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CHAPTER 3:ELASTICITY

Elasticity of demand
Elasticity of supply

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Definition of elasticity
Elasticity refers to the degree of

responsiveness of a dependency
variable due to changes in the
independent variable .
The concept of elasticity is divided into
two special areas i.e. elasticity of
demand and elasticity of supply.

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ELASTICITY OF DEMAND
This is the degree of responsiveness

of quantity demanded due to changes

in any of the factors affecting demand.
Under elasticity of demand there are
several sub-divisions and these
include:
Price elasticity of demand
Income elasticity of demand
Cross elasticity of demand

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PRICE ELASTICITY OF DEMAND

According to the law of demand, when price goes up,

consumers demand fewer quantities of a product. If the

price of a product falls, quantity demanded will rise.
But when the price of a product changes, by how much
more (or less) will consumers buy?
To help answer this question, we will use a measurement
called the Price Elasticity of Demand.

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PRICE ELASTICITY OF DEMAND

This refers to a percentage change in

quantity demanded resulting from a

percentage change in price of that very
commodity. Alternatively it can be said to
be the degree of responsiveness of
quantity demanded of a commodity due
to changes in price of that particular
commodity.

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Formula for price elasticity of

demand

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Variation / interpretation of PED

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Introduction to Micro Economics I AMBROSE

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This
means
that a fall
in price
reduces
total
revenue
where as
an

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This
implies
that
selling
more or
less of
the
commod

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This means
that customers
will buy nothing
until price 0P0
is reached and
then they will
buy all they can
at that price.

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This means that a

fall in price

reduces total
revenue where as
an increase in

price increases

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This means
that reducing
the price of a
commodity
will increase
the total
revenue and
vice-versa.

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Example one
The quantity demanded of a certain
commodity X is 200 units when the
price is Shs 500; however when the
price increases to Shs. 1000 quantity
demanded goes down to 100 units.
Calculate the price elasticity of
demand.

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Example one

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MEASUREMENT OF PRICE ELASTICITY OF

DEMAND

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DETERMINANTS OF PED
DETERMINAN
T OF PED

EXPLAINATION

Availability of
substitutes

Commodities which have variety of cross substitutes tend to

have elastic demand e.g. toothpaste and different brands of
bread. However, commodities which have few or no cross
substitute tend to inelastic demand.

The nature of
the
commodity

The elasticity of demand for any commodity depends upon

whether the commodity is necessity or luxury. The demand for
a necessity such as salt is general inelastic. This is because
the demand for such goods does not change very much with
a rise or a fall in prices.

Income group
or peoples
income

People who belong to a higher income group normally have

demand for their commodities as being inelastic however
individuals in lower income groups have demand for their
commodities being elastic.

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The
proportion
of income
spent on
the
commodity

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If consumers spend small proportional of their income

on a commodity it means the demand for such
commodity will be inelastic because their amount
does not matter to the consumers so much e.g.
needles matchboxes. However commodities which
necessity a larger proportion will always have their
demand being elastic e.g. mobile phones, cars.

Uses of a commodities that have more than one use tend to

commodity have inelastic demand this is because even if they
are not demanded for one use they will be demand
for another. E.g. electricity. However commodities
with limited or one use tend to have elastic demand
this is because once that use is suspended or
controlled then less of them will be demanded

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IMPORTANCE OF PRICE ELASTICITY OF DEMAND

The concept of elasticity is not
(2) Importance for
just an abstract idea its practical
Businessmen
importance is very great.

(1) Importance For Government

Determination of tax rates: When

a tax is imposed the price tends to
rise. But if the demand is very
elastic it will considerably fall when
the price has risen and thus the
government will not be able to earn
expected revenue. Thus this
concept of elasticity of demand
helps the government to impose the
tax on a commodity whose demand
lass elastic and hence earn
valuable revenue.

The businessmen also

take cue from the nature of
demand while fixing his
price. IF the demand is
inelastic he knows that the
people must buy such
commodities. Thus he will
be able to change a higher
price and big profits.
.

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IMPORTANCE OF PED
(3) Importance for Monopolist: The concept of elasticity
of demand is of special importance to the monopolist.
He is in a position to control the price and fix high
price when demand is inelastic and low price when it
is elastic will bring him the maximum profit.
(4) Application in Case of Joint Products
In case of joint products separate costs are not
ascertainable. Hence the producer will mostly be
guided by the nature of demand while fixing the price.

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IMPORTANCE OF PED
(6) Importance for

(5) Determinitation of
Wages
The concept of elasticity
of demand influences
the determination of
wages of a particular
type of labour. If the
demand of particular
type of labour is inelastic
trade union can easily
get their wages raised.
On the other hand of the
demand for labour is
relatively elastic trade
union trade unions may
not be successful in
raising wages.

International Trade
The concept of elasticity
of demand is used in
calculating the terms of
trade. Whenever a
country fees an adverse
balance of payment the
government considers
the elasticity of demand
for the countries export
and imports before
devaluing its currency
OR applying
protectionism.

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Income Elasticity of Demand

Income elasticity of demand measures the

responsiveness of consumer purchases to

changes in consumer income.
The coefficient of income elasticity of
demand Ei is determined with the formula
percentage change in quantity
demanded
percentage change in income

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Income Elasticity of Demand

Normal Goods will have an income

elasticity of demand that is positive. More

of them are demanded as income
increases. Ei > 0
Inferior goods have a negative income

elasticity of demand. As income rises, the

demand for them falls. Ei < 0

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CROSS ELASTICITY OF DEMAND

Cross elasticity of demand this refers to the percentage

change in quantity demanded of a commodity say X due

to the percentage change in price or related commodity
say Y.
Alternatively it can be defined as the degree of
responsiveness of quantity of a commodity due to
changes in price of related commodity.

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CROSS ELASTICITY OF DEMAND

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Example
Given that quantity demanded for commodity Y

increased from 200 units to 300 units due to a fall of

price of Y from Shs 800 to Shs 600 per unit.
Calculate the cross elasticity of demand.

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Example

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Price Elasticity of Supply

Price elasticity of supply measures the

responsiveness of sellers to changes in the

price of a product.
If producers are relatively responsive, supply is

elastic.
If producers are relatively insensitive to price
changes, supply is inelastic.

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The price elasticity of supply coefficient Es is defined as:

percentage change in quantity supplied of X

percentage change in price of X
To calculate Es, we employ the midpoint approach to

determine the percentage changes.

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If Es < 1, supply is inelastic.

If Es > 1, supply is elastic.
If Es = 1, supply is unit-elastic.
Since price and quantity supplied are

directly related, Es is never negative.

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The market period is a period in which

producers of a product are unable to

change the quantity produced in response
to a change in price.
During this time period, the supply of a

product is fixed, or supply is perfectly inelastic.

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ILLUSTRATING PRICE ELASTICITY OF

SUPPLY

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Price Elasticity Of Supply

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Application of price elasticity of supply

When supply is perfectly inelastic, a shift in the demand curve has no

effect on the equilibrium quantity supplied onto the market. Examples

include the supply of tickets for sports or musical venues, and the
short run supply of agricultural products (where the yield is fixed at
harvest time) the elasticity of supply = zero when the supply curve is
vertical.
When supply is perfectly elastic a firm can supply any amount at the
same price. This occurs when the firm can supply at a constant cost
per unit and has no capacity limits to its production. A change in
demand alters the equilibrium quantity but not the market clearing
price.
When supply is relatively inelastic a change in demand affects the
price more than the quantity supplied. The reverse is the case when
supply is relatively elastic. A change in demand can be met without a
change

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Determinants of Price Elasticity Of Supply

Determinant
of PES

Explaination

Gestation
period

When the gestation period is short the supply of a

commodity will be elastic because in case of an
increase in prices, quantity supplied will take a
short period of time. in case of a long gestation
period the reverse is true.

Durability of
the
commodity

perishable goods have inelastic supply because

they cant be stored for long e.g. tomatoes, fruits
e.t.c. however durable goods such as coffee,
cotton have elastic supply. This is because they
can be stored once prices are low.

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Determinants of Price Elasticity Of

Supply
Time lag

In the short run, producers are able to change the quantities of

some but not all the resources they employ. This time period is
too short to change plant capacity but long enough to use fixed
plant more or less intensively. The supply of a product is more
elastic in the long run than the short run.

Costs of
productio
n

When the costs of commodity is high its production will be low

leading to inelastic supply. However, when production costs are
low the production of a commodity will increase in case of price
increases hence elastic supply.

The mode
of
productio
n

If production is carried out inefficiently with a better technology

more out put will be produced and supplied hence supply being
elastic. However, if the production process is poor or inefficient
there will be a tendency to produce low output even if prices are
high hence supply being inelastic.

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