Chapter 4

The market system 2

price elasticity

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CHAPTER CONTENTS
LEARNING OUTCOMES -------------------------------------------------- 45
CALCULATION OF PRICE ELASTICITY OF DEMAND ------------------ 46
DETERMINANTS OF PRICE ELASTICITY OF DEMAND

50

CALCULATION OF PRICE ELASTICITY OF SUPPLY-------------------- 51

DETERMINANTS OF PRICE ELASTICITY OF SUPPLY

44

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LEARNING OUTCOMES
(a) Calculate the price elasticity of demand and the price elasticity of supply.

(b) Explain the determinants of the price elasticities of demand and supply.

(c) Identify the effects of price elasticity of demand on a firms revenues

following a change in prices.

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CALCULATION OF PRICE ELASTICITY OF DEMAND

Price elasticity of demand (PED) is a measure of the extent of change in the
market demand for a good in response to a change in its price.

Inelastic Demand

Elastic Demand
$

Qty

Qty

There are two means by which the elasticity of demand may be calculated

(i)

Point elasticity of demand

PED =

(ii)

Arc elasticity of demand

PED =

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Interpretation
The output is typically a negative value, however it is usual to ignore the minus
sign and just state the absolute value of the co-efficient for the purpose of
interpretation.

The value of demand elasticity may be anything from zero to infinity.

Demand is inelastic if the absolute value is less than 1.
Demand is elastic is the absolute value is greater than 1.

The following table summarises the various price elasticities of demand:

Levels of elasticity

Coefficient value

Type of good

Example

Perfectly inelastic

0 (zero)

Necessity

Food

Relatively elastic

>1

Luxury

Designer clothes

Perfectly elastic

Infinity

Relatively inelastic
Unit elasticity

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Between 0

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DISCUSSION 1
Complete the following demand diagrams so as to illustrate -

Perfectly elastic demand

Unitary elastic demand

$

Qty

Qty

Perfectly inelastic demand

$

Qty

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EXERCISE 1
If the quantity demanded for a good rises from 200 to 300 units when the price
falls from $10 to $6, state the following:
a) % change in quantity demanded.

b) % change in price.

c) Price elasticity of demand (PED)

point method .

EXERCISE 2
Calculate the PED based on the following:
a) The price increases from $10 to $12 and the quantity demand falls from 400
units to 200 units.

b) The price increases from $6 to $9 and the quantity demanded falls from 500
units to 250 units.

c) The price decreases from $40 to $30 and the quantity demanded increases
from 50 units to 55 units.

Results Table:

a)
b)
c)

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Determinants of price elasticity of demand

1. Degree of necessity

2. Availability of substitutes

3. Period of time

4. Percentage of income spent on good

5. Habitual purchasing

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CALCULATION OF PRICE ELASTICITY OF SUPPLY

The price elasticity of supply indicates the responsiveness of supply to a change in
the price.
The calculation remains the same as for price elasticity of demand, insofar as the
point method and arc method.

DISCUSSION 2
Complete the following supply diagrams so as to illustrate :

Perfectly elastic supply

Unitary elastic supply

$

Qty

Qty

Perfectly elastic supply

$

Qty

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DETERMINANTS OF PRICE ELASTICITY OF SUPPLY

1. Existence of inventories

2. Availability of labour

3. Spare capacity

4. Availability of raw materials

5. Barriers to entry

6. Time scale

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