Applied

Economics Class
Ma’m Mendoza
At the end of the session, you should be able to
1. determine the implications of market pricing in making
economic decisions
2. explore the elasticity of demand and supply
3. solve problems on price elasticity of demand and supply
4. value the implications of market pricing in decision making
TRUE OR FALSE
Directions: Write TRUE if the statement is correct and FALSE if incorrect.
1. _________ Equilibrium is attained when the quantity demanded is
equal to the quantity supplied at a certain price.
2. _________If the price is above the equilibrium level, the quantity
demanded is greater than the quantity supplied.
3. _________If the price is below the equilibrium point, the quantity
demanded is lesser than the quantity supplied.
4. _________The law of demand applies during online sales of computers
when consumers rush to buy products at 30% discount.
5. _________The law of supply applies when the producers supply more
masks at a higher price which resulted to an increase in revenue.
Last week, we talked about the market demand, market supply and
market equilibrium. When there is equilibrium in the market, the
quantity of the good that consumers are willing to buy is equal to the
quantity that sellers are willing to offer. There is no shortage or surplus.
Price ceilings and price floors are examples of price controls. Price ceilings
set the minimum price for a commodity while price floors dictate the
minimum price.
Salt bags bread
watch soap gasoline
What Is Elasticity?
Elasticity is a measure of a variable's sensitivity to a change in another
variable, most commonly this sensitivity is the change in price relative to
changes in other factors. It is a measure of how much buyers and sellers
respond to changes in market conditions.
In business and economics, elasticity refers to the degree to which
individuals, consumers or producers change their demand or the amount
supplied in response to price or income changes. It is predominantly used
to assess the change in consumer demand as a result of a change in a
good or service's price.
 Degrees of Elasticity of Demand
1. Elastic
 A product is considered to be elastic if the quantity demand of the
product changes drastically when its price increases or decreases.
Example:
1. Bouncy balls are highly elastic in that they aren't a necessary good, and
consumers will only decide to make a purchase if the price is low. Therefore,
if the price of bouncy balls increases, the quantity demanded will greatly
decrease, and if the price decreases, the quantity demanded will increase.

2. If the price of LPG increases by 10% and as a result the quantity demanded
goes down by 12%, then we say that the demand for LPG is elastic.
2. Inelastic
 A product is considered to be inelastic if the quantity demand of the product
changes very little when its price fluctuates.
Example:
1. Insulin is a product that is highly inelastic. For diabetics who need insulin, the
demand is so great that price increases have very little effect on the quantity
demanded. Price decreases also do not affect the quantity demanded; most
of those who need insulin aren't holding out for a lower price and are already
making purchases.
2. Suppose the price of cellphone load goes up by 5% and the quantity
demanded goes down by 3%, then we can say that demand for cellphone load
is inelastic.
3. Unitary Elastic
 A unitary elasticity means that a given percentage change in price leads to an
equal percentage change in quantity demanded or supplied.
Example:
1. The price of digital cameras increases by 10%, the quantity of digital cameras
demanded decreases by 10%. The price elasticity of demand is (unitary elastic
demand).
2. Let us say that the price of string beans goes down by 6% and as a result, the
quantity demanded goes up by 6% also, we describe the demand for string
beans as unitary elastic.
ELASTICITY OF DEMAND
There are 3 types of elasticity of demand that deal with the responses to a
change in the price of the good itself, in income, and in price of a related good,
which is a substitute or a complement.
1. Price elasticity of Demand.
When there is a relationship between the change in the quantity demanded
and the price of a good or service, the elasticity is known as price elasticity of
demand. This measures the responsiveness of demand to a change in price of a
good. The concept of elasticity is measured in percentage changes.
a. Arc Elasticity
b. Point Elasticity
 2. Income Elasticity of Demand
This measures how the quantity demanded changes as consumer
income changes. It also refers to the sensitivity of the quantity demanded for a
certain good to a change in real income of consumers who buy this good, keeping
all other things constant. With income elasticity of demand, you can tell if a
particular good represents a necessity or a luxury.
3. Cross-price elasticity of demand
This measures how quantity demanded changes as the price of a related
good changes. Cross-price elasticity measures the responsiveness of the demand
for a good to the change in the price of the substitute good or a complement.
PRICE ELASTICITY
1. Arc Elasticity.
The value of elasticity is computed by choosing two points on the
demand curve and comparing the percentage changes in the quantity and the
price on those two points.
Calculating Arc Elasticity of Demand
To calculate arc elasticity of demand we first take the midpoint in between.
Once we have the midpoint, we calculate the PED in the usual way

The mid point of Q = (80+88)/2 = 84

The mid-point of P =(10+14)/2 =12

%change in Q = (14-10)/12 = 0.3333

%change in price = 88-80/84 = -0.9524

PED = 0.333/-0.9524 = -0.35

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 2. Point Elasticity
Measures the degree of elasticity on a single point on the demand
curve. Changes in a single point are infinitesimally small.
Comparison with measuring elasticity as point A to B
If we calculate elasticity from point A to B.
We would take the starting point as the
reference.

The % change in Q would be 8/88 = 10%

The % change in Price would be 4/10 = -40%
Therefore PED would be 10/-40 = -0.25
2. Income Elasticity
Income elasticity of demand measures the responsiveness of demand for a
particular good to changes in consumer income. The higher the income elasticity of
demand in absolute terms for a particular good, the bigger consumers' response in
their purchasing habits—if their real income changes. Businesses typically evaluate
income elasticity of demand for their products to help predict the impact of a
business cycle on product sales.
It is given by the formula:
Example:
If a person decides to buy 20% more bananas because of a 10% income increase, the
person’s income elasticity of demand for bananas is 20% / 10%, or 2.

Unlike price elasticity of demand, we cannot leave off the minus sign
for income elasticity of demand, because income elasticity of demand can be either
positive (for a normal good) which is what a consumer tends to buy more when his
income increases, or negative (for an inferior product) which are goods that are
bought when income is low because low incomes prevent the consumers from
buying higher priced goods.
3. Cross Price Elasticity of Demand
In the case of a product that has a substitute (like oranges and apples), the price
change of one product affects the demand for the other. Cross price elasticity of
demand measures this effect.
It is given by the following equation:
Example:
What is the cross-price elasticity of demand for Pepsi if the demand for Pepsi
decreases by 10% after the price of Coke decreases by 5%?

Coke and Pepsi are substitute products. If Pepsi’s demand decreases by 10%
because Coke’s price decreases by 5%, and assuming no change in the price of
Pepsi and no change in other variables in the economy (ceteris paribus), then the
cross-price elasticity of demand for Pepsi relative to a price change in Coke is

Ecp = (-10%) / (-5%) = +2

A positive (+) sign for CE signifies that the two goods involved are substitute goods
which means that as the price of the substitute goods increases, the demand for
the other good will increase.
Example: Rice and bread

The negative (-) sign for CE indicate that the two goods are complements, which
means that the demand for a good will increase when the price of the
complement decreases.
Example: Cellphones and Cellphone loads
 LESSON 2. PRICE ELASTICITY OF SUPPLY
The concept of elasticity can also be applied to supply. In this case, we want to
know how sensitive producers are to changes in output prices. This formula for the
price elasticity of supply is defined as:

We know from the law of supply that as the equilibrium price of the product
increases, producers will supply more of the product. How much more will they
supply as the price of a product increases by, for example, 10%?
Example:
What is the price elasticity of supply if producers increase their quantity supplied
by 30% as a result of a 10% price increase in the market price?
Solution: The price elasticity of supply is:
Es = (+30) / (+10) = 3
Price elasticity of supply is always positive, because the law of supply states that
(ceteris paribus) as the market price increases, the quantity supplied increases.
Goods that are easy to produce have elastic supply while those which need a
long time to produce and which are hard to make have inelastic supply.
Perfect Inelastic Supply
Perfect inelastic supply is when the PES formula equals 0. That is, there is no
change in quantity supplied when the price changes. Examples include products
that have limited quantities, such as land or painting from deceased artists.
Relatively Inelastic Supply
The PES for relatively inelastic supply is between 0 and 1. That means the
percentage change in quantity supplied changes by a lower percentage than the
percentage of price change. Inelastic goods include nuclear power, which has a
long lead time given the construction, technical know-how, and long ramp-up
process for plants.
Unit Elastic Supply
Unit Elastic Supply has a PES of 1, where quantity supplied change by the same
percentage as the price change.
Relatively Elastic Supply
A price elasticity supply greater than 1 means supply is relatively elastic, where the
quantity supplied changes by a larger percentage than the price change. An
example would be a product that’s easy to make and distribute, such as a fidget
spinner. The resources to make additional spinners are readily available and the
total cost would be minimal to ramp production up or down.
Perfectly Elastic Supply
The PES for perfectly elastic supply is infinite, where the quantity supplied is
unlimited at a given price, but no quantity can be supplied at any other price.
There are virtually no real-life examples of this, where even a small change in price
would dissuade, or disallow, product makers from supplying even a single product.
Elasticity measures the degree of responsiveness of consumers or sellers to
changes in income and prices. The own price elasticity of demand measures
the degree of responsiveness of consumers to a price change of the
commodity.

The cross-price elasticity of demand tells us the degree of responsiveness of

consumers to a price change of another commodity while the income elasticity
of demand tells us how sensitive is the demand of consumers following an
income change
The price elasticity of supply indicates the responsiveness of producers
following a change in the price of the product.