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1. Elasticity of Demand

2. Elasticity: the Concept
 The responsiveness of one variable to changes in
another
 When price rises, what happens to demand?
 Quantity demanded falls
 BUT!
 How much does demand fall?
 “Elasticity” is a (standard) measure of the degree of
sensitivity (or responsiveness) of one variable to
changes in another variable.

3. Ed =
% Change in One variable
__________________________
% Change in another variable
The elasticity measure is a ratio between two percentage
measures: percentage change in one variable over the
percentage change in another variable

4. Types of Elasticity of Demand
 Price Elasticity of Demand
 Income Elasticity of Demand
 Cross-price Elasticity of Demand or Just
Cross Elasticity

5. Price Elasticity of Demand:
 The (self) price elasticity of demand is a measure of the
degree of sensitivity of demand to changes in the (self)
price, ceteris paribus.
 2 situations:
 Where % change in quantity demanded is greater
than % change in price – elastic
 Where % change in quantity demanded is less than
% change in price - inelastic

6. Degrees
 Perfectly Elastic Demand
 ep=∞ (in absolute terms)
 Unlimited quantities can be sold at the prevailing price and even
a negligible increase in price would result in zero change in
quantity demanded
 Perfectly elastic demand curve is a horizontal line, parallel to the
quantity axis
D D
O x
y
p

7. More than Unit Elastic demand
or More Elastic
 ep>1 (in absolute terms),
 A proportionate change in quantity demanded is more than a
proportionate change in price
 Flatter demand curve
D
D
O x
y

8. Unitary Elastic Demand:
 ep =1 (in absolute terms)
 Rectangular hyperbola, asymptotic to the axes
 Uncommon in real life
D
D
O x
y

9. Relatively inelastic demand:
 ep<1 (in absolute terms)
 Steeper demand curve
 Necessities, since they are less responsive to a given
change in price
D
D
O x
y

10. Perfectly inelastic demand:
 ep=0 (in absolute terms)
 Quantity demanded is totally unresponsive to changes in
price.
 Neutral goods
 Vertical demand curve, parallel to the price axis
D
D
O x
y

11. Elasticity (more)
Ped =
% Change in Quantity Demanded___________________________
% Change in Price
Note: PED has – sign in front of it; because as price rises
demand falls and vice-versa (inverse relationship between
price and demand)
1. Ratio (Percentage) Method

12. General Formula for Price Elasticity
 P = Current price of a good
 Q = Quantity demanded at that price
 DP = Small change in the current price
 DQ = Resulting change in quantity demanded
PriceinChangePercentage
DemandedQuantityinChangePercentage
Elasticity
Pd
Qd
P
P
Q
Q
ln
ln
Elasticity 
D
D


13. Slope Compared to Elasticity
 The slope measures the rate of change of one variable
(Q, say) in terms of another (P, say).
 The elasticity measures the percentage change of one
variable (Q, say) in terms of another (P, say).

14. Slope of the Demand Curve
 DP is the
change in
price. (DP<0)
Price
Quantity
Demand
Q Q + DQ
DQ
P
P - DP
DP
 DQ is the
change in
quantity.
 slope =
DP/ DQ
Q
P
D
D
slope

15. Elasticity: Mathematical Definition
slope
P
Q

D
D
1
slope
Q
P

D
D
elasticity
P
Q slope

1

16. Exercise: Linear Demand
 Compute the elasticity
at the point indicated
in red on the table
(Q=18,P=24).
 Slope = -2
 1/Slope = -1/2
 P/Q = 24/18 = 4/3
 Elasticity = -2/3
Quantity Price
10 40
11 38
12 36
13 34
14 32
15 30
16 28
17 26
18 24
19 22
20 20

17. Other Methods of Measurement
 2. Arc Elasticity Method
 Used in case the available figures on price and
quantity are discrete
 To calculate price elasticity of demand between any
two points on the demand curve.
 To find the elasticity at the midpoint of an arc between
any two points on a demand curve, by taking the
average of the prices and quantities.

18. Arc Elasticity
To get the average elasticity between two points on a demand
curve we take the average of the two end points (for both price
and quantity) and use it as the initial value:
Q2-Q1
1/2(Q1+Q2)
Ep =
P2-P1
1/2 (P1+P2)

19. P
10
Q
D
a
b
c
d2
4
8
8 18 80 90
D

20. Sign of Demand Elasticity
 Price elasticity of demand is always negative.
 Economists usually refer to the price elasticity of demand
by its absolute value (ignore the negative sign).
 So, even though the formula says that the price elasticity
of demand is negative, we would say the elasticity of
demand is 1.5 or 0.67.

21. Elasticity and the Price Level
Along a linear demand curve as
the price goes up, |elasticity |
increases.
Note that between points "a"
and "b" the (arc) elasticity of
the above demand curve is -
3.46, whereas between "c" and
"d" it is -0.17.
P
D
8 18 80 90
a
b
c
d
2
4
8
10
| Ep | > 1 : Elastic
| Ep | < 1 : Inelastic
| Ep | = 1 : Unit-elastic
E = -3.46
E = -0.17

22. 3. Total Outlay Method
When demand is elastic, a decrease in price will
result is an increase in the revenue (sales).
 When demand is inelastic, a decrease in price will
result is a decrease in the revenue (sales).
 When demand is unit-elastic, an increase (or a
decrease) in price will not change the revenue (sales).

23. According to this method we can know the Elasticity of demand
from the effect on the total expenditure as a result of change
in price which can be in two forms-
(A) Fall in price
Price Quantity
demanded
Total
Expenditure
Nature of Elasticity of
Demand
Rs. 10
Rs. 8
200
250
2000
2000
Unit Elasticity
Rs. 10
Rs. 8
200
280
2000
2240
More Elastic
Rs. 10
Rs. 8
200
240
2000
1920
Less Elastic

24. (B) Rise in price
Price Quantity
demanded
Total
Expenditure
Nature of Elasticity of
Demand
Rs. 8
Rs. 10
250
200
2000
2000
Unit Elasticity
Rs. 8
Rs. 10
250
180
2000
1800
More Elastic
Rs. 8
Rs. 10
250
240
2000
2400
Less Elastic

25. Price (£)
Quantity Demanded
The demand curve can be a range of
shapes each of which is associated with a
different relationship between price and the
quantity demanded.

26. Price
Quantity Demanded (000s)
D
The importance of elasticity is the information it
provides on the effect on total revenue of changes
in price.
£5
100
Total revenue is price x quantity sold. In this
example, TR = £5 x 100,000 = £500,000.
This value is represented by the grey shaded
rectangle.
Total Revenue

27. Price
Quantity Demanded (000s)
D
If the firm decides to decrease price to
(say) £3, the degree of price elasticity
of the demand curve would determine
the extent of the increase in demand
and the change therefore in total
revenue.£5
100
£3
140
Total Revenue

28. Price (£)
Quantity Demanded
10
D
5
5
6
% Δ Price = -50%
% Δ Quantity Demanded = +20%
Ped = -0.4 (Inelastic)
Total Revenue would fall
Producer decides to lower price to attract sales
Not a good move!

29. Price (£)
Quantity Demanded
D
10
5 20
Producer decides to reduce price to increase sales
7
% Δ in Price = - 30%
% Δ in Demand = + 300%
Ped = - 10 (Elastic)
Total Revenue rises
Good Move!

30.  If demand is price
elastic:
 Increasing price
would reduce TR
(%Δ Qd > % Δ P)
 Reducing price would
increase TR
(%Δ Qd > % Δ P)
 If demand is price
inelastic:
 Increasing price
would increase TR
(%Δ Qd < % Δ P)
 Reducing price would
reduce TR (%Δ Qd <
% Δ P)

31. 4. Point Method or the Geometric
Method
O x
y
ep = 1
ep = ∞
Quantity
B
A
Price
M
ep = 0
ep < 1
ep > 1
Elasticity on a Linear Demand Curve
Lower segment of demand curve
Upper segment of demand curve
ep =

32. Income Elasticity of Demand:
The responsiveness of demand to changes in
incomes
 Normal Good – demand rises as income rises and vice versa
 Inferior Good – demand falls as income rises and vice versa
 Neutral Good – no change in demand as income changes
Ped =
Proportionate Change in Quantity Demanded of Comm X
_____________________________________________
Proportionate Change in income of consumer

33.  Income Elasticity of Demand:
 A positive sign denotes a normal good
 A negative sign denotes an inferior good

34.  For example:
 Yed = - 0.6: Good is an inferior good but inelastic – a rise in
income of 3% would lead to demand falling
by 1.8%
 Yed = + 0.4: Good is a normal good but inelastic –
a rise in incomes of 3% would lead to demand rising
by 1.2%
 Yed = + 1.6: Good is a normal good and elastic –
a rise in incomes of 3% would lead to demand rising
by 4.8%
 Yed = - 2.1: Good is an inferior good and elastic –
a rise in incomes of 3% would lead to a fall in demand of 6.3%

35. Cross Elasticity:
 The responsiveness of demand of one
good to changes in the price of a related
good – either
a substitute or a complement
Xed =
% Δ Qd of good t__________________
% Δ Price of good y

36.  Goods which are complements:
Cross Elasticity will have negative sign
(inverse relationship between the two)
 Goods which are substitutes:
Cross Elasticity will have a positive sign
(positive relationship between the two)

37. Elasticity of demand are interpreted
as follows
Value Descriptive Terms
Ed = 0 Perfectly inelastic demand
- 1 < Ed < 0 Inelastic or relatively inelastic demand
Ed = - 1
Unit elastic, unit elasticity, unitary elasticity, or unitarily
elastic demand
- ∞ < Ed < - 1 Elastic or relatively elastic demand
Ed = - ∞ Perfectly elastic demand

38.  Price Elasticity of Supply:
 The responsiveness of supply to changes
in price
 If Pes is inelastic - it will be difficult for suppliers to
react swiftly to changes in price
 If Pes is elastic – supply can react quickly to changes
in price
Pes =
% Δ Quantity Supplied____________________
% Δ Price

39. Determinants of Elasticity
 Time period – the longer the time under consideration
the more elastic a good is likely to be
 Number and closeness of substitutes –
the greater the number of substitutes,
the more elastic
 The proportion of income taken up by the product –
the smaller the proportion the more inelastic
 Luxury or Necessity - for example,
addictive drugs

40. 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