Chapter IV

Concept of Elasticity
Definition of elasticity
Price Elasticity of Demand (PED)
Income Elasticity of Demand
Cross Elasticity of Demand
Elasticity of Supply
 Definition of Elasticity
 General definition : Measurement of the magnitude of responsiveness of
variable (eg. Qd or Qs) to the change in one of the determinant’s factor
(eg. Price and income)

 General Formula :  % Q 
  
 %P 

 Types of Elasticity :-

( )

(p ) (y ) (x) (s)

 Price Elasticity of Demand
 Degree of Price Elasticity
 Def : measure how much the  Elastic ( p  1 )
quantity demanded of a good • Shows that % changes in quantity is
responds to a change in price of larger than % changes in price (Qd  P)
that good.
 % Qd 
• Eg: Goods with high substitutes
 Formula : p  
 % P  (toothpaste & clothing)
 Qd1  Qd 0 P0 
p   X  Price
 Qd 0 P1  P0 
 Qd P0 
p   X 
 P Qd 0  (%Qd  %P )

P1
~ Qd0 = original quantity demanded
~Qd1 = new quantity demanded P0

~P0 = original price level D

~P1 = new price level 0 Q1 Q0 Quantity

~ -ve sign indicates the negative Example : P0 =6, P1=8 : Q0=250 Q1=100
Ed= (Qd / P ) XP0 / Q0 = (100-250)/(8-6)X6/250
(inverse) relationship between
price level & quantity demanded of =-(-150)/2 X 6/250
the goods. =-(-75 X 0.024) =-1.8
 Continue.... Price Elasticity of Demand
 Inelastic (p  1 )
• Shows that % changes in price is  Unitary Elastic ( p  1 )
larger than % changes in quantity • Shows that % changes in quantity is
demanded (Qd  P) equal as % changes in price (Qd  P)
• Low substitution goods eg. Petrol &
cigarettes
Price
Price

P1
(%Qd  %P )
(% Qd  %P)
P1
P0
D
P0

D
0 Q0 Q1 Quantity
0 Q1 Q0 Quantity
 Continue.... Price Elasticity of Demand
 Perfectly Inelastic ( p  0)  Perfectly elastic (p  )
• Shows that any % changes in P will • A condition when at fixed P level,
have no effect on the %changes in Qd. consumers will purchase the good
Coefficient = 0 but not be demanded when price is
• Eg goods: insulin for diabetic patients higher than the fixed P. Increasing
in P will cause quantity DD drop to
Price
D
zero & decrease in P will cause Qd
increase by infinite amount.
Price

P1

P0 P0 D

0 Q0 Quantity

0 Q0 Q1 Quantity
 Continue.... Price Elasticity of Demand
 Determinants  Exercise
 Availability of Substitutes or 1. Given, the price of Book is increase
Substitutability from RM1.50 to RM2.00 with the
 Proportion of Consumer’s Income quantity fall from 27 to 10 unit.
Spent on a Good Calculate the price elasticity of
demand for this good.
 Degree of Necessity (Nature of
goods)
 Time Dimension 2. Given, the price of motorcycle
decreasing by 30% from RM4,500
 Income Level
with quantity demanded increase to
 Habits 150 units from 120 units. Calculate
the price elasticity of demand and
interpret the coefficient.
 Income Elasticity of Demand
 Def : measure how much the  Sign of the coefficient
quantity demanded of a good  Positive
responds to a change in consumer • Normal & luxury goods)
income.
• in Y will in Qd for this goods.
 Formula :  %Qd 
y   %Y  • +ve & greater than 1 luxury
 
 Qd  Qd 0 Y0  • +ve & between 0 and necessity
y   1 X 
 Qd 0 Y1  Y0   Negative
 Q Y 
y   X 0  • Inferior goods (giffen goods)
 Y Qd 0 
• in Y will in Qd for this goods & vv

~ Qd0 = original quantity demanded

~Qd1 = new quantity demanded
~Y0 = original income level
~Y1 = new income level
 Continue... Income Elasticity of Demand
Cooeficient Degree of Types of  Responses of Income Elasticity
of EY Elasticity Good  Perfectly Inelastic
EY = 0 Perfectly Necessity
Income
inelastic goods
EY > 1 Elastic Luxury D

Goods
0<EY< 1 Inelastic Normal Y1

goods
EY < 0 -ve elastic Inferior Y0

0 Q0 Quantity

• also known as zero income elasticity

of demand
• Condition in which Qd of a product
does not change even though Y
• Example of goods : rice, vegetables,
salt
 Continue... Income Elasticity of Demand
 Elastic  Negative Elastic
• Condition in which Y , Qd • Condition in which Qd as Y
(grater then increasing in Y) • Example of goods : Giffen goods or
• Example of goods : antique inferior goods such as used cars,
furniture, luxury cars, gold & salted fish & low grade potatoes.
jewelry.

 Inelastic
• Condition in which as Qd as Y
although increasing in Y more
faster than Qd.
• Example of goods : food & clothing
 Cross Price Elasticity of Demand
 Def : measure how much the  Sign of the coefficient
quantity demanded of a good  Positive
responds to a change in the price of • The 2 goods (X & Y) are substitute to
another good. (% Qdx / % Py) each other.
 Formula : • Increase in Py will cause increase in
 %Qdx 
x    Qdx.
 %Py 
• Example : Vico & Milo, Nissan &
 Qdx1  Qdx0 Py 0 
x   X  Perdana
 Qdx0 Py1  Py 0 
 Qx Py 0 
x   X   Negative
 Py Qdx0 
• Implies this 2 goods are
~ Qdx0= original quantity demanded complementary goods.
of good X • Increase in Py will cause decrease in
~Qdx1 = new quantity demanded of Qdx.
good X. • Example : Tennis rackets & tennis
~ Py0 = original Price level of good Y ball.
~Py1 = new Price level of good Y
 Continue... Cross Price Elasticity of Demand
 Equal to 0  Exercise
a. The following table shows the price of good X
• Implies this 2 goods are and quantity demanded for goods X and Y.
independent or unrelated goods. Price of Good Quantity of Quantity of
• Example : Tennis rackets & petrol. X (RM/Unit) Good X Good Y
Demanded Demanded
(units) (units)
Sign of Types of Goods 10 2 10
Elasticity 8 4 8
(+ve sign) Goods X & Y, substitute goods 6 6 6

Goods X & Y, complementary 4 8 4

(-ve sign)
goods 2 10 2

Exy=0 Goods X & Y, not related goods i. Calculate the price elasticity of demand for good
X when price increases from RM4 per unit to
RM6 per unit.
ii. Calculate the cross elasticity of demand for good
Y when the price of good X decreases from RM8
per unit to RM6 per unit.
ii. What is the relationship between goods X and Y
 Price Elasticity of Supply
 Def : measure how much the  Degree of Price Elasticity of
quantity supplied of a good Supplied
responds to a change in price of  Elastic (s  1)
that good. • Shows that small % change in P will
 Formula : s   % Qs  lead to a large % change in Qs.(Qs  P)
 % P 
 
 Qs  Qs0 P0 
s   1 X  Price
 Qs 0 P1  P0 
(% Qs  %P) S
 Q P  P1
s   X 0 
 P Qs0 
P0
~ Qs0 = original quantity supplied
~Qs1 = new quantity demanded
~P0 = original price level
~P1 = new price level
0 Q0 Q1 Quantity
 Continue.... Price Elasticity of Supply
 Inelastic ( s  1 )  Unitary Elastic ( s 1 )
• Shows that large % changes in P • Shows that % changes in P equals
will only affect a small % of the Qs. the % change in Qs. (Qs  P)
(Qs  P)

Price
(% Qs  %P ) S
Price
(% Qs  %P ) S
P1

P0
P1

P0

0 Q0 Q1 Quantity
0 Q0 Q1 Quantity
 Continue.... Price Elasticity of Supply
 Perfectly Inelastic ( s  0 )  Perfectly Elastic ( s  
)
• Shows that % changes in P have no • Shows an almost zero % in P brings a
effect on the %changes in Qs. very large % change in Qs.

Price Price

P0 S
P1

P0

0 Q0 Quantity 0 Q0 Q1 Quantity
 Continue.... Price Elasticity of Supply
 Determinants
 The time factor involved in making
adjustment to supply
- very short run
- short run
- long run
 Change in the cost of factor of
production
 Gestation period of Production
 Perishability