Name: Karina Permata Sari (29115447)

Program: GM 2

Business Economics Summary

Price and Income Elasticity

The Economic Concept of Elasticity
Price elasticity of demand showed the measurement of sensitivity in changing the quantity
demanded by the change of price. In most general terms, we can define elasticity as a percentage
relationship between two variables, that is, the percentage change in one variable relative to a
percentage change in another. In different terms, we divide one percentage by the other:
Coefficient of elasticity =

Percent charge A
Percent chargeB

The Price Elasticity of Demand

When we speak of the price elasticity of demand, we are dealing with the sensitivity of quantities
bought to a change in the producer's price. Thus, this concept describes an action that is within
the producer's (or, in this case, the dealer's) control. Other elasticities discussed later are outside
the producer's control and may evoke other actions on the producer's part to counteract them.
Demand price elasticity is defined as a percentage change in quantity demanded caused by a I
percent change in price. Let us develop this concept mathematically. We can write the
expression, "percentage change in quantity demanded" as:
Quantity demanded
Initial Quantity Demanded
Where (delta) signifies an absolute change. The second part of this relationship, percentage
charge in price, can be written as:
Quantity Price
Initial Price

Dividing the first expression by the second, we arrive at the expression for the price
elasticity of demand:
Quantity Price Quantity

=
Quantity
Price
Price

Measurement of Price Elasticity and Determinants of Elasticity

The formula indicator to measure price elasticity is as follows:
E p=

Q2Q1
P2P1

(Q2+Q1 )/2 (P2+P 1)/2

Ep= Coefficient of are price elasticity

Q1= Original quantity demanded
Q2= New quantity demanded
P1= Original Price
P2= New Price
Factors affecting Demand Elasticity are as follows:
Ease of Substitution
Proportion of total expenditures
Durability of Product
Possibility of postponing purchase
Possibility of repair
Used product market
Length of time period
Elasticity in the Short-Run and in the Long-Run
A long-run demand curve will generally be more elastic than a short-run curve. Here "short run"
is defined as an amount of time that does not permit a full adjustment by consumers to a price
change. In the shortest of runs, no adjustment may be possible, and the demand curve over the
relevant range may be almost perfectly inelastic. As the time period lengthens, consumers will
find ways to adjust to the price change by using substitutes (if the price has risen), by substituting
the good in question for another (if the price has fallen), or by shifting consumption to or from
this particular product (i.e., by consuming more or less of other commodities).
Demand Elasticity and Revenue
There is a relationship between the price elasticity of demand and revenue received. A decrease
in price would decrease revenue if nothing else were to happen. But because demand curves tend
to be downward sloping, a decrease in price-will increase the quantity purchased, and this will
increase receipts. Which of the two tendencies is stronger? Remember that elasticity is defined as
the percentage change in quantity divided by the percentage change in price. If the former is
larger, (and therefore the coefficient will be greater than I in absolute terms), then the quantity
effect is stronger and will more than offset the opposite price effect. What does that entail for
revenue? If price decreases and, in percentage terms, quantity rises more than price has dropped,
then total revenue will increase. The rules describing the relationship between elasticity and total

revenue (TR). The concept is as follows:

TR = Price x Quantity
MR =

TR
Q

Figure 1 The Relationship between Price Elasticity and Total Revenue (TR)

Marginal Revenue (MR) is positive as total revenue rises (and the demand curve is elastic).
When total revenue reaches its peak (elasticity equals 1), marginal revenue reaches zero.

The Cross-Elasticity of Demand

Cross-elasticity (or cross-price elasticity) deals with the impact (again, in percentage terms) on
the quantity demanded of a particular product created by a price change in a related product
(while everything else remains constant). What is the meaning of "related" products? In
economics, we talk of two types of relationships: substitute good and complementary good. The
definition of cross-elasticity is a measure of the percentage change in quantity demanded of
product A resulting from a 1 percent change in the price of product B. The general equation can
be written as
E x=

Q A P B

QA
PB

Income Elasticity
Income elasticity is a term we use to measure the sensitivity of demand for a product to changes
in the income of the population. This represents quantity of sales as a function of (i.e., influenced
by) consumers' income. The general expression for this elasticity is as follows:
Ey = %Q %Y
where Y represents income. The definition of income elasticity is a measure of the percentage
change in quantity consumed resulting from a 1 percent change in income.

Elasticity of Supply
The price elasticity of supply measures the percentage change in quantity supplied as a result of a
1 percent change in price. In other words, this elasticity is a measure of the responsiveness of
quantities produced by suppliers to a change in price. Thus, the arc coefficient of supply
elasticity,
Es =

Q2Q1
P2 P 1

(Q2 +Q1)/2 (P2 + P1)/2

is a positive number: quantity and price move in the same direction. The interpretation of the
coefficient is the same as for the case of demand elasticity. The higher the coefficient, the more
quantity supplied will change (in percentage terms) in response to a change in price. Again, as in
the case of demand elasticity, it is important for a manager to know how supply elasticity affects
price and quantity when demand changes. When the supply curve is more elastic, the effect of a
change in demand will be greater on quantity than on price of the product. In contrast, with a
supply curve of low elasticity, a change in demand will have a greater effect on price than
quantity.