five broad categories:
Perfectly Elastic, Elastic, Perfectly Inelastic, Inelastic, and Unitary.
An Elastic demand or elastic supply is one in which the elasticity is
greater than one, indicating a high responsiveness to changes in price.

An inelastic demand or inelastic supply is one in which elasticity is less

than one, indicating low responsiveness to price changes.

Unitary elasticity's indicate proportional responsiveness of either demand

or supply.

Perfectly elastic and perfectly inelastic refer to the two extremes of

elasticity. Perfectly elastic means the response to price is complete and
infinite: a change in price results in the quantity falling to zero. Perfectly
inelastic means that there is no change in quantity at all when price
changes.
Measuring Elasticity
We use the word "coefficient" to describe the values for price
elasticity of demand
• If Ped = 0 demand is perfectly inelastic - demand does not change
at all when the price changes – the demand curve will be vertical.
• If Ped is between 0 and 1 (i.e. the % change in demand from A to B
is smaller than the percentage change in price), then demand is
inelastic.
• If Ped = 1 (i.e. the % change in demand is exactly the same as the %
change in price), then demand is unit elastic. A 15% rise in price
would lead to a 15% contraction in demand leaving total spending the
same at each price level.
• If Ped > 1, then demand responds more than proportionately to a
change in price i.e. demand is elastic. For example if a 10%
increase in the price of a good leads to a 30% drop in demand. The
price elasticity of demand for this price change is –3
Inelastic demand (Ped <1)
Elastic demand (Ped >1)
Perfectly inelastic demand (Ped = zero)
Perfectly elastic demand
Unitary price elasticity of demand
 Price elasticity of demand –
Price elasticity of demand relates to the responsiveness of
quantity demanded of a good to the change in its price.
Price elasticity of demand ,
responsive ness of changes quantity demanded
Ed
responsive ness of change in price
change in quantity demand
quantity demand

change in price
price
Q
Q

P
P
Q P
 
Q P
Q P
 .
P Q
Elasticity of demand
Income elasticity of demand

• =
 Cross elasticity of demand –
Cross Elasticity of demand

change in quantity demand of x

quantity demand
e xy 
change in the price of good y
price of good y
ΔQx
Qx

ΔPy
Py
ΔQx Py
 
Qx ΔPy
ΔQx Py
 .
ΔPy Qx
Elasticity of demand
• Elasticity of demand refers to the degree of
responsiveness 0f quantity demanded of a good to a
change in its price, income and prices of related goods.
• Substitute goods and complementary goods
• Substitute goods are those goods which can be used in
place of one another for satisfaction of a particular want ,
like tea and coffee.
• Complementary goods are those goods which are used
together to satisfy a particular want.
Elasticity of Demand
• Point elasticity of a linear demand curve varies from zero
to infinity….
• Elasticity at a certain point of demand curve is called point
Elasticity.
• Q=f(P) is a demand function
• % change in price =
• % change in Quantity= .100
Elasticity of demand
• Point elasticity of a demand curve=

Point elasticity at point A ==,e

PE at point D= , e
PE at point, C(midpoint)= =1= Unitary elastic demand, e=1
PE at point, E= ,e
PE at point, B = =o perfectly inelastic demand
Normal goods, luxury goods, inferior goods, necessary
goods
Elasticity of Demand
DETERMINANTS OF PRICE ELASTICITY OF
DEMAND: Some products are elastic (buyers are price
sensitive), and some products are inelastic (buyers are
not price sensitive). What makes people more sensitive to
one product’s price change compared to another
product’s price change? Some people will choose to not
buy a car if its price increases by 10%, but are unaffected
by an increase of 10% in the price of a bag of salt.
Elasticity of Demand
1.Nature of commodity:
Commodities are classified as necessities, luxuries and
comforts.
• (i) A necessity that has no close substitute (salt,
newspaper, polish etc.) will have an inelastic demand
because its consumptions cannot be postponed.
Moreover, consumers purchase almost a fixed amount of
a necessity per unit of time whether the price is
somewhat higher or lower.
DETERMINANTS OF PRICE ELASTICITY OF
DEMAND
(ii) Demand of luxuries is relatively more elastic because
consumption of luxuries (TV. sets, decoration items, etc.)
can be dispensed with or postponed when their prices
rise.
(iii) Comforts have more elastic demand than necessities
and less elastic in comparison to luxuries.
• Commodities are also classified as durable and
perishable. Demand for durable goods is more elastic
than perishable goods (non-durable) because when the
price of former increases, people either get the old one
repaired or buy a second hand.
DETERMINANTS OF PRICE ELASTICITY OF
DEMAND
2. Range of substitutes:
• A commodity has elastic demand if there are close
substitutes of it. A small rise in the price of a commodity
having close substitute will force the buyers to reduce the
consumption of the commodity in favour of substitutes.
• A lower price will attract the buyers’ of the other
substitutes to purchase the commodity. If no substitutes
are available, demand for goods tends to be inelastic.
Demand for salt is highly inelastic because it has no
substitute.
• For example, if the price of coffee rises, the demand for
coffee decreases and the demand for tea increases and
vice-versa.
DETERMINANTS OF PRICE ELASTICITY OF
DEMAND
3 . Goods having several uses or Number of uses of a
commodity:
• If a commodity has several uses, it has an elastic
demand. For example, electricity has several uses. It is
used for lighting, room heating, cooking, etc. if the tariffs
of electricity increase, its uses will be restricted to
important uses. If the tariffs of electricity increases, its
uses will be restricted to important uses. On the other
hand, it will be withdrawn for less important uses.
DETERMINANTS OF PRICE ELASTICITY OF
DEMAND
4. Possibility of postponement of purchase:
• If the use or purchase of a commodity can be postponed
for some times, then the demand of such commodity will
be elastic.
• For example, if cement, bricks, wood and other building
materials become costlier, people will postpone the
construction of houses. Therefore, price elasticity of
building materials will be high.
• On the other hand, goods whose demand cannot be
postponed, their demand will be inelastic.
DETERMINANTS OF PRICE ELASTICITY OF
DEMAND
5. Importance of the commodity in consumers budget:
(Proportion of income spent)
• Goods on which a consumer spends a very small
proportion of his income, e.g. salt, newspaper, tooth paste
etc. the demand will nor be much affected by a change in
the price. Hence, it will be inelastic. On the other hand,
goods on which the consumer spends a large proportion
of his income e.g clothes, food etc. their demand will be
elastic.
DETERMINANTS OF PRICE ELASTICITY OF
DEMAND
6. Range of prices:
• At a very high or very low range of prices, demand tends
to be inelastic Demand for high priced commodities come
from only the rich people who give little importance to
price.
• A change in the price of high-priced commodities will not
generally affect the demand of rich consumers.
• On the other hand low priced commodities are either
necessities or a small part of income is spent an them.
Therefore, their demand is inelastic.
DETERMINANTS OF PRICE ELASTICITY OF
DEMAND
• 7. Income level:
• People with high incomes are less affected by price
changes than people with low incomes. A rich man will not
curtail his consumption of vegetables, milk, fruits even if
their prices rise significantly and he will continue to
purchase the same amount as before.
• But a poor man cannot do so. Thus, the distribution of
national income has an important bearing on the elasticity
of demand
DETERMINANTS OF PRICE ELASTICITY OF
DEMAND
8. Time:
In the short-run the demand is inelastic while in the long-
run demand is elastic. The reason is that in the long-run
consumer can change their habits and consumption
pattern.
DETERMINANTS OF PRICE ELASTICITY OF
DEMAND
• 9. Joint demand:
• Elasticity of demand for a commodity is also influenced by
the elasticity of its jointly demanded commodities.
• If the demand for pen is inelastic then the demand for ink
will be inelastic. Generally, the elasticity of jointly
demanded goods is inelastic.
Elasticity of demand
• Determinants of price elasticity of demand:
• Availability of Substitution. Train ticket close Substitute,
bus ticket air ticket
• The position of a commodity in a consumer budget.
Pencil/Cloth 50%, 2% inelastic, consumption decrease
elastic
• Number of uses of a commodity. Milk inelastic
• Intensity of a necessary goods salt , insulin inelastic
• Nature of goods
• Luxury goods……more elastic
• Habit and addiction
• Differed use
 Elasticity of demand
• Total revenue approach to measure Elasticity:
• Unitarily Elastic demand

Price Quantity Total Revenue

20 30 600
25 24 600

First , if total revenue remains unaltered with any change In Price, demand is unitarily
Elastic. Total revenue is the product of price and quantity, TR= P.Q= 20.100=2000
TC= total cost= P.Q, 15.100=1500,profit= TR- TC=500 MR= marginal revenueMR= d/dQ(p
 Elasticity of demand
• Elastic Demand:

Price Quantity Total Revenue

20 30 600
25 20 500

Second, if total revenue falls as price rises or vice versa, demand is elastic. We
Observe more responsive demand in the table provided where total revenue falls
With an increase in price due to a sharp fall in quantity of demand.
 Elasticity of demand
• Inelastic Demand:

Price Quantity Total Revenue

20 30 600
25 28 700

Third , if total revenue falls as price falls or total revenue rises as price rises, demand is
Inelastic. In the table we observe , quantity of demand did not fall that much although
Price increased, which rather resulted an increase in total revenue.