ECON01G- Lec4

Ep = Percentage change in quantity demanded

Elasticity of Demand and Supply
Percentage change in price
= QD2 - QD1 / QD1
THE CONCEPT OF ELASTICITY
P2 - P1 / P1
Sellers are naturally expected to hope for more
demand for their products. Their real objective,
however, is higher revenues. They find it necessary, Where:
therefore, to make some decisions to improve demand Ep = price elasticity of demand
for their products. Improving demand is not simple thing QD2 = new quantity demand
to handle, however. This is so because not all efforts will QD1 = original quantity demanded
produce the expected results. The seller must first P2 = the new price
reckon with demand elasticity before he is supposed to P1 = the original price
make an intelligent decision.
Sample Problem:
THE CONCEPT OF ELASTICITY What is the demand elasticity given the following?
The buyer, ever anxious in getting the best value 1. Original quantity demanded= 10,000 kg
for his money, is also in the same predicament as the 2. Original price = P5.00 per kilo
seller. Both can us a little knowledge of the concept of 3. New quantity demanded = 16,000 kg
elasticity. 4. New price = P4.00 per kilo

WHAT IS ELASTICITY Answer:

Changes in price (or other factors) may or may
not affect the demand or supple of any good or service.
Decision making for either buyer or seller will be more
meaningful if there is a way to know the extent to which
demand and supply are affected by changes in some
determinants. The effect is attributed to elasticity.
A definition of elasticity is provided as follows:
 It is measure of the sensitivity or responsiveness
of quantity demand or quantity supplied to
changes in price (or other factors).
 The definition indicates that elasticity concerns
both supply and demand.
ELASTICITY OF DEMAND
Demand elasticity “indicates the extent to which
changes in price (or other factors) cause changes in the
quantity demanded.”
Demand elasticity may be classifies as follows:
1. Price elasticity of demand
2. Income elasticity of demand, and
3. Cross elasticity of demand.
PRICE ELASTICITY OF DEMAND
Price elasticity is used to determine the
responsiveness of demand to changes in the price of the
commodity. It may be calculated with the use of the
formula below:
Ep = 16,000-10,000/10,000
4.00-5.00/5.00
=3
PRICE ELASTICITY OF DEMAND CLASSIFIED AS TO PRICE
ELASTICITY DEMAND MAY BE CLASSIFIED INTO THE
FOLLOWING TYPES:
1. Elastic demand
 Type of demand where the quantity that will be
bought is affected greatly by changes in price.
The change must be greater than elasticity
coefficient of 1. The sample problem indicate
above provides an answer which corresponds to
an elastic demand. The relationship is illustrated
in graph in Figure 18.
 The demand for common luxuries (like most
households appliances) and goods capable of
many uses (like paper) is elastic.
2. Inelastic demand
 Refers to the demand where a percentage
change in price creates a lesser change in
quantity demanded. An example is when a 20%
reduction is price caused only a 10% increase in
demand. The elasticity coefficient in this type is
less than 1.

 The demand for necessities like food, clothing
and shelter is inelastic. Consumers will continue
to buy necessities in quantities previously
purchased regardless of changes in price of such
goods. Figure 19 illustrates such relationship.
3. Unitary demand
 Type of demand, a change in price creates an
equal change in quantity demanded. An example
is when a 20% price reduction resulted to a 20%
increase in demand. Elasticity under the unitary
demand is equal to the coefficient of 1 (Figure
20).
 Semi-luxury items are goods considered with
unitary elasticity. Example are the designer
clothes, watches, and bath soap.
IMPLICATION OF PRICE ELASTICITY OF DEMAND
Determining demand elasticity serves a certain
purpose. When elasticity is known, it can guide the seller
in making decisions about price. At this point, a certain
rule may be derived as follows:
“If the price elasticity of demand is greater than
one, the price should be lowered; if less than one, the
price should be increased.”
The elastic demand of the product shown in
figure 18 yields a total revenue of P50,000 if sold at P5.00
per kilo. When the price is lowered to P4.00 per kilo, total
revenue is only P60,000.
Figure 19 indicates a price elasticity lower than
1. When the product are sold at P4.00, total revenue is
only P44,000 at P5.00 per kilo, however, total revenue is
P50,000.

 Figure 18. ELASTIC DEMAND INCOME ELASTICITY OF DEMAND

Original Quantity demanded = 10,000 kilos The demand for a product or service is affected
Original price = P5.00 per kilo not only by its price but also by other factors like
New Quantity demand = 16,000 kilos consumer income. To measure the effect of consumer
New price = P4.00 per kilo income on demand, the elasticity concept may be used.
Income elasticity of demand to change in
Ep = 16,000 – 10,000 / 10,000 consumer income, it may be calculated by using the
4.00 – 5.00 / 5.00 formula as follows:
=3
Ep = Percentage change in quantity demanded
 Figure 19. INELASTIC DEMAND Percentage change in income
Original quantity demanded = 10,000 kilos = QD2-QD1/QD1
Original price = P5.00 P2-P1/P1
New quantity demanded = 11,000 kilos When elasticity is greater than 1, demand is said
New price = P4.00 to be income elastic; when less than 1, it is income
inelastic; and when equal to 1, it is unitary elastic.
Ep = 11,000 – 10,000 / 10,000
4.00 – 5.00 / 5.00
= 0.5 CROSS ELASTICITY OF DEMAND
The demand for a certain good may be affected
 Figure 20 INELASTIC DEMAND also by a change in the price of another good. From the
economic standpoint, it is very useful for a person to
Original quantity demanded = 10,000 kilos
know this relationship between goods.
Original price = P5.00
New quantity demanded = 11,000 kilos
The responsiveness of the quality demanded of
New price = P4.00
a particular good to changes in the price of another good
is referred to as cross elasticity of demand. It is measure
Ep = 11,000 – 10,000 / 10,000 by computing for the percentage change in the quantity
4.00 – 5.00 / 5.00 demanded of the first good and dividing it by the
= 0.5 percentage change in the price of the second good. The
mathematical representation of this relationship is as
follows:

Ec = Percentage change in quantity demanded
Percentage change in the quantity demanded
= QA2 - QA1 / QA1
PB1 - PB1/PB1
Where:
Ec = cross elasticity of demand
QA2 = new demand for product A
QA1 = original demand for product A
PB2 = new price of product B
PB1 = original piece of product B
If cost elasticity is positive, the goods are
substitutes. An example is the 2% increase in the price of
rice which causes a 0.66% increase in the demand for pan
de sal.
If cross elasticity is negative, the goods are
complements. If tuition fee increases results to a
decrease in the demand for dormitories, school
dormitories are complements.
DETERMINANTS OF DEMAND ELASTICITY
The demand elasticity of goods and services are
not similar; some are inelastic. This is so because of
certain factors (or determinants). They are as follows:
1. The price of good in relation to the consumer`s
budget. Consumers are more sensitive to price
changes of goods take a big amount of their budget.
A change in the price of cars drive consumers to
think seriously about buying; while a change in the
price of toothpicks (from 50 centavos per box to 75
centavos per box) are taken in stride.
2. The availability of substitutes. The demand
elasticity of good is affected by the availability of
substitutes. The more and the closer substitutes
are, the more people will switch to substitutes,
when the price of the good rises.5
. an illustration.
3. The type of good. The demand elasticity of a good
is affected by its type, like whether it is luxury or a
necessity. The demand for basic staples like rice is
inelastic since consumers can scarcely avoid buying
them. Magazines and comics are luxuries and their
demand is elastic because people can avoid buying
them when their price rises.
4. The time under consideration. The demand for a
good becomes more elastic over a longer period of
time. For example, if the price of rice rises, people
may consider switching to bread, corn, or other
cereals. Switching will be slow, however, buy much
can be achieved when longer period is considered.
ELASTICITY OF SUPPLY
Elasticity of supply refers to the responsiveness
of the sellers to a change in price. This may be
determined my computing for the percentage change in
the quantity supplied of good divided by the percentage
change in the price. The mathematical formula for
determining elasticity of supply is:
Es = Percentage change in quantity supplied
Percentage rise in price
= QS2 - QS1 / QS1
P2 - P1 / P1
Where:
Es = price elasticity of demand
QS2 = new quantity demand
QS1 = original quantity demanded
P2 = the new price
P1 = the original price
Classification of Supply Elasticity
Like demand elasticity, supply elasticity may
also be classified into the following:
1. Elastic supply
2. Inelastic supply
3. Unitary elastic supply
Elastic supply is where the quantity supplied is
affected greatly by changes in the price. The change is
greater than the elasticity coefficient of 1. And
illustration is provided in Figure 21.
When the quantity supplied is not affected
greatly by changes in the price, supply is said to be
inelastic. The elasticity is less than 1. Figure 22 provides
When the percentage change in the
quantity supplied is equal to the percentage change in
price, supply is unitary elastic. The elasticity coefficient
is equal to 1. Figure 23 illustrates this point.

 Figure 21. ELASTIC SUPPLY
New quantity supplied (QS2)
Old quantity supplied (QS1)
New price (P2)
Old price (P1)
3. Time. With the passage of time, especially for
long periods, supply tends to be elastic. If there is
= 18,000 kilos a rise in prices, the producers may not be able to
= 10,000 kilos make adjustment quickly, but given sufficient
= P6.00/kilo time, they may be able to produce more.
= P5.00/kilo

Es = 18,000 – 10,000 / 10,000 SUMMARY

6.00 – 5.00 / 5.00  Knowledge of the concept of elasticity may be
=4 useful to both buyer and seller. What is presented
under the concept is that demand and supply may
be affected by changes in price or other factors.
 Figure 22. INELASTIC SUPPLY
The responsiveness to change is referred to as
New quantity supplied (QS2) = 11,000 kilos elasticity.
Old quantity supplied (QS1) = 10,000 kilos
New price (P2) = P6.00/kilo  Demand elasticity may be measured in terms of:
Old price (P1) = P5.00/kilo (1) price elasticity, (2) income elasticity, and (3)
cross elasticity. In computing for elasticity, is
Es = 11,000 – 10,000 / 10,000 percentage change in quantity demanded (or
6.00 – 5.00 / 5.00 supplied) is compared with the percentage
= 0.5 change in the variable.

 Figure 23. UNITARY ELASTIC SUPPLY  Demand or supply elasticity may be classified as
(1) elastic (one greatly affected by a change in the
New quantity supplied (QS2) = 11,000 kilos
variable); (2) inelastic (one minimally affected);
Old quantity supplied (QS1) = 10,000 kilos
and (3) unitary (one not affected at all).
New price (P2) = P6.00/kilo
Old price (P1) = P5.00/kilo  The determinants of demand elasticity are: (1) the
price of the good in relation to the consumer`s
Es = 11,000 – 10,000 / 10,000 budget; (2) the availability of substitutes; (3) the
6.00 – 5.00 / 5.00 type of good; and (4) the time under
= 0.5 consideration.

3 DETERMINANTS OF SUPPLY ELASTICITY  Supply elasticity is also affected by the following

Supply is either elastic or inelastic depending on determinants: (1) the feasibility and coast of
whether or not the sellers are able to respond effectively storage; (2) the ability of produces to respond to
to changes in price. Supply elasticity will depend on the the price changes; and (3) the time under
following factors: consideration.

1. The feasibility and cost of storage. Regardless of

price, perishable goods like vegetables must be
brought to the market. It storage cost is high, even
if it is available. The sellers have no choice but to sell
at prevailing prices. Supply is inelastic in this case.

2. The ability of producers to respond to price

changes, if the producers can easily increase or
decrease output when prices rise or fall, supply in
elastic.