CHAPTER 3

ELASTICITIES
Elasticity is a measure of the responsiveness of a variable to changes in
price or any of the variable’s determinants
Price elasticity of demand ( PED )
• Price Elasticity of Demand (PED) is defined as the responsiveness of quantity
demanded to a change in price.
• The demand for a product can be elastic or inelastic, depending on the rate of
change in the demand with respect to the change in the price
What does Price Elasticity mean?

• Demand is said to be elastic demand has a higher proportionate response to a

smaller change in price
• demand is inelastic when there is little movement in demand with a significant
difference in price
• For example, if I increase the price of a phone from $300 to $500, then how much
can I expect my demand to fall?
Factors Affecting Price Elasticity of Demand

• Once a manufacturer or producer knows the Price Elasticity of Demand for their
product, it can help them determine their change in Total Revenue if they have to
change the price of the product
• Total revenue is the number of goods they sell multiplied by the Price its sold at.
• The change in total revenue depends on the elasticity
• 1. Substitutes
• If there is a greater availability of substitutes, then the good is likely to be more
elastic. For example, if the price of one soda brand goes up, people can turn to
other brands. So, a small change in price is likely to cause a greater fall in quantity
demanded
• 2. Necessities
• If a good is a necessity, then the demand tends to be inelastic. For example, if
the price for drinking water rises, then there is unlikely to be a huge drop in the
quantity demanded since drinking water is a necessity
• 3. Time
• Over time, a good tends to become more elastic because consumers and
businesses have more time to find alternatives or substitutes. For example, if the
price of gasoline goes up, over time people will adjust for the change, i.e., they
may drive less or use public transportation or form carpools
• 4. Habit
• The demand for addictive or habitual products is usually inelastic. This is because
the consumer has no choice but no pay whatever the producer is demanding.
For example, if the price for a pack of cigarettes goes up, it will likely not have any
effect on demand
Price Elasticity of Demand Formula

%∆ in Qd = Percentage Change in Quantity Demanded

Calculation of % change in quantity demanded

New Quantity Demanded -the Old Quantity Demanded / Old Quantity

Demanded

%∆ in P = Percentage Change in Price

This is the New Price minus the Old Price divided by the Old Price.
• The value of Price Elasticity of Demand (PED) is always negative, i.e. price and
demand have an inverse relationship
• This is because the ratio of changes of the two variables is in opposite directions,
so if the price goes up, demand goes down and the change will end up negative.
• However, the common practice is to drop the minus sign and consider PED as a
positive number.
• This is done to avoid confusion when making comparisons between different
values of PED.
• Using positive numbers, we can say, for example, that a PED of 3 is larger than a
PED of 2. (Had we been using the minus sign, −2 would be larger than −3.)
• Suppose consumers buy 6000 DVD players when the price is $255 per unit, and
they buy 5000 DVD players when the price is $300.
The use of percentages
• Page 48
Types of Price Elasticity of Demand
• 1. Perfectly Inelastic Demand, (PED = 0)

• With a perfectly inelastic demand, there is no change in the demand for a product with a
change in its price
• This means that the demand remains constant for any value of price. The demand curve is
represented as a straight vertical line
It is practically impossible to find a product that has perfectly inelastic demand. The closest thing could be
essentials like water or certain food products.

• This is the effect on total revenue with a change in price:

• Price ↑ → Total Revenue ↑
• Price ↓ → Total Revenue ↓
.
2. Inelastic demand( 0 < PED < 1 )(greater
than zero and less than one)
• Inelastic demand occurs when the percentage change in demand is less than the
percentage change in the price of a product.
• For example, if the price of a product increases by 15% and the demand for the
product decreases only by 7%, then the demand would be called relatively
inelastic
• The demand curve of relatively inelastic demand is rapidly sloping.
• This is the effect on total revenue with a change in price:
• Price ↑ → Total Revenue ↑
• Price ↓ → Total Revenue ↓
3. Unit Elastic Demand, (PED = 1)

• Demand is said to be unit elastic when the proportionate change in demand

produces the same change in the price.
• The quantity demanded changes by the same percentage as the change in price.
• This is the effect on total revenue with a change in price:
• Price ↑ → No Change in Total Revenue
• Price ↓ → No Change in Total Revenue
4. Elastic Demand, (1 < PED < ∞) (greater than
1 and less than infi nity)
• Relatively elastic demand is defined as the proportionate change produced in
demand is greater than the proportionate change in the price of a product
• The quantity demanded changes by a larger percentage than the change in price.
• For example, if the price of a product increases by 10% and then the demand
for the product decreases by 15%, then the demand would be relatively elastic
• This is the effect on total revenue with a change in price:
• Price ↑ → Total Revenue ↓
• Price ↓ → Total Revenue ↑
5. Perfectly Elastic Demand, (PED = ∞)

• In Perfectly Elastic Demand, a small rise in price will result in a fall in demand to
zero, while a small fall in price will result in the demand to become infinite
• Consumers will buy all available at some price, but none at any other price.
• In a perfectly elastic demand, the demand curve is represented as a horizontal
straight line.
• This is the effect on total revenue with a change in price:
• Price ↑ → 0 Total Revenue
• Price ↓ → 0 Total Revenue