Elasticity of Demand Law of demand explains the directions of changes in demand. A fall in price leads to an increase in quantity demanded and vice versa. But it does not tell us the rate at which demand changes to change in price. The concept of elasticity of demand was introduced by Marshall. This concept explains the relationship between a change in price and the consequent change in quantity demanded. Nutshell, it shows the rate at which changes in demand take place.

1. Elasticity of Demand
Unit 15
Instructor:
Atta Hussain Syed

2. 1.ELASTICITY OF DEMAND
• Law of demand explains the directions of changes in
demand. A fall in price leads to an increase in quantity
demanded and vice versa.
• But it does not tell us the rate at which demand changes to
change in price.

3. 1.ELASTICITY OF DEMAND
• The concept of elasticity of demand was introduced by
Marshall.
• This concept explains the relationship between a change in
price and consequent change in quantity demanded.
• Nutshell, it shows the rate at which changes in demand
take place.
Alfred Marshall,
(26 July 1842 – 13 July 1924)

4. 2. TYPES ELASTICITY OF DEMAND
• Elasticity of demand can be defined as “the degree (measure)
of responsiveness in quantity demanded to a change in
price”.
• It represents the rate of change in quantity demanded due to
a change in price.

5. 1.PRICE ELASTICITY OF DEMAND
• 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.
• When we talk about elasticity, that responsiveness is
always measured in percentage terms.

6. • The price elasticity of demand is computed as the
percentage change in the quantity demanded divided by
the percentage change in price.
Price elasticity of demand =
Percentage change in quantity demanded
Percentage change in price
Computing the Price Elasticity of Demand

7. Computing the Price Elasticity of Demand
priceinchangePercentage
demandedquatityinchangePercentage
demandofelasticityPrice 
Example: If the price of an ice cream cone increases from Rs.2.00 to Rs.2.20
and the amount you buy falls from 10 to 8 cones then your elasticity of
demand would be calculated as:
2
10
20
100
00.2
)00.220.2(
100
10
)108(





percent
percent

8. Computing the Price Elasticity of Demand
Using the Midpoint Formula
The midpoint formula is preferable when calculating the
price elasticity of demand because it gives the same answer
regardless of the direction of the change.
In mid-point method we calculate the percentage change in
price or quantity demanded by taking midpoint of the initial
and final values price and quantity demanded respectively as
a base.
)/2]P)/[(PP(P
)/2]Q)/[(QQ(Q
=DemandofElasticityPrice
1212
1212



9. Computing the Price Elasticity of Demand Using the Midpoint
Formula
Example: If the price of an ice cream cone increases from
Rs.2.00 to Rs.2.20 and the amount you buy falls from 10 to 8
cones, then your elasticity of demand, using the midpoint
formula, would be calculated as:

10. DEGREES OF PRICE ELASTICITY OF DEMAND
• Different commodities have different price elasticity’s.
• Some commodities have more elastic demand while others
have relative elastic demand.
• Basically, the price elasticity of demand ranges from zero
to infinity.
• It can be equal to zero, less than one, greater than one and
equal to unity.

11. DEGREES OF PRICE ELASTICITY OF DEMAND
• There are five types of price elasticity of demand.

12. • When the percentage change in quantity demanded is less
than the percentage change in its price, the demand is
called inelastic.
• Here a large change in price leads to small change in
demand.
• If the Ed=<1, the demand is inelastic, an increase in price
leads to an increase in total revenue, a decrease in price
leads fall in total revenue.
1.INELASTIC DEMAND
(RELATIVELY INELASTIC DEMAND)

13. Example 1:
Petrol: petrol has few alternatives because people with a car
need to buy petrol. For many driving is a necessity.
Example 2:
Cigarettes: If cigarette tax increases and the price of all
tobacco increases, demand will be inelastic because many
smokers are addicted and don’t have any alternatives to
keep buying.
1.INELASTIC DEMAND
(RELATIVELY INELASTIC DEMAND)

14. Inelastic Demand: Elasticity of Demand Ed=<1
Quantity0
Rs.5
90
Demand1. A 22%
increase
in price . . .
Price
2. . . . . . . leads to an 11% decrease in quantity demanded.
4
100
Example: If the price of a product increases from Rs.4 to Rs.5 as a
result its quantity demanded decreases from 100 units to 90 units.
Ed= 11%/22%=0.5

15. • When the percentage change in quantity demanded is
greater than the percentage change in its price, the
demand is called elastic.
• Here a small change in price leads to very big change in
quantity demanded.
• If the Ed=>1, the demand is elastic, an increase in price will
cause a decrease in total revenue, and a decrease in price
will lead to an increase in total revenue.
2.ELASTIC DEMAND
(RELATIVELY ELASTIC DEMAND)

16. • For example: Air-travel for vacationers is very sensitive to
price.
• An increase in the air fare will lead the vacationer to
choose another mode of transportation like car or lead him
to postpone the vacation plan for the time being.
2.ELASTIC DEMAND
(RELATIVELY ELASTIC DEMAND)

17. Elastic Demand: Elasticity of Demand Ed= >1
Demand
Quantity
Rs.4
1000
Price
Rs.5
50
1. A 22%
increase
in price . . .
2. . . . leads to a 67% decrease in quantity demanded.
Example: If the price of a product increases from Rs.4 to Rs.5 as a
result its quantity demanded decreases from 100 units to 50 units.
Ed= 67%/22%=3.04

18. • When quantity demanded of a good does don’t change to
whatever change in price, the demand is said to be
perfectly inelastic or elasticity of demand is zero (an
exceptional case).
• In case of perfectly inelastic demand Ed= 0
• If the Ed=0, the demand is perfectly inelastic, an increase in
price leads to an increase in total revenue, a decrease in
price leads fall in total revenue.
3. PERFECTELY INELASTIC
DEMAND

19. Perfectly Inelastic Demand: Elasticity of Demand Ed=0
Quantity Demanded (D)0
Price (P)
Example: Emergency services, lifesaving drugs and essential food item have perfectly
inelastic demand, that people will pay any price to obtain. Even if the price of the
drug were to increase dramatically, the quantity demanded would remain the same.
P-1
P-2
P-3 D
1. An
increase
in price . . .
2. . . . leaves the quantity demanded unchanged.

20. • When a small change in price of a product causes a major
change in its demand, it is said to be perfectly elastic
demand.
• A demand is perfectly elastic when with a small increase in
the price of a good, its quantity demanded by the consumers
drops down immediately to zero, while a small fall in price
causes increase in demand to infinity.
• In such a case, the demand is perfectly elastic or Ed= ∞
4. PERFECTLY ELASTIC DEMAND
(INFINITELY ELASTIC)

21. • Perfectly elastic demand implies that individual producers
can sell all they want at a ruling price but can’t charge a
higher price.
• If any producer tries to charge even one penny more, no
consumer would buy his product.
• The consumer would prefer to buy the good from another
producer who sells same good at the prevailing market price.
4. PERFECTLY ELASTIC DEMAND
(INFINITELY ELASTIC)

22. (Perfectly Elastic Demand: Elasticity of Demand=∞)
Quantity0
Price
Rs.40,000 Demand
2. At exactly Rs.40,000
consumers will
buy any quantity.
1. At any price
above Rs.40,000 quantity
demanded is zero.
3. At a price below Rs.40,000,
quantity demanded is infinite.****
Example: In today’s Pakistan’s bike market, the demand for bikes is
increasing day by day without any effect of price change.
****Subject to the size of market

23. • When the percentage change in quantity demanded of a
good is exactly equals to percentage change in its price.
• In such a case, the Ed= 1
• When elasticity of demand is equal to one or unitary, a rise
or fall in price leaves total revenue unchanged.
5. UNITERY ELASTIC DEMAND

24. 2. . . . leads to a 22% decrease in quantity demanded.
Unitary Elastic Demand: Elasticity of Demand Ed= 1
Quantity
4
1000
Price
Rs.5
80
1. A 22%
increase
in price . . .
Demand
Example: If the price of a product increases from Rs.4 to Rs.5 as a
result its quantity demanded decreases from 100 units to 80 units.
Ed= 22%/22%=1

25. ELASTICITIES, PRICE CHANGES AND TOTAL REVENUE
Elasticity
Co-efficient
Nature of Demand Change in Price Change in Total
Revenue
Ed= ∞
Ed= 0
Ed= <1
Ed= 1
Ed= >1
Perfectly Inelastic
Inelastic
Unitary elastic
Elastic
Finitely Elastic
Increase Increase
Decrease Decrease
Decrease Decrease
Increase Increase
Increase
Decrease
No Change
No Change
Decrease
Increase
Increase
Decrease
Decrease
Increase Decrease to zero
Infinite increase**
**Subject to the size of market

26. The price elasticity of demand is not same for all
commodities.
It may high or low depending upon number of factor.
Following factors influence price elasticity of demand.
1.Nature of commodities
2. Availability of substitutes:
3. Proportion of the purchaser’s budget consumed by the
item:
4. Possibility of postponement of purchase:
5. Time
Determinants of Price Elasticity on Demand

27. • Nature of commodity also affects the price elasticity of
demand.
• Commodities can be put under luxuries, comforts, and
necessities on the basis of their nature.
1. Nature of Commodities

28. • Demand for luxury goods (e.g. car, decoration items etc.) is
more elastic because their consumption can be dispensed
or postponed when their price rise.
• The consumption of necessary goods , (e.g. sugar, cloths,
vegetables) essential for life, cannot be postponed, and
their demand is inelastic.
• Comforts have more elastic demand than necessities and
less elastic demand than luxuries.
1. Nature of Commodities

29. • One of the most important determinants of elasticity of
demand is the availability of close substitutes of the
commodity.
• The more substitutes for a good, the higher the price
elasticity of demand, the fewer substitutes for a good, the
lower the price elasticity of demand.
1. Availability of Substitutes

30. • Example: If the price of Coca Cola rises in in market, people
will switch over to the consumption of Pepsi Cola, which is its
close substitute.
1. Availability of Substitutes

31. • The greater the percentage of one’s budget that goes to
purchase a good, the higher the price elasticity of demand.
• The smaller the percentage of one’s budget that goes to
purchase a good, the lower the elasticity of demand.
3. Proportion of the purchaser’s budget consumed by the item

32. • If the price of a box of matches, pencil or salt rises by 50%, it
will not affect the consumers demand for these goods.
3. Proportion of the purchaser’s budget consumed by the item

33. • On the other hand, if the price of a car rises from Rs.800,000 to
Rs.850,000 and it takes a greater portion of the income of the
consumers, its demand would fall.
• The demand for car is, therefore elastic.
3. Proportion of the purchaser’s budget consumed by the item

34. • 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.
4. Possibility of postponement of purchase

35. • The period of time plays an important role in shaping the
demand cure.
• When the price rises the consumers may take a time to adjust
their consumption patterns and find alternatives.
• 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.
4. Time

36. • Example: If the price of electricity goes up in Pakistan , it is
very difficult to cut back its consumption in the short run.
• However, if the rise in price persists, people will plan
substitutes/they may use alternative sources of electricity.
4. Time