Elasticity

IITTM, Gwalor by Prof. A.G. Naolekar

Elasticity of demand
Shows how sensitive demand is to:
1. A change in the price of the good itself
Price Elasticity of Demand (PED)
2. A change in consumers income
Income Elasticiy of Demand (YED)
3. A change in the price of another good
Cross Elasticity of Demand (CED)
IITTM, Gwalor by Prof. A.G. Naolekar

Price Elasticiy of Demand

Is the percentage/proportionate
change in the demand (quantity) for a
good caused by the
percentage/proportionate change in
the price of that good.

IITTM, Gwalor by Prof. A.G. Naolekar

PED is measured by using

the following formula:
P1 + P2
Q1 + Q2

Q
P

Where:
P1 = the original price of the good
P2 = the new price of the good
Q1 = the original quantity demanded
Q2 = the new quantity demanded
Delta Q = the change in quantity demanded
Delta P = the change in price
IITTM, Gwalor by Prof. A.G. Naolekar

Note 1
A negative () number means that the good:
Obeys the law of demand (eg a normal good)
When P
QD or when P QD
Applying this to the formula

Q
+ P

or

+ Q

Each gives a
negative number

IITTM, Gwalor by Prof. A.G. Naolekar

Note 2
A positive (+) number means that the good
Does not obey the law of demand (eg. a giffen
good)
When P
QD or when P QD
Applying this to the formula

+ Q
+ P

or

Each gives a
positive number

IITTM, Gwalor by Prof. A.G. Naolekar

Note 3
If the numerical value (ignoring the sign) is >1
then the PED is elastic.
This means that the percentage change in demand is
greater than the percentage change in price.
If the ans is > 1 then it is a Luxury Good (holiday)
ie: even if the price changes slightly there will be a large
reduction in demand.

IITTM, Gwalor by Prof. A.G. Naolekar

Elastic Demand Curve

(flatter)
The Price Elasticity of
Demand for this product
is elastic.
The change in price
causes a more than
proportionate change in
demand.
Degree of slope > 45.

Price

Luxury goods, e.g. foreign holidays.

P2
P1

Q2
IITTM, Gwalor by Prof. A.G. Naolekar

Q1

Quantity

Note 4
If the result is
< +1 or < 1
then the PED is inelastic.
This means that the percentage change in demand
is less than the percentage change in price.
If the ans is < 1 then it is a Necessity
ie. even if the price change is large the demand will
not change much as people cannot do without it.

IITTM, Gwalor by Prof. A.G. Naolekar

Price

Inelastic Demand Curve

(steeper)

The price elasticity of

demand for this product is
P2
inelastic.
The change in price has P1
caused a less than
proportionate change in
quantity demanded.
Degree of slope < 45.

Necessities, e.g. Domestic

use of electricity.

D
Q2

Q1

IITTM, Gwalor by Prof. A.G. Naolekar

Quantity

Note 5
If the result is
= +1 or = 1
then the PED is equal to unity or unit elasticity.
This means that the percentage change in demand
is equal to the percentage change in price.
If the ans is = 1 then it is a Luxury-necessity
Eg. needs that are really wants, dvd player, I-pod

IITTM, Gwalor by Prof. A.G. Naolekar

Equal to Unity Curve

Price

Luxury/necessities, e.g. a freezer.

The price elasticity of

demand for this
P1
product
is equal to unity.
The price change has P2
caused demand to
change in direct
proportion to the
change in price.
Degree of slope = 45.

D
Q1

Q2

IITTM, Gwalor by Prof. A.G. Naolekar

Quantity

Example 1
2008 Q 1. (b) (iii)
Q
P1= Rs.40
P1 + P2

P2 = Rs.50
P
Q1 + Q2
Q1=60 units
Q2=40 units
40 + 50 X 20 = -1.8
60 + 40
10
Therefore PED is elastic, obeys the law of
demand, eg. luxury good
IITTM, Gwalor by Prof. A.G. Naolekar

Example 2
2007 SQ 3.
Q
P 1 = Rs.1.50
P1 + P2

P 2 = Rs.1.00
P
Q1 + Q2
Q 1 = 50 units
Q 2 = 90 units
1.50 + 1.00 X 40 = - 1.43
50 + 90
- 0.50
Therefore PED is elastic, obeys the law of
demand, eg. luxury good
IITTM, Gwalor by Prof. A.G. Naolekar

Exceptional PED (perfect

comp)
Price

Quantity

In this case any change in price will cause D to fall

to zero.
Thus PED is perfectly elastic (or equal to infinity).
IITTM, Gwalor by Prof. A.G. Naolekar

Exceptional PED (vital

D
med)
P2
Price

P1
D
Q1

Quantity

In this case any change in price between P1 and

P2 will have no effect on the amount demanded.
Thus the PED is perfectly inelastic (or = zero).
IITTM, Gwalor by Prof. A.G.
Naolekar

Factors affecting elasticity

Necessity = inelastic v luxury =
elastic
Substitute available = elastic v
no substitute available = inelastic
Alternative uses = elastic
Durable = elastic v non durable =
inelastic

IITTM, Gwalor by Prof. A.G.

Naolekar

Complementary good

Eg.
Set of golf clubs = dearer = elastic
Golf balls = cheaper = inelastic
The demand for golf balls will be
influenced more by the price of clubs
rather than the balls themselves.
IITTM, Gwalor by Prof. A.G.
Naolekar

An increase in the price of balls is

unlikely to have much effect on the
demand for balls or clubs.
However an increase in the price of
clubs will affect both the demand for
clubs and balls.
IITTM, Gwalor by Prof. A.G.
Naolekar

PED of normal goods and

Total Revenue
When PED > 1
You need to decrease price to increase
total revenue (same direction)
When PED < 1
You need to decrease increase price to increase
total revenue (opp dir)
When PED = 1
There is no effect on TR when P changes
IITTM, Gwalor by Prof. A.G.
Naolekar

Giffen goods and change in

TR
For Giffen goods
Price and total revenue always change in the same
direction regardless of the degree of PED.
The demand for Giffen goods goes up when their
price is increased.
As price increases more goods are sold at a higher
price therefore TR must also increase.
The same logic applies to a decrease in price.
IITTM, Gwalor by Prof. A.G.
Naolekar

Income Elasticity of Demand

(YED)
Measures the relationship between a change in
income and the resulting change in demand.
It can be:
Positive (+) = Normal Good, as Y rises D rises
Negative (-) = Inferior Good & Giffen Good, as
Y rises D falls
IITTM, Gwalor by Prof. A.G.
Naolekar

YED can be
Elastic (> I1I): the change in income causes a
more than proportionate change in demand.
(Luxury Good)
Inelastic (< I1I): the change in income causes
a less than proportionate change in demand.
(Food)
Equal to unity ( = I1I): the change in income
causes a proportionate change in demand.
IITTM, Gwalor by Prof. A.G.
Naolekar

Measurement of YED
YED is measured by using the following
Q
formula: Y1 + Y2
Q1 + Q2

Where:
Y1 = the original income
Y2 = the new income
Q1 = the original quantity demanded
Q2 = the new quantity demanded
Delta Q = the change in quantity demanded (sign nb)
Delta Y = the change in income (sig nb)
IITTM, Gwalor by Prof. A.G.
Naolekar

Example

Income went from 200 to 250

Demand went from 5 units to 8 units
200+250 x +3
5+8
+50
+2.07
Normal, Luxury Good
IITTM, Gwalor by Prof. A.G.
Naolekar

2002 Q 3 (a)

Normal Good Y inc, QD inc (+)

Eg. holiday

Inferior Good Y inc, QD dec (-)

Eg. potatoes

IITTM, Gwalor by Prof. A.G.

Naolekar

(b)
Let Y = Rs.100
Consumer spends
(40 % of Rs.100) Rs.40 on the good
Y doubles to Rs.200
Consumer spends
(30 % of Rs.200) Rs.60 on the good
Y Inc and QD Inc Normal Good
IITTM, Gwalor by Prof. A.G.
Naolekar

(c)

YED potatoes
-0.1

YED designer clothes

+2.5

IITTM, Gwalor by Prof. A.G.

Naolekar

(d) YED = +1.8 Y D

Y expected to rise by 5%
Demand (Sales) will rise by
1.8 times 5%
5% X 1.8 = 9%
20,000 x 9 = 1,800
100
20,000 + 1,800 = 21,800 units

IITTM, Gwalor by Prof. A.G.

Naolekar

YED = -0.5 Y D
Y expected to rise by 2%
Demand (Sales) will decrease by
2 times 0.5 %
0.5 % X
2 = 1%
10,0000 x 1
= 100
100
10,000 - 100 = 9,900
units

IITTM, Gwalor by Prof. A.G.

Naolekar

2009 Q 1. (b) (ii)

YED low price meat

-0.1
YED for iphones
+4.6
IITTM, Gwalor by Prof. A.G.
Naolekar

2009 Q 1 (c)

YED = +2.5 Y D

Y decreases by 8%
Sales decrease by 2.5 times 8%
8%X2.5=20%
Sales falls by 20%
100,000X20
= 20,000 units
100
100,000-20,000 = 80,000 units

IITTM, Gwalor by Prof. A.G.

Naolekar

Uses of YED

IITTM, Gwalor by Prof. A.G.

Naolekar

Cross Elasticity of Demand

(CED)
Cross elasticity of demand measures the
relationship between the change in price of
one good (A) and the resulting change in
demand for another good (B).
+ive = substitute, an inc P A = an inc D B
-ive = complementary, an in P A = dec in D
B
> 1 elastic, < 1 inelastic, = 1 unitary
IITTM, Gwalor by Prof. A.G.
Naolekar

Measurement of CED
CED is measured by using the following formula:

P(A)1 + P(A)2
Q(B)1 + Q(B)2

Q(B)
P(A)

The demand for product B reacts to a change in the price of

product A.
Where:

P(A)1 = the original price of A

P(A)2 = the new price of A

Q(B)1 = the original quantity of B

Q(B)2 = the new quantity of B

Delta Q(B) = the change in quantity of B (sign nb)

IITTM, Gwalor by Prof. A.G.

Delta P(A) = the change in Naolekar

price of A (sign nb)

2006 Q 1 (c)
5+6
X +4
10 + 14
+1
+ 1.83
Substitute, elastic

IITTM, Gwalor by Prof. A.G.

Naolekar

2003

Q 2 (b)

27 + 23
X
1,200 + 800

-400
-4

+ 2.5
Substitute, elastic
IITTM, Gwalor by Prof. A.G.
Naolekar

1999 Q 4 (b)
B = +2.5
Substitute, elastic
C = -0.6
Complementary, inelastic
D = + 0.3
Substitute, inelastic
E = -1.4
Complementary, elastic
IITTM, Gwalor by Prof. A.G.
Naolekar

Closest substitute

+0.3

IITTM, Gwalor by Prof. A.G.

Naolekar