Data

Price Quantity Quantity

Demanded Supplied
$7 200 50
$8 180 90
$9 150 150
$10 110 210
$11 60 250

The Price Elasticity of Demand (commonly

known as just price elasticity) measures the
rate of response of quantity demanded due
to a price change. The formula for the Price
Elasticity of Demand (PEoD) is:
PEoD = (% Change in Quantity
Demanded)/(% Change in Price)
Calculating the Price Elasticity of
Demand
You may be asked the question "Given the
above data, calculate the price elasticity of
demand when the price changes from $9.00
to $10.00"
First we'll need to find the data we need.
We know that the original price is $9 and
the new price is $10, so we have
Price(OLD)=$9 and Price(NEW)=$10.

From the chart we see that the quantity

demanded when the price is $9 is 150 and
when the price is $10 is 110.
Since we're going from $9 to $10, we have
QDemand(OLD)=150 and
QDemand(NEW)=110, where "QDemand" is
short for "Quantity Demanded". So we have:
Price(OLD)=9
Price(NEW)=10
QDemand(OLD)=150
QDemand(NEW)=110
To calculate the price elasticity, we need to
know what the percentage change in
quantity demand is and what the
percentage change in price is. It's best to
calculate these one at a time.
Calculating the Percentage Change in
Quantity Demanded
The formula used to calculate the
percentage change in quantity demanded
is:
[QDemand(NEW) - QDemand(OLD)] /
QDemand(OLD)
By filling in the values we wrote down, we
get:
[110 - 150] / 150 = (-40/150) = -0.2667
We note that % Change in Quantity
Demanded = -0.2667 (We leave this in
decimal terms. In percentage terms this
would be -26.67%). Now we need to
calculate the percentage change in price.
Calculating the Percentage Change in
Price
Similar to before, the formula used to
calculate the percentage change in price is:
[Price(NEW) - Price(OLD)] / Price(OLD)
By filling in the values we wrote down, we
get:
[10 - 9] / 9 = (1/9) = 0.1111
We have both the percentage change in
quantity demand and the percentage
change in price, so we can calculate the
price elasticity of demand.
Final Step of Calculating the Price
Elasticity of Demand
We go back to our formula of:
PEoD = (% Change in Quantity
Demanded)/(% Change in Price)
We can now fill in the two percentages in
this equation using the figures we calculated
earlier.
PEoD = (-0.2667)/(0.1111) = -2.4005
When we analyze price elasticities we're
concerned with their absolute value, so we
ignore the negative value. We conclude that
the price elasticity of demand when the
price increases from $9 to $10 is 2.4005.

How Do We Interpret the Price Elasticity

of Demand?
A good economist is not just interested in
calculating numbers. The number is a
means to an end; in the case of price
elasticity of demand it is used to see how
sensitive the demand for a good is to a price
change.

The higher the price elasticity, the more

sensitive consumers are to price changes.

A very high price elasticity suggests that

when the price of a good goes up,
consumers will buy a great deal less of it
and when the price of that good goes down,
consumers will buy a great deal more.
A very low price elasticity implies just the
opposite, that changes in price have little
influence on demand.
Often an assignment or a test will ask you a
follow up question such as "Is the good
price elastic or inelastic between $9 and
$10". To answer that question, you use the
following rule of thumb:
• If PEoD > 1 then Demand is Price
Elastic (Demand is sensitive to price
changes)
• If PEoD = 1 then Demand is Unit

Elastic
• If PEoD < 1 then Demand is Price

Inelastic (Demand is not sensitive to

price changes)
Recall that we always ignore the negative
sign when analyzing price elasticity, so
PEoD is always positive. In the case of our
good, we calculated the price elasticity of
demand to be 2.4005, so our good is price
elastic and thus demand is very sensitive to
price changes.

The Arc Elasticity of Demand - 16

The arc elasticity of demand refers to the
relationship between changes in price and
the subsequent change in quantity
demanded.
Qo is the
initial
quantity
demanded.
Q1 is the
new
quantity
demanded.
Po is the
initial price.
P1 is the
new price.
The arc elasticity formula is used if the
change in price is relatively large. It is more
accurate a measure of elasticity than simple
''price elasticity''.
If the arc or price elasticity of demand is
greater than 1, demand is said to be
elastic.
If the arc or price elasticity of demand is
less than 1, demand is said to be inelastic.
i n c om e e la s ti c i ty o f d e m a n d
Introduction
Income elasticity of demand measures the
relationship between a change in quantity
demanded and a change in income.

The basic formula for calculating the

coefficient of income elasticity is:
Percentage change in quantity
demanded of good divided by the
percentage change in real consumers'
income
IEoD = (% Change in Quantity
Demanded)/(% Change in
Income)

Normal Goods
Normal goods have a positive income
elasticity of demand so as income rise more
is demand at each price level.
We make a distinction between normal
necessities and normal luxuries (both have
a positive coefficient of income elasticity).
Necessities have an income elasticity of
demand of between 0 and +1.
Demand rises with income, but less than
proportionately. Often this is because we
have a limited need to consume additional
quantities of necessary goods as our real
living standards rise.
The class examples of this would be the
demand for fresh vegetables, toothpaste
and newspapers. Demand is not very
sensitive at all to fluctuations in income in
this sense total market demand is relatively
stable following changes in the wider
economic (business) cycle.
Luxuries on the other hand are said to
have an income elasticity of demand > +1.
(Demand rises more than proportionate to a
change in income).
Luxuries are items we can (and often do)
manage to do without during periods of
below average income and falling consumer
confidence.
When incomes are rising strongly and
consumers have the confidence to go
ahead with “big-ticket” items of spending, so
the demand for luxury goods will grow.
Conversely in a recession or economic
slowdown, these items of discretionary
spending might be the first victims of
decisions by consumers to rein in their
spending and rebuild savings and
household financial balance sheets.
Many luxury goods also deserve the
sobriquet of “positional goods”. These are
products where the consumer derives
satisfaction (and utility) not just from
consuming the good or service itself, but
also from being seen to be a consumer by
others.

Inferior Goods
Inferior goods have a negative income
elasticity of demand. Demand falls as
income rises.

In a recession the demand for inferior

products might actually grow (depending on
the severity of any change in income and
also the absolute co-efficient of income
elasticity of demand).
For example if we find that the income
elasticity of demand for cigarettes is -0.3,
then a 5% fall in the average real incomes
of consumers might lead to a 1.5% fall in
the total demand for cigarettes (ceteris
paribus).

Within a given market, the income elasticity

of demand for various products can vary
and of course the perception of a product
must differ from consumer to consumer.
The hugely important market for overseas
holidays is a great example to develop
further in this respect.
What to some people is a necessity might
be a luxury to others.
For many products, the final income
elasticity of demand might be close to zero,
in other words there is a very weak link at
best between fluctuations in income and
spending decisions.
In this case the “real income effect” arising
from a fall in prices is likely to be relatively
small.

Most of the impact on demand following a

change in price will be due to changes in
the relative prices of substitute goods and
services.
The income elasticity of demand for a
product will also change over time – the
vast majority of products have a finite life-
cycle.
Consumer perceptions of the value and
desirability of a good or service will be
influenced not just by their own experiences
of consuming it (and the feedback from
other purchasers) but also the appearance
of new products onto the market.
Consider the income elasticity of demand
for flat-screen colour televisions as the
market for plasma screens develops and
the income elasticity of demand for TV
services provided through satellite dishes
set against the growing availability and
falling cost (in nominal and real terms) and
integrated digital televisions.

---------------------------------------------------------
Data
Income Quantity Demanded
$20,000 60
$30,000 110
$40,000 150
$50,000 180
$60,000 200

The Income Elasticity of Demand measures

the rate of response of quantity demand due
to a raise (or lowering) in a consumers
income. The formula for the Income
Elasticity of Demand (IEoD) is given by:
IEoD = (% Change in Quantity
Demanded)/(% Change in Income)
Calculating the Income Elasticity of
Demand
On an assignment or a test, you might be
asked "Given the following data, calculate
the income elasticity of demand when a
consumer's income changes from $40,000
to $50,000".
The first thing we'll do is find the data we
need. We know that the original income is
$40,000 and the new price is $50,000 so we
have Income(OLD)=$40,000 and
Income(NEW)=$50,000.

From the chart we see that the quantity

demanded when income is $40,000 is 150
and when the price is $50,000 is 180. Since
we're going from $40,000 to $50,000 we
have QDemand(OLD)=150 and
QDemand(NEW)=180, where "QDemand" is
short for "Quantity Demanded". So you
should have these four figures written down:
Income(OLD)=40,000
Income(NEW)=50,000
QDemand(OLD)=150
QDemand(NEW)=180
To calculate the price elasticity, we need to
know what the percentage change in
quantity demand is and what the
percentage change in price is. It's best to
calculate these one at a time.
Calculating the Percentage Change in
Quantity Demanded
The formula used to calculate the
percentage change in quantity demanded
is:
[QDemand(NEW) - QDemand(OLD)] /
QDemand(OLD)
By filling in the values we wrote down, we
get:
[180 - 150] / 150 = (30/150) = 0.2
So we note that % Change in Quantity
Demanded = 0.2 (We leave this in decimal
terms. In percentage terms this would be
20%) and we save this figure for later. Now
we need to calculate the percentage change
in price.
Calculating the Percentage Change in
Income
Similar to before, the formula used to
calculate the percentage change in income
is:
[Income(NEW) - Income(OLD)] /
Income(OLD)
By filling in the values we wrote down, we
get:
[50,000 - 40,000] / 40,000 =
(10,000/40,000) = 0.25
We have both the percentage change in
quantity demand and the percentage
change in income, so we can calculate the
income elasticity of demand.
Final Step of Calculating the Income
Elasticity of Demand
We go back to our formula of:
IEoD = (% Change in Quantity
Demanded)/(% Change in Income)
We can now fill in the two percentages in
this equation using the figures we calculated
earlier.
IEoD = (0.20)/(0.25) = 0.8
Unlike price elasticities, we do care about
negative values, so do not drop the
negative sign if you get one. Here we have
a positive price elasticity, and we conclude
that the income elasticity of demand when
income increases from $40,000 to $50,000
is 0.8.
How Do We Interpret the Income
Elasticity of Demand?
Income elasticity of demand is used to see
how sensitive the demand for a good is to
an income change.
The higher the income elasticity, the more
sensitive demand for a good is to income
changes.
A very high income elasticity suggests that
when a consumer's income goes up,
consumers will buy a great deal more of that
good.
A very low price elasticity implies just the
opposite, that changes in a consumer's
income has little influence on demand.
Often an assignment or a test will ask you
the follow up question "Is the good a luxury
good, a normal good, or an inferior good
between the income range of $40,000 and
$50,000?" To answer that use the following
rule of thumb:
•If IEoD > 1 then the good is a Luxury
Good and Income Elastic
 • If IEoD < 1 and IEOD > 0 then the
good is a Normal Good and Income
Inelastic
• If IEoD < 0 then the good is an

Inferior Good and Negative Income

Inelastic
In our case, we calculated the income
elasticity of demand to be 0.8 so our good is
income inelastic and a normal good and
thus demand is not very sensitive to income
changes.