Chapter 5: Elasticity

Intro; The extent of these changes is measured by the price elasticity of demand and the elasticity of supply.

Elasticity; general concept that can be used to quantify the response in one variable when other variable changes.

Types of Elasticity:

  1. Price elasticity of demand
  1. Cross elasticity of demand
  1. Income elasticity of demand
  1. Price elasticity of supply
  1. Price elasticity of demand is a measure of the responsiveness of the quantity demanded to the change in its price.

Computing; law of demand when the price is increasing quantity demanded is decreasing, elasticity’s of demand must be negative.


Change in quantity to the percentage change in price (% change in quantity / % change in price).

Types of Elasticity of demand;

Elasticity when Ed > 1

Inelasticity when Ed < 1

Unit elasticity when Ed = 1

Perfectly inelastic demand when Ed = 0

Infinitely elastic demand when Ed= ¥

Determinants of Ed

number of substitute goods
The more the number of substitute goods, the more elasticity the demand.


the income level
The lower the income for an individual, the more elasticity of demand for the goods.

  1. Cross Elasticity of Demand; the responsiveness of the quantity demanded of a good to a change in the price of another good.

As the percentage change in quantity demanded for the first good that occurs in response to a percentage change in the price of the second good.

Demand:

Positive in the case of substitutes

Example: coffee & tea

Price of coffee increases, the quantity of tea demanded will increases

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Negative in the case of complements

Example : car & petrol

Price of petrol increases, the quantity of car demanded will decreases

  • Zero (0) in the case of no relationship

An increase in Py would not affect the demand for good x, good x and y have no relationship.

  1. Income Elasticity of Demand:

o Normal goods

i. Positive coefficient

ii. Demand varies in the same direction as income

o Inferior goods

i. Negative coefficient

ii. Demand varies inversely with changes in income

o Essential goods

  • Coefficient Zero (0)
  1. Price of Elasticity of Supply: “The responsiveness of quantity supplied to a change in price.”

Elasticity of supply can be determined by comparing the % change in quantity supplied with the % change in the price of the product.

Computing: price increases quantity supplied also increases, so that the elasticity’s of supply are always positive.


Elasticity of supply is the percent change in quantity supplied given divided by the percent change in price (% change in quantity / % change in price).