Elasticity Of Demand

Definition:
Elasticity means responsiveness. Thus, elasticity of demand means the
responsiveness of demand due to some changes to the factors which influence
demand.
There three types of elasticity of demand:
1. Price Elasticity of Demand (PED) - (Ed)
2. Income Elasticity of Demand (IED) - (EI)
3. Cross Elasticity of Demand (CED) - (Ec)
1. Price Elasticity of Demand (PED)
a. Definition of PED:
It measures the responsiveness of quantity demanded due to a change in
its price.
b. Formula :
i. Ed =
Ed =
Note:

% in Qty demanded for product A

% in price for product A

(Percentage Method)

% Q
% P
The following are the steps to convert from percentage
method to proportionate method:

Ed =

Q 100%
q0
_________
P 100%
p0
Q p0
P q0

ii. Ed =
Ed =

Note:

Q p0
P q0

(Proportionate Method)

(q1 q0) p0
(p1 p0) q0

absolute value

All answers must be for PED must be converted by the absolute

value to turn it to positive.

Example 1:

If the price of product Y has increased by 10% then the quantity

demanded has decreased by 20%. Calculate the price elasticity of
demanded when price increases.
% P = 10%
% Q = 20%
Ed = % Q
% P
Ed = 20%
10%
Ed = 2
Ed = 2

absolute value
(Since 1<Ed < , the demand is elastic)

Example 2:

Given the price of product X is RM 4 and the quantity demanded is 12

units. When the price of product X increases to RM 5 the quantity
demanded is 6 units. Calculate the price elasticity of demanded when
price increases.
p0 = RM4 q0 = 12
p1 = RM5 q1 = 6

Ed =

Q p0
P q0

Ed =

(q1 q0) p0
(p1 p0) q0
(6 12) 4
(5 4)
12

=
=
=
Ed = 2

(Proportionate Method)

6 1
1
3
2
(Since 1<Ed < , the demand is elastic)

c. Objective for PED or Degrees of PED:

Once we have calculated the PED then we need to interpret the coefficient
value. For PED coefficient there are degrees of PED :

Elastic Demand , (1<Ed < )

Inelastic Demand , (0< Ed < 1)
Unitary Elastic Demand , ( Ed = 1)
Perfectly Inelastic Demand , ( Ed = 0)
Perfectly Elastic Demand , ( Ed = )

2.

Income Elasticity of Demand (IED)

a. Definition of IED:
It measures the responsiveness of quantity demanded due to a
change in consumers income.
b. Formula :
i. EI =

% in Qty demanded
% in Income

EI = % Q
% I
Note:

(Percentage Method)

Note : Im using notation I for Income but the

manual is using Y.

The following are the steps to convert from percentage

method to proportionate method:

ii.

Q 100%
q0
_________
I 100%
I0
Q I0
I q0

EI = Q I0
I q0

(Proportionate Method)

EI = (q1 q0) I0
(I1 I0) q0

b. Objective for IED:

Is to identify the types of good.

i.

Normal Goods

Luxury Goods, if (EI > 1)

i.e antique furniture, antique cars
Necessity Goods, if (0< EI =< 1)
i.e clothings, shoes.

(Note : As income increased , the quantity demanded will also increased.)

ii.

Inferior Goods
(Giffen Goods)

(EI < 0)

i.e low-grade rice, black&white TV, secondhand

clothings
(Note : As income increased , the quantity demanded will also decreased.)
iii.

c.

Essential Goods

(EI = 0)
i.e Insulin for diabetic patient
(Note : As income increased , the quantity demanded no changed.)

Example 1 :
Given the consumers income increased by 10% , the quantity demanded
for houses have increased by 5% . Calculate the income elasticity of
demanded for houses when income increases.
Given :

%I = 10%

% Q = 5%

EI = % Q = 5%
% I
10%
EI = 0.5 ( Since 0<Ed =<1 , the good is Necessity good)

Example 2:
Given the following table:
Income
($)
300
400
500
600
700
800

Qty for Good Qty for Good Qty for Good

A
B
C
20
20
20
25
18
20
30
15
20
35
10
20
40
5
20
45
0
20

Questions:
Find the EI when consumers income changes from RM500 to RM600 for
good A,B and C respectively. Then determine the type of goods from the
above calculation.
Suggested Solutions:
Since we have three (A,B & C) goods, so there should be three calculation to
find the EI for good A, B & C respectively.
For Good A :
EI =

I0 = RM500 q0 = 30
I1 = RM600 q1 = 35
Q I0
I q0

(Proportionate Method)

(35 30)
500
=

(600 500) 30
EI

= 0.833

(Since EI is 0 < EI =< 1, thus the good is a necessity

good)

For Good B :

I0 = RM500 q0 = 15
I1 = RM600 q1 = 10

EI =

Q I0
I q0
(10 15)

=
(600 500)
EI = 1.67
For Good C :

500

15
(Since EI is EI < 0, thus the good is an inferior good)

I0 = RM500 q0 = 20
I1 = RM600 q1 = 20

EI =

Q I0
I q0

(20 20)
=

(600 500)
EI =

(Proportionate Method)

(Proportionate Method)
500
20

(Since EI is EI = 0, thus the good C is an essential good)

3. Cross Elasticity of Demand (CED)

a. Definition of CED:
It measures the responsiveness of quantity demanded (i.e in Qx)
due to a change in price of related product ( in Py).
b. Formula :
i. Ec =

% in Qty of X
% in Price of Y

(Percentage Method)

Ec = % Qx
% Py
Note: The following are the steps to convert from
percentage method to proportionate method:

Q x 100%
qx0
_________
Py 100%
py0

ii. Ec = Q x py0
Py q x0

(Proportionate Method)

c. Objective :
It is to establish the relationship between good X and good Y.
There are three possibilities of goods:
i) X and Y are substitute goods => Ec = + (positive value)
Note : As price Py increase, the quantity Qx will also increase.

ii) X and Y are complementary goods => Ec = (negative value)

Note : As price Py increase, the quantity Qx will also decrease.
iii) X and Y has no relationship => Ec = 0 (zero value)
Note : As price Py increase, there is no effect on Qx.

Examples :
The following table shows the demand for two goods Y and Z, when there is a
change in price for good X :
Price of Good X Qty of Good Y Qty of Good Z
5
10
5
6
8
8
7
7
10
8
6
14
Questions:
1. Calculate the CED of good Y when price of good X increased from
RM6 to RM7 per unit.
2. Calculate the CED of good Z when price of good X increased from
RM6 to RM7 per unit.
Suggested Solutions:
1.

px0 = 6
px1 = 7
Ec =

q y0 = 8
q y1 = 7
Q y px0
Px q y0

(Proportionate Method)

(7 8)
=

(7 6)

Ec = 0.75 (Since Ec is Ec < 0 , thus as Px increased the Q y will

decreased which mean Good X & Y are complementary goods)
2.

px0 = 6
px1 = 7
Ec =

q z0 = 8
q z1 = 10
Q y px0
Px q y0
(10 8)

=
Ec =

(Proportionate Method)
6

(7 6)
8
1.5
(Since Ec is Ec > 0 , thus as Px increased the Q y will
increased which mean Good X & Z are substitute goods)
9