1.2 - Elasticities

1.
2: Elasticities
Definitions
1. Price elasticity of demand (PED) is a measure of the responsiveness of the quantity

demanded for a good or service to change in its price.
2. Inelastic demand is where a change in price of a good or service leads to a
proportionately smaller change in the quantity demanded of the good or service. PED
value is between zero and one.
3. Elastic demand is where a change in price of a good or service leads to a proportionately
larger change in the quantity demanded of the good or service. PED value is greater than
one.
4. Cross elasticity of demand (XED) is a measure of the responsiveness of the demand for
one good or service to a change in price of another good or service.
5. Substitute goods are goods that can be used against each other, such as sugar or honey.
Substitute goods have a positive cross elasticity of demand.
6. Complementary goods are goods which can be used together, such as MP3 players and
headphones. Complementary goods have a negative cross elasticity of demand.
7. Income elasticity of demand (YED) is a measure of the responsiveness of the demand for
a good or service to a change in income.
8. Normal goods have positive income elasticity of demand. As income rises, the demand
for the good increases.
9. Inferior goods have negative income elasticity of demand. As income rises, the demand
for the good decreases.
10. Price elasticity of supply (PES) is a measure of the responsiveness of the quantity
supplied for a good or service to a change in its price.
11. Inelastic supply is where a change in price of a good or service leads to a proportionately
smaller change in the quantity supplied of the good or service. PES value is between zero
and one.
12. Elastic supply is where a change in price of a good or service leads to a proportionately
larger change in the quantity supplied of the good or service. PES value is greater than
one.
Price elasticity of demand (PED)
● Measure of how much quantity demanded of a product changes when there is a change in
price of a product.
● PED = % change in quantity demanded of a product
% change in price of a product
● If PED = 0, change in price → No effect on quantity demanded → % change would
be 0 → PED is perfectly inelastic.
● If PED = infinity, change in price → Demand will fall to 0.
● Normal goods have PED between 0 and 1.
● Demand for commodities tend to be inelastic since they are scarce resources.
● Demand for manufactured goods tend to elastic due to variety of choice presented to
customers.
● Three categories of PED
❖ Inelastic demand
➢ Happens when PED is less than 1 and greater than 0.
➢ Change in price → Proportionally smaller change in quantity demanded →
Total revenue gained by the firm increases when price increases.
❖ Elastic demand
➢ Happens when PED is less than infinity and greater than 1.
➢ Change in price → Proportionally larger change in quantity demanded →
Total revenue gained by the firm decreases when price increases.
❖ Unit elastic demand
➢ Happens when PED = 1.
➢ Change in price → Proportionate, opposite change in quantity demanded →
Total revenue gained by the firm stays the same when price increases.
● Determinants of PED
❖ Number and closeness of substitutes
➢ More substitutes for a product → More elastic the demand for the product will
be.
➢ Products with fewer substitutes → Inelastic demand for the product.
❖ Necessity of the product and how widely the product is defined
➢ Necessity products such as food, clothes → Demand is inelastic.
➢ Products that are people’s wants → Demand is elastic.
❖ Time period considered
➢ PED is inelastic in the short term and becomes more elastic in the long term.
Cross elasticity of demand (XED)
● Measure of how much the demand of the product changes when there is a change in price
of another product.
● XED = % change in quantity demanded of product X
% change in price of product Y
● If XED is positive, two goods, like wheat and rice, are substitute goods.
● If XED is negative, two goods, like iPod and earphones, are complementary goods.
● XED doesn’t change if two goods compared are unrelated to each other.
Income elasticity of demand (YED)

● Measure of how much the demand for a product changes when there is a change in
consumer’s income.
● YED = % change in quantity demanded of the product
% change in customer’s income
● If YED is positive, it is a normal good.
○ Low positive YED → Necessity good, such as food.
○ High positive YED → Superior good, such as luxury products.
● If YED is negative, it is an inferior good.
Price elasticity of supply (PES)

● Measure of how much the supply of a product changes when there is a change in the
price of the product.
● PES = % change in quantity supplied of a product
% change in price of the product
● Same effects as PED but in this case, it is the supply of a product being impacted, rather
than the demand.
● Supply for commodities tend to be inelastic and manufactured goods tend to be elastic
due to same reasons as mentioned in PED section.
● Determinants of PES
❖ How much costs rise as output is increased
➢ Rise in total costs → Producers doesn’t increase supply → PES is inelastic.
➢ Existence of unused stocks, mobility of factors of production prevents a huge rise
in costs for products.
❖ Time period considered
➢ Same effects as PED, except the effects are on supply of the product, instead of
demand of the product.
❖ Ability to store stock
➢ High levels of stock → Firms tend to react quickly to price changes → PES of
the product is elastic.
Paper 3 Questions
The price of meat increases by 10%, the quantity demanded of meat falls by 12% and the
quantity of fish consumed increases by 9%.
1. Calculate the price elasticity of demand (PED) for meat and state if the demand for meat is
price elastic or inelastic.
PED = 12%
-10%
PED = 1.2
Demand for mea is price elastic.
2. Calculate the cross-price elasticity for demand between meat and fish, and state what kind of
products meat and fish are to each other.
XED = 9%%
-10%
XED = 0.9
Coke and meat are substitute goods.
An individual’s income increased between $16,000 to $20,000. The spending on purchases of

bread fell by 5% while the spending on purchases of food in general and eating out in restaurants
increased by 15% and 30% respectively.
3. Calculate the income elasticity for demand (YED) for each item and state the kind of item it is.
YED for bread = 20,000 - 16,000 * 100 = 25%
16,000 -10%__
-10%
YED = -2.5
YED for food = 25% YED for restaurants = 25%

15% 30%
YED for food = 1.67 YED for restaurants = 0.83
Bread is an inferior good.

Food is a necessity good.
Restaurants is a luxury product.

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1. Price elasticity of demand (PED) is a measure of the responsiveness of the quantity

Income elasticity of demand (YED)

Price elasticity of supply (PES)

Demand for mea is price elastic.

Coke and meat are substitute goods.

An individual’s income increased between $16,000 to $20,000. The spending on purchases of

YED for food = 25% YED for restaurants = 25%

Bread is an inferior good.

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