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Elasticity

u Elastic
u Measures the responsiveness of one variable to a certain
ELASTICITY and its USES change of another variable
u When the Quantity is sensitive to the change in price

Percentage change in variable x

Elasticity = Percentage change in variable y

Price Elasticity of Demand Inelastic Demand

u PED measures the responsive quantity demanded is to u The change in price has relatively little
effect on quantity demanded; the
a price change percentage change in the quantity demanded
u PED = %ΔQd / %ΔP %Δ = (Q 2 -Q 1 /Q 1 ) x 100 or (P2 -P1 /P1 ) x 100
is less than the percentage change in price
u Large changes in price lead to small changes
u Mid-point Method: in quantity demanded.
u The resulting absolute value is less than 1.0
PED = Q2 – Q1
Q1 + Q2 ÷
P2 – P1
P1 + P2
u Products with inelastic demand have very
few substitutes
2 2 u Necessity

Elastic Demand Perfectly Inelastic

u A change in price that has a relatively

large effect on quantity demanded; • Any change in the price creates
the percentage change in quantity
demanded exceeds the percentage
no change in the quantity
change in price demanded.
u Small changes in price lead to larger
changes in quantity demanded. % Change in Quantity
u The resulting absolute value is greater
=0
than 1.0 % Change in Price
u Products with elastic demand have
many substitutes

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Perfectly Elastic Unit-Elastic Demand

• Without a change in price, an u The percentage change in quantity demanded

infinite change occurs in equals the percentage change in price; the
resulting price elasticity has an absolute value of

∞
quantity demanded. 1.0

% Change in Quantity
% Change in Price =

Types of Price Elasticity of Demand What does PED tells us?

uPED is the percentage change

in quantity demanded resulting
from a 1% change in the price.
Per fect ly Inelast ic Inelast ic U nit Elast ic Elast ic Per fect ly Elast ic

0 <1 1 >1 ∞

PED = %ΔQd / %ΔP PED = %ΔQd / %ΔP

1. Price of cigarette goes up from Php6 to 1. Price of McDonald’s Big Mac increased from
Php7. Quantity demanded goes down from $3 to $4, and the quantity demanded
150pcs to 135pcs. decreased from 5000 sandwiches to 3000.

2. Price of books goes down from Php500 to 2. Price of gasoline increased from $3 to $4,
Php300. Quantity demanded goes up from and the quantity demanded decreased
200 books to 380. from 4m gallons to 3.5m gallons.

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Available Substitutes

u The number of available substitutes

u Goods with greater substitutes are elastic

Determinants of Price Elasticity of
Demand u Consumers tend to go for substitutes if
there is an increase in price of a certain
S. P. L. A. T. product

u Ex. Fried Chicken

Proportion of Income Necessity or Luxury

u The proportion of income in price changes u The importance or degree of necessity of the goods

u Inelastic if the demand for the product is not affected by u The more essential, the more inelastic
change in income u Change in price does not matter much to consumers
u Elastic if any change in price results to a substantial
effect in consumer income
u The less essential or not important goods tend to be elastic
u Consumers tend to be more responsive to goods that
make up a much larger percentage of income. u Change in price affects the consumers

Addictiveness of a Good The Time Period

uAddictive goods tend to have inelastic § The amount of time following a price change.
demands. § The longer the adjustment period, the greater
the consumer’s ability to substitute higher-
uEx. Cigarettes, alcohol, DRUGS
priced goods to lower priced alternatives.

uShort-run – Price is inelastic

uLong-run – Price is elastic

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Important Notes

uElasticity varies along the demand

Elasticity Along the curve
Demand Curve uSlope of the line will be the same
along the demand curve
uElasticity is NOT the slope

Important Notes

u The top part is always the elastic section

u The bottom part is always the inelastic
section
u The middle is always unit – elastic Elasticity of Supply
u The top most is perfectly elastic
u The bottom most is perfectly inelastic

Price Elasticity of Supply Elastic Supply

u Measures the responsiveness of quantity uA certain decrease in price

supplied in response to a price change in leads to a greater decrease in
the price of goods quantity supplied
% Δ Qs u The % change in Qs is greater
ℇS = % Δ P than the % change in price
u The elasticity coefficient is
greater than 1

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Inelastic Supply Perfectly Elastic Supply

u A decrease in price leads to a u No change in price, and

lesser change in quantity
supplied there is an infinite change in
u The % change in Qs is smaller quantity supplied
than the % change in price u The resulting elasticity
u The resulting elasticity coefficient is infinity.
coefficient is less than 1
u Common to agriculture which
takes time to be produced

Perfectly Inelastic Supply Unit-Elastic

u A change in price has no u Change in price leads to an

effect in quantity supplied equal change in quantity
u The resulting elasticity supplied
coefficient is zero. u The elasticity coefficient
u Goods that exist in fixed equals 1.
amounts

Practice Problems

1. Assumethat the price of blue jeans increased

from $40 to $50, and that the quantity supplied
increased from 3,000 pairs to 7,200 pairs of blue
jeans. Determinants of Price Elasticity of
Supply
2. Assumethat the quantity supplied of cotton was
10% following a 25% in price. What is the PES of
cotton?

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Mobility / substitution of factors of Spare Production Capacity

production

u Factors ofproduction: uThe more spare capacity, the more

u Land,Labor and capital - how quickly can price elastic the supply is going to
these be mobilized towards the production
be.
or out of production following the price
change

Stocks of finished products and Production Lag

components

u The larger the level of stocks, the more
price elastic supply is going to be.
u The lower the level of stocks, the more
inelastic supply is going to be.
uThe longer the production lag, the
more inelastic supply is
uThe shorter the production lag, the
more elastic

u Eg. Perishable goods

Time Period

u Monetary or Intermediate – perfectly

inelastic, as supply is fixed Total Revenue Test of
u Short-run – supply is price inelastic, even
if equipment is fixed Price Elasticity
u Long-run – supply is price elastic, as new
firms are expected to enter the market,
or old firms are expected to leave

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Total Revenue and Price Elasticity
uTR is the business income from sale of
products
uTotal Revenue (TR) is the amount
sellers receive for a good or service
uCalculated as the product price times
quantity sold (p x q)
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Total Revenue and PED
u If a decrease in price leads to an increase in TR, then PED is
elastic
u If an increase in price leads to an increase in TR, the PED is
elastic
u If a decrease in price leads to a decrease in TR, then PED is
inelastic
u If an increase in price leads to an increase in TR, then PED is
inelastic
u If a change in price (increase or decrease) leads to no change in
TR, then the good is unit-elastic.