Elasticities of Demand and Supply and Application [1] Elasticity refers to the responsiveness of quantity demanded or supplied to changes in factors like price and income. There are different types of elasticity including own price elasticity and cross price elasticity. [2] Elasticities are measured using the percentage change formula and can be point or arc elasticities. Own price elasticity measures the responsiveness of quantity to price changes. Inelastic demands are less responsive than elastic demands. [3] Elasticities help determine how taxes impact consumers versus producers. Demands more elastic than supply means producers bear more of the tax burden.

1. ELASTICITIES OF DEMAND AND
SUPPPLY AND APPLICATION

2. Definition
• Elasticity – refers to the responsiveness of quantity
demanded/supplied to changes in any of the factors
affecting them
Types of Elasticity
• Own price elasticity of demand and supply
• Cross price elasticity of demand
• Income elasticity of demand

3. Measurement of Elasticity
• Point elasticity measurement
-elasticity is measured for a single point on the demand
curve or supply curve
• Arc elasticity measurement
- elasticity is measured for two points along the demand
curve or supply curve

4. • Working Formula for Arc Elasticity
Q2 –
Q1
P2
– P1
ε = ------------- / -----------
Q2 +
Q1
P2
+ P1
• Working Formula for Point Elasticity
q
ε = slope of Qd or Qs / -----------
p
Where: q is the equilibrium quantity
p is the equilibrium price

5. Own Price Elasticity of Demand/Supply
• This refers to the percentage change in quantity
demanded or quantity supplied for every one percent
change in own price
εd
= %Δ Qd
%Δ P
where: εd
is own price elasticity
of demand;
Qd
is quantity demanded
P is own price
Δ denotes change
Same formula is used for elasticity of supply except that quantity
supplied is used instead of quantity demanded

6. Elasticity Value and Description
|ε| = 0 - Perfectly inelastic; the demand curve is vertical and at any price
level, the same quantity will be demanded; ∆Q is zero
|ε| < 1 - Inelastic; %∆Q < %∆P, quantity demanded is relatively
insensitive to price changes
|ε| = 1 - Unitary elastic; %∆Q = %∆P
|ε| > 1 - Elastic; %∆Q > %∆P
|ε| = ∞ - Perfectly Elastic; demand curve is horizontal; at a given price,
quantity demanded could range from zero to infinity

7. Example of Own Price Elasticity Computation
Price Quantity Demanded
9 40
7 60
Q2 –
Q1
P2
– P1
ε = ------------- / --------
Q2 +
Q1
P2
+ P1
ε = 60 – 40 7 - 9
60 + 40 7 + 9
= _20_ -2
100 16
ε = - 1.60
The demand for the good is elastic. The quantity demanded
for the good will decrease(increase) by 1.6% for every one
percent increase(decrease) in own price

8. Determinants of Own Price Elasticity of Demand
• availability of good substitute for the
good;
• number of uses the good can be put into;
• the price of the good relative to the consumer’s purchasing power;
more substitutes,
more elastic
more uses, more
elastic
- the higher the price of the good and if it takes a larger share of
the budget, the more likely to be more elastic
• the time frame under consideration; - the longer period of
time, the more elastic
• location along the demand curve

9. Cross Price Elasticity of Demand (εij
)
Should analyze two goods; say goods i and j
- the cross price elasticity measures the percentage change in the
demand for one good, say good i, for every one percent change
in the price of another good, say good j
Formula for cross price elasticity
εij =
% ∆ Qi / % ∆ Pj
The sign of the cross price elasticity between two goods
can be positive or negative that gives the indication
with regards to the relationship of the goods in question

10. Interpretation of Cross Price Elasticity
If εij
> 0, the goods are substitutes.
Example: εij =
0.80, a one percent increase (decrease) in the
price of good j will result in a 0.80 percent increase
(decrease) in the demand for good i
If εij
< 0, the goods are complementary.
Example: εij =
- 0.75, a one percent increase (decrease) in the
price of good j will result in a 0.75 decrease (increase) in the
demand for good i

11. Income Elasticity of Demand (εy
)
- this measures the percentage change in demand for a good for
every one percent change in income.
Formula for Computing Income Elasticity of Demand
εy
= %∆Qd
/ %∆Y
• The sign of εy
could be positive or negative depending on the
nature of the good in question

12. Interpretation of the Value of εy
• If εy
> 0, the good is normal, a one percent increase (decrease)
in income will result in a percentage increase (decrease) in the
demand for a good.
Qualifier: If 0 < εy
< 1, the good is a necessity
Example: εy =
0.60
If εy
> 1, the good is a luxury item.
Example: εy =
2.50
• If εy
< 0, the good is inferior, a one percent increase (decrease)
in income, will result in a percentage decrease (increase) in the
demand for a good.

13. Application of Own Price Elasticity
• Own Price Elasticity of Demand and Total Revenue
Total Revenue (TR) = Price of the good x Quantity Sold
If Price increases  Quantity demanded decreases but the
effect on TR is uncertain unless the εd
is known.
• If demand is elastic, P↑; % ↓ in Qd
> % ↑P  ↓TR
• If demand is inelastic, P↑; % ↓ in Qd
< % ↑P  ↑TR
• If demand is unit
elastic,
P↑; % ↓ in Qd
= % ↑P  TR
does not change

14. Elasticities of Demand and Supply and
Tax Incidence
Question - who bears the greater portion of the tax? Is it the
consumer or the producer?
The tax could be a specific or excise tax or ad valorem tax
• Specific tax or excise tax – tax per unit of the product
• Ad valorem tax – tax as percentage of the selling price
Imposition of a tax affects consumption and production.
If demand is downward sloping and supply is upward sloping,
the tax is likely to raise the equilibrium price, but by an amount
less than the tax

15. Sharing of the Tax
The issue on who pays the greater portion of the tax depends
on the elasticities of demand and supply.
• If demand is more elastic than supply, the greater portion
of the tax is likely to be shouldered more by the producers.
• If demand is less elastic than supply, the consumers pay
a greater portion of the tax
• If demand is perfectly inelastic, the consumers pay
100% of the tax.

16. Some Guide Questions
1. The coefficient-of-demand elasticity is:
a. the change in total revenue divided the change in price.
b. the percentage change in quantity demanded divided by the percentage
change in price.
c. constant for all ranges of every demand curve, regardless of shape.
d. the quantity demanded divided by the change in price.
2. Elasticity of demand is important because it shows how:
a. higher prices result from shifts in the supply curve.
b. total revenue changes when declining price induces rising quantity
along the demand curve.
c. a percentage reduction in quantity induces an increase in price along
the demand curve.
d. a fall in price induces a percentage change in the supply curve.

17. Some Guide Questions
3. Why are farm revenues higher in years of lower production due to bad
weather?
a. Demand is more elastic than supply.
b. Supply is perfectly elastic.
c. Demand is inelastic; a leftward shift in supply will increase total
revenue. d. Supply is inelastic; a leftward shift in supply will increase total
revenue.
4. If a store sells 500 bottles of perfume a month when the price is P6 and only
sells 460 bottles a month when the price rises to P7, then the price elasticity
of demand is:
a. 0.54 and inelastic.
b. 1..85 and elastic.
c. 1.85 and inelastic.
d. 0.54 and elastic.

18. Some Guide Questions
5. If the cross-price elasticity of demand between meat and fish is 2.50, we
can say that:
a. Meat and fish have elastic demand
b. Meat is a normal good
c. Meat and fish are substitute goods
d. a and b are correct
6. Suppose a specific tax is applied to C2 (cool and clean) drink. After the
application of the tax it was observed that the consumers share 25% of
the tax. What can you conclude about the price of elasticities of supply
and demand?
a. demand is perfectly inelastic and supply is perfectly elastic
b. the elasticity of demand is equal to the elasticity of supply
c. demand is relatively more elastic than supply
d. supply is relatively more elastic than demand