Measures the responsiveness of one variable to a certain change of another variable. “Measures”, reported as numbers or coefficients. “Responsiveness”, meaning reaction to change. Thus, any change causes people to react, and elasticity measures this extent to which the people react. Proportional measure or percentage change in the variables measures the responsiveness of consumers and producers.

1. Concept of Elasticity
College of Business Administration and Accountancy
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4. 4
Concept of Elasticity
• Introduction
• What is elasticity
• Price elasticity of demand
• Income elasticity of demand
• Cross-price elasticity of demand
• Price elasticity of supply

5. 5
What is elasticity?
• Measures the responsiveness of one
variable to a certain change of another
variable.
• “Measures”, reported as numbers or
coefficients.
• “Responsiveness”, meaning reaction to
change.
• Thus, any change causes people to react,
and elasticity measures this extent to
which the people react.
• Proportional measure or percentage
change in the variables measures the
responsiveness of consumers and
producers.

6. 6
What is elasticity?
▪ Basic formula used to determine elasticity is:
percentage change in variable X
Elasticity = -----------------------------------------------------------
percentage change in variable Y
▪ Using mathematical symbols,
% ∆ X where: ε = elasticity
ε = -------------------- ∆ = change
% ∆ Y % = percentage
▪ Therefore, elasticity is the percentage change in one variable in relation to the
change in another variable.

7. 7
Price elasticity
▪ Measures the percentage change in quantity with respect to percentage change in
price.
▪ This includes price elasticity of demand and price elasticity of supply
▪ Measures the responsiveness of the quantity demanded with respect to its price.
▪ The basic formula used to calculate the coefficient of price elasticity of demand
(P εD):
Price elasticity
percentage change quantity demanded
Price Elasticity of Demand = -------------------------------------------------------
percentage change in price

8. 8
Price elasticity of demand
▪ It is the percentage change in quantity demanded that occurs with respect to
percentage change in price.
▪ Mathematically (point elasticity of demand),
∆ Qd Qd2 – Qd1
------- -----------
%∆ Qd Qd Qd1
εD = ---------------- or ------- or -----------
%∆ P ∆ P P2 – P1
------- -----------
P P1

9. 9
Price elasticity of demand
▪ The formula for arc elasticity is as follows:
Qd2 – Qd1 P1 + P2 / 2
εD ----------- X -------------------
P2 – P1 Qd1 + Qd2 / 2

10. 10
Price elasticity of demand
Table 1
Hypothetical Data of Point and Arc Elasticity
Points Price of Good X
(Px)
Quantity Demanded of
Good X (Qdx)
A 2 600
B 4 375
C 7 330
D 10 300
E 12 293
F 15 244
G 22 210
H 27 200
I 34 150
Compute for:
1. Point Elasticity of Points B to H
2. Arc Elasticity of Points H to B

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Degree of price elasticity of demand
1. Elastic demand
▪ Demand is price elastic when the elasticity coefficient is greater than one.
▪ This means that a small change in price results to a greater change in
quantity demanded. (ε > 1).
2. Inelastic demand
▪ Demand is price inelastic when the elasticity coefficient is less than one.
▪ This means that a percentage in quantity demanded is less than the
percentage change in price. (ε < 1)
3. Unitary elastic demand
▪ Demand is unitary elastic when the elasticity coefficient is equal to one.
▪ This means that a change in price is equal to a change in quantity
demanded. (ε = 1)

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Degree of price elasticity of demand
4. Perfectly elastic demand
▪ Demand is perfectly elastic when the elasticity coefficient equals to
infinity.
▪ This means without the change in price, an infinite change occurs in
quantity demanded. (ε = ∞)
5. Perfectly inelastic demand
▪ Demand is perfectly inelastic when elasticity coefficient equals to zero.
▪ This means that any change in price creates no change in quantity
demanded. (ε = 0)

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Determinants of price elasticity of demand
1. The importance or degree of necessity of the goods.
2. Number of available substitutes.
3. The proportion of income in price changes.
4. The time period.

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Price elasticity of demand and Total revenue
Total Revenue (TR = P * Q)
▪ Price per unit (P) multiply with total quantity (Q)
▪ The area of a rectangle with heigh equal to price and width to quantity
demanded.
Price increase (P )
▪ Inelastic demand, εD < 1, then TR 
▪ Elastic demand, εD > 1, then TR 
▪ Unitary elastic demand, εD = 1, then TR is constant.

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Price elasticity of demand and Total revenue

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Price elasticity of demand and Total revenue
Q
P
(a) Inelastic Demand
D
95
11 B
105
9 A
In panel (a), demand is inelastic, so a rise
in price causes total revenue to increase.
Specifically, at a price of Php9 (point A),
total revenue is Php9 × 105 = Php945.
When price rises to Php11 (point B),
total revenue increases to Php11 × 95 =
Php1,045.

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Price elasticity of demand and Total revenue
Q
P
(b) Elastic Demand
D
11
9
A
B
85 115
In panel (b), demand is elastic, so a rise
in price causes total revenue to
decrease. Specifically, at a price of Php9
(point A), total revenue is Php9 × 115 =
Php1,035. When price rises to Php11
(point B), total revenue falls to Php11 ×
85 = Php935.

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Price elasticity of demand and Total revenue

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Income elasticity of demand
▪ The responsiveness of quantity demanded in response to a change in income.
▪ This measures the percentage change in demand over the percentage change in
income.
percentage change quantity demanded
Income Elasticity of Demand = ----------------------------------------------------------
percentage change in income

20. 20
Income elasticity of demand
▪ Applying mathematical symbols,
%∆ Qd ∆ Qd Y
εY = ---------------- or ------- X -----------
%∆ Y ∆ Y Qd
Where:
Y = income ∆ = change
ε = elasticity Qd = quantity demanded
% = percentage

21. 21
Income elasticity of demand
Summary of Income Elasticity Coefficient
Types of Goods Income Elasticity Coefficient
Normal good Positive elasticity (ε > 0)
Inferior good Negative elasticity (ε < 0)
Normal, luxury good Positive elasticity greater than 1 (ε > 1)
Normal, necessity good Positive elasticity less than 1 (ε >0<1)

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Income elasticity of demand
Hypothetical Data for Income Elasticity
Y Qd %∆ Qd %∆ Y εY Type of Good
200 30
300 40
400 53
500 68
600 82
700 74
800 58

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Cross price elasticity of demand
▪ The response of consumer in buying a certain product if the price of another
product changes.
▪ Measures the responsiveness of quantity demanded of a good to a change in the
pie of another good
percentage change Qd of good X
Cross Elasticity of Demand = --------------------------------------------------------
percentage change in price of good Y

24. 24
Cross-price elasticity of demand
▪ Applying mathematical symbols,
%∆ Qdx ∆ Qdx / Qdx
εxy = ---------------- or ----------------
%∆ Py ∆ Py / Py
Where:
ε = elasticity ∆ = change
Qdx = quantity demanded of good X
Py = price of good Y % = percentage

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Cross-price elasticity of demand
Complementary goods
▪ Goods that are used in conjunction with other goods.
▪ Indicates a negative elasticity coefficient.
Cross Elasticity of Complementary Goods
Commodity
BEFORE AFTER
Price (PhP) Qd Price (PhP) Qd
Creamer 45 150 55 100
Coffee 75 200 75 150

26. 26
Cross-price elasticity of demand
Substitute goods
▪ Goods that can be used in place of another good, such that, an
increase in pride of one tends to increase the quantity demanded of its
substitute good.
▪ Indicates a positive elasticity coefficient.
Cross Elasticity of Substitute Goods
Commodity
BEFORE AFTER
Price (PhP) Qd Price (PhP) Qd
PS4 1000 90 1000 100
xBox 360 900 55 950 45

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Price elasticity
▪ Measures the percentage change in quantity with respect to percentage change in
price.
▪ This includes price elasticity of demand and price elasticity of supply
▪ Measures the responsiveness of the quantity supplied with respect to its price.
▪ The basic formula used to calculate the coefficient of price elasticity of supply (P εS):
Price elasticity of supply
percentage change quantity supplied
Price Elasticity of Supply = -------------------------------------------------------
percentage change in price

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Price elasticity of supply
▪ It is the percentage change in quantity supplied that occurs with respect to
percentage change in price.
▪ Mathematically,
∆ Qs Qs2 – Qs1
------- -----------
%∆ Qs Qs Qs1
εS = ---------------- or ------- or -----------
%∆ P ∆ P P2 – P1
------- -----------
P P1

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Degree of price elasticity of supply
1. Elastic supply
▪ Supply is price elastic when the elasticity coefficient is greater than one.
▪ This means that a small change in price results to a greater change in
quantity supplied. (ε > 1).
2. Inelastic supply
▪ Supply is price inelastic when the elasticity coefficient is less than one.
▪ This means that a percentage in quantity supplied is less than the percentage
change in price. (ε < 1)
3. Unitary elastic supply
▪ Supply is unitary elastic when the elasticity coefficient is equal to one.
▪ This means that a change in price is equal to a change in quantity supplied.
(ε = 1)

30. 30
Degree of price elasticity of supply
4. Perfectly elastic supply
▪ Supply is perfectly elastic when the elasticity coefficient equals to infinity.
▪ This means without the change in price, an infinite change occurs in
quantity supplied. (ε = ∞)
5. Perfectly inelastic supply
▪ Supply is perfectly inelastic when elasticity coefficient equals to zero.
▪ This means that any change in price creates no change in quantity
supplied. (ε = 0)

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Determinants of price elasticity of supply
1. Intermediate
▪ In this period supply will be perfectly inelastic and the supply is fixed.
2. Short-run
▪ In this state supply is inelastic. The output of production can increase even
if equipment is fixed.
3. Long-run
▪ In this period, supply is elastic. New firms are expected to enter or the old
one may leave the industry
▪ The primary determinant of price elasticity of supply is the time period involved,

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