Chapter 6:

Elasticity

A general definition of elasticity

Elasticity a measure of responsiveness
or sensitivity
Elasticity coefficient the percentage
change in a dependent variable if the
relevant independent variable changes by
one per cent

Types of elasticity
The price elasticity of demand
The income elasticity of demand
The cross elasticity of demand
The price elasticity of supply

The price elasticity of demand

The price elasticity of demand the
percentage change in the quantity
demanded if the price of the product
changes by one per cent, ceteris paribus

 The impact of different demand elasticities

on the equilibrium price and quantity

Figure 6-1: The impact of

different demand
elasticities on the
equilibrium price and
quantity

Two formulas for price elasticity of demand:

Point elasticity (use for small price

changes)

Q P
ep

P Q

Arc elasticity (use for larger price

fluctuations)

Q2 Q1 / Q1 Q2

ep
P2 P1 / P1 P2

 The price elasticity of demand can be used

to determine by how much the total
expenditure by consumers on a product
changes when the price of the product
changes

Price elasticity of demand > 1

TR increases as Q increases

Price elasticity of demand = 1

TR reaches a maximum

Price elasticity of demand < 1

TR falls as Q increases

Figure 6-2: The relationship between price elasticity of

demand and total revenue

The demand for cappuccinos and total

revenue from cappuccino sales

Different categories of price elasticity of

demand:

Perfectly inelastic demand (ep = 0)

Inelastic demand (0 < ep < 1)
Unitary elastic demand (ep = 1)
Elastic demand (1 < ep < )
Perfectly elastic demand (ep = )

Table 6-2: Price elasticity of demand: a summary

Figure 5-3: The different categories of price

elasticity of demand (Textbook page 118)

Determinants of the price elasticity of

demand:

Substitution possibilities
The degree of complementarity of the product
The type of want satisfied by the product
The time period under consideration
The proportion of income spent on the product
The definition of the product
Advertising
Durability
The number of uses for the product
Addiction

The combined effect of the determinants

Income elasticity of demand

The income elasticity of demand
measures the responsiveness of the
quantity demanded to changes in income
0 < ey < 1

normal good, essential good

1 < ey

normal good, luxury good

ey < 0

inferior good

Cross elasticity of demand

Cross elasticity of demand measures
the responsiveness of the quantity
demanded for a particular good when the
price of another good changes
0 < ec

substitutes
ec < 0

complements
ec = 0

unrelated goods

The price elasticity of supply

Price elasticity of supply the ratio
between the percentage change in the
quantity supplied of a product and the
percentage change in the price of the
product
By how much will the quantity supplied
change if the price changes by one per
cent?

Different categories of price elasticity of

supply:

Perfectly inelastic supply (es = 0)

Inelastic supply (0 < es < 1)
Unitary elastic supply (es = 1)
Elastic supply (1 < es < )
Perfectly elastic supply (es = )

Figure 5-4: The different categories of price

elasticity of supply (Textbook page 128)

Determinants of the price elasticity of supply:

Time
Expectations
Stockpiling
Excess capacity
Availability of inputs