2. Elasticity
• Elasticity is a general concept that can be used to quantify the
response in one variable when another variable changes.
elasticity of A with respect to B
A
B
%
%
3. Price Elasticity of Demand
• Measures the responsiveness of demand to changes in
price, given other things constant.
• It is the ratio of the percentage change in quantity demanded
to the percentage change in price.
• Its value is always negative, but stated in absolute terms.
• The value of the line of the slope and the value of elasticity
are not the same.
price elasticity of demand
% change in quantity demanded
change in price
%
4. Response to
Price Changes
Responsive
Unresponsive
Proportional
Value of
Elasticity
> |1|
< |1|
= |1|
Characteristics of Demand
Elasticity
Type of
Demand
Elastic
Inelastic
Unitary elastic
Magnitudes of
Change
%Qd > %P
%Qd < %P
%Qd = %P
Type of
Elasticity
Elastic
Inelastic
Substitutes
Available
Many
Few
7. Hypothetical Demand Elasticity
for Four Products
PRODUCT
% CHANGE
IN PRICE
(%P)
Insulin 10% 0% 0 Perfectly inelastic
Electricity 10% -1% -0.1 Inelastic
Chiken 10% -10% -1 Unitary elastic
Bananas 10% -30% -3 Elastic
% CHANGE IN
QUANTITY
DEMANDED
(%Qd)
ELASTICITY
(%Qd/%P)
Hypothetical Demand Elasticities for Four Products
8. Calculating Percentage Changes
• Elasticity is a ratio of percentages, and it involves computing
percentage changes.
% change in quantity demanded x 100%
2
Q Q
Q
1
1
price elasticity of demand
100%
333%
30
.
.
• Using the values on the graph to
compute elasticity, then:
% change in price x 100%
2
P P
P
1
1
9. Computing the Value of
Elasticity
%
%
( ) /
( ) /
Q
P
Q Q
Q Q
P P
P P
d
2 1
1 2
2 1
1 2
2
100%
2
x
x 100%
%
%
( ) /
( ) /
. .
Q
P
d
10 5
5 10 2
100%
2 3
3 2 2
5
7 5 167
x
x 100%
x 100%
-1
2.5
x 100%
=
66.7%
-40.0%
• The midpoint formula to
compute elasticity is:
10. Interpreting the Value of
Elasticity
• When e = 0.2, a 10% increase in price leads to a 2%
decrease in quantity demanded, given other things
constant.
• When e = 2.0, a 10% increase in price leads to a 20%
decrease in quantity demanded, given other things
constant.
Here is how to interpret two different values of
elasticity:
11. Elasticity Changes along a
Straight-Line Demand Curve
• Price elasticity of demand
decreases as we move
downward along a linear
demand curve.
• Demand is elastic on the upper
part of the demand curve and
inelastic on the lower part.
12. Elasticity Changes along a
Straight-Line Demand Curve
• Along the elastic range,
elasticity values are greater
than one.
6.4
.29
• Along the inelastic range,
elasticity values are less
than one.
13. Elasticity and Total Revenue
• When demand is inelastic, price and total revenues are directly
related. Price increases generate higher revenues.
• When demand is elastic, price and total revenues are indirectly
related. Price increases generate lower revenues.
Type of
demand Value of Ed
Change in quantity
versus change in price
Effect of an
increase in
price on total
revenue
Effect of a
decrease in price
on total revenue
Elastic Greater than 1.0 Larger percentage change
in quantity
Total revenue
decreases
Total revenue
increases
Inelastic Less than 1.0 Smaller percentage
change in quantity
Total revenue
increases
Total revenue
decreases
Unitary
elastic
Equal to 1.0 Same percentage change
in quantity and price
Total revenue
does not change
Total revenue does
not change
14. Determinants of Demand
Elasticity
• Availability of substitutes -- demand is more elastic
when there are more substitutes for the product.
• Importance of the item in the budget -- demand is more
elastic when the item is a more significant portion of the
consumer’s budget.
• Time frame -- demand becomes more elastic over time.
15. Other Important
Elasticities
• Income elasticity of demand – measures the responsiveness
of demand to changes in income.
income elasticity of demand
% change in quantity demanded
change in income
%
EI >0 implies normal good.
EI <0 implies inferior good.
• Normal goods may be necessity or luxury.
16. Other Important
Elasticities
• Cross-price elasticity of demand: A measure of the
response of the quantity of one good demanded to a change
in the price of another good.
cross- price elasticity of demand
% change in quantity of demanded
change in price of
Y
X
%
17. Cross Elasticity of Demand
When two goods are substitutes, than increase in the price of
one good decreases its own demand and increases the demand
of another good. In this case cross elasticity of demand is
positive
In the case of complementary goods the increase in the price of
one good decreases the demand for both the goods. In this case
cross elasticity of demand is negative
18. Promotional
(or Advertising) Elasticity
of Demand
• The advertising elasticity of demand measures an extent to
which the demand of a product will be influenced by
advertisement and other promotional activities.
• Advertising elasticity of demand measures the responsiveness
of quantity demanded to changes in the expenditure on
advertising and other sales promotional activities.
eA =
ðQ
ðA
A
Q
.
19. Other Important Elasticities
• Elasticity of supply: A measure of the response of quantity
of a good supplied to a change in price of that good. Likely
to be positive in output markets.
elasticity of supply
% change in quantity supplied
change in price
%
20. Other Important Elasticities
• Elasticity of labor supply: A measure of the response of
labor supplied to a change in the price of labor.
elasticity of labor supply
% change in quantity of labor supplied
change in the wage rate
%
21. Importance of Elasticity
• Relationship between changes in price and total revenue.
• Importance in determining what goods to tax (tax revenue)
• Importance in analysing time lags in production
• Influences the behaviour of a firm
