Elasticity refers to the responsiveness of one variable to changes in another. There are four main types of elasticity: price elasticity of demand, price elasticity of supply, income elasticity of demand, and cross elasticity of demand. Price elasticity of demand measures the responsiveness of quantity demanded to changes in price. Factors like availability of substitutes and percentage of income spent affect price elasticity. Price elasticity of supply measures responsiveness of quantity supplied to price changes and depends on production period length and capacity.

1. Elasticity
Warning: It’s long!

2. Elasticity
• “The proportionate responsiveness of a
second variable to an initial
proportionate change in the first
variable.”

3. Elasticity
For example:
• An increase of price by 5% increases
supply by 10%. (Elastic)
• An increase of price by 10% increases
supply by 5%. (Inelastic)
• When the price rises but the supply is still
kept constant. (Unity = elasticity = 1) It is
neither elastic nor inelastic.

4. 4 types of elasticity
• Price elasticity of demand:
• Price elasticity of supply:
• Income elasticity of demand:
• Cross elasticity of demand for good A
with respect to good B:

5. Price elasticity of demand
• “The proportionate change in demand
for a good following an initial
proportionate change in the good’s
own price.”
• Note that the price is the good’s own price,
not of the price of its substitute good.

6. Price elasticity of demand
• If we look at the curve of a constant
elasticity = 1 at all points of PeD:

7. • Since area of ∆P
and ∆Q is the
same, there is no
overall
proportionate
change. Thus,
elasticity = 1.

8. • Imagine the upper
horizontal box as
∆P1 and lower one
as ∆P2; left vertical
box as ∆Q1 , and
right as ∆Q2.
• We can see that
the area of ∆P1 is
bigger than that of
∆Q1.

9. • This shows the
small change in
price causes bigger
change in quantity.
(It is elastic)
• Vice versa to the
case in ∆P2 and
∆Q2. Smaller
change in price
causes quantity to
change in a bigger
magnitude. Thus, it
is inelastic.

10. • In this case, there is
no ∆Q but there is
infinite ∆P. Although
price changes,
quantity demanded
is still constant.
• This is known as
completely
inelastic demand.

11. • There are two extremes
which are not possible in a
real life scenario:
• In mathematics, anything
divided by zero is infinite (not
maths error!)
• There is no ∆P but there are
∆Q demand present in the
diagram.
• This is known as perfectly
inelastic demand.
• Remember this is perfect!
Everyone wants a Ferrai car
at $15. Ferrari is supplying
unlimited cars to meet this
demand at $15. (Not much
different to a free lunch!
Perfecto!)

12. Factors affecting PeD
• Substitutability:
When there are substitute good available,
customers will always switch to them when
the price of the original good rises. This is
elastic. When there are no subsititutes
available demand will be inelastic.
• Percentage of income:
More expensive good tends to be more
elastic as households spends a higher
proportion of their income compared to cheap
items.

13. Factors affecting PeD
• “The width of mesurement”:
If we solely measure the responsiveness
of the change of a single product from a
single firm, the elasticity may be more
apparent. Since the market is quite large,
elasticity will be lowered when we
measure the responsiveness of the
products as a whole market.

14. Factors affecting PeD
• Time:
Longer the time period, more time we are
allowing things to be changed. Thus
elasticity is more apparent in long run
compared to short run.

15. Price elasticity of supply
• “The proportionate change in supply of
a good following an initial
proportionate change in the good’s
own price.”

16. Measuring elasticity:
• When the gradient of the curve increases
(towards positive), it reduces the elasticity.
• If the S curve intersects the (Y) price-axis,
PeS is elastic at all points.
• If the S curve intersects the (X) demand-
axis, PeD is inelastic at all points.
• If the S curve passes through the origin
(O), elasticity = unity = 1.

18. Varying elasticity of PeS
• The diagram shows a
curve, and has the points
A to F.
• When we find the line
tangent to A, it crosses
the Y axis; tangent of C
crosses O, tangent of E
and F crosses X axis,
etc. (dy/dx)
• Considering (previous
slide), the elasticity
changes from elastic to
inelastic in this case.

19. Factors determining PeS
• Length of production period (how long?)
• The availability of spare capacity
• The ease of accumulating stocks (Selling
stocks when there is an increase in
demand)
• How easy for the firm to enter the market
• Ease of switching between different
production methods

20. Extremes
• Perfectly inelastic supply:
Time is an important determinant on elasticity
of supply.
Imagine there is a increased demand on
electricity in the UK, but there is only one
power plant, running 24/7 at full capacity. It
could not produce anymore than it is
producing.
The price of electricity rose, but supply is
still kept constant.

21. • ∆Q = 0
∆P = infinity
PeS: infinity

22. Extremes
• Price elastic supply:
The change of prices immediately
changes the quantity demanded to zero.
• This is because the customer will
immediately switch to another perfect
substitute which price hasn’t changed.

23. • E.g. US Gold Treasury. The
treasury has to maintain its
number of gold to regulate
the value of the US dollar.
• To maintain a certain value it
has to keep its gold value at
a certain price (to make the
trust of the US dollar at a
controllable level!)
• It will buy all the gold
available when it below
$35/oz; and sell the gold
when it reaches just above
$35/oz.
• (The Gold Standard is
abolished in 1971 after the
collapse of Bretton Woods
Agreements, where the world
currency is tied with the US
dollar.)

24. Income elasticity of demand
• The proportionate change in demand
for a good following an initial
proportionate change in consumer’s
income.
• Positive for normal good.
Luxury good is above +1.
Basic good is between 0 and 1.
• Negative for inferior good.

25. Cross elasticity of demand
• The proportionate change in demand
for a good following an initial
proportionate change in price of
another good.
• There are three possibilities:
1. Joint (complementary) demand
2. Competing (substitutes) demand
3. Absence of any sort of relationship.

26. Effects of tax on elasticity of
demand
• A tax shifts the supply curve leftwards.
There is an opportunity cost for it.
• The quantity supplied shifted leftwards
and is decreased.
• The quantity demanded remain constant.

27. • The firm has a profit-
maximisation
objective, would want
P1 to push the price up to
P2
P1 (with tax) to make
the customer paying
all the tax.
• But there is an over-
supply with P1.
• Market mechanism
brings price back to
P2.

28. • Shifted incidence:
The tax which is passed onto the
customers.
• Unshifted incidence:
The tax which is borne by firms.
• Vice versa, subsidies shifts the supply
curve rightwards or downwards.

29. Reference
• Source: http://cstl-
hcb.semo.edu/kerr/EC101/Price%20Elasti
city/price%20elasticity%20frt%20pg.htm