ELASTICITY

InEconomics,elasticityis the
measurement of how changing one
economic variable affects others.
Note: Most commonly used variables are
PRICE or INCOME and QUANTITY
Supplied or Demanded

 For example:
"If I lower the price of my product,
how much more will I sell?
"If I raise the price, how much less
will I sell?
"If we learn that a resource is becoming
scarce, will people scramble to acquire
it?"

Elastic vs Inelastic
Generally, an elastic variable is
one which responds a lot to small
changes in other parameters.
Similarly, an inelastic variable
describes one which does not
change much in response to
changes in other parameters.

 In more technical terms, it is the ratio of

thepercentage changein one variable
(i.e. price or income) to the percentage
change in another variable (i.e.
quantity demanded or supplied).
It is a tool for measuring the
responsiveness of a function to changes
in parameters in a unitless way.

Frequently used
elasticities include
price elasticity of demand
price elasticity of supply
income elasticity of demand

 "Elasticity is a measure of responsiveness.

The responsiveness of behavior measured
by variable Q to a change in environment
variable P
It is the change in Q observed in response
to a change in P.
Specifically, this approximation is common:

elasticity = (percentage change in Q) /

(percentage change in P)

The Price Elasticity of

Demand
(commonly known as just price
elasticity) measures the rate of
response of quantity demanded due to
a price change.
The formula for the Price Elasticity of
Demand (PEoD) is:
PEoD = (% Change in Quantity
Demanded)/(% Change in Price)

Calculating the Price Elasticity

of Demand
"Given the following data, calculate
the price elasticity of demand when
the price changes from Ph9.00 to
Ph10.00"

 First we'll need to find the data we need.

We know that the original price is Ph9
and the new price is Ph10,
so we have Price(OLD)=Ph9 and
Price(NEW)=Ph10.
From the chart we see that the quantity
demanded when the price is Ph9 is 150
and when the price is Ph10 is 110.
Since we're going from Ph9 to Ph10, we
have Qd(OLD)=150 and Qd(NEW)=110,
Note: "Qd" is short for "Quantity
Demanded".

 So we have:
Price (OLD)=9
Price (NEW)=10
Qd (OLD)=150
Qd (NEW)=110

 To calculate the price elasticity, we

need to know what the percentage
change in quantity demand is and
what the percentage change in price
is. It's best to calculate these one at
a time.

Calculating the Percentage

Change in Quantity
Demanded
The formula used to calculate the
percentage change in quantity
demanded is:
[Qd(NEW) - Qd(OLD)] / Qd(OLD)

 By filling in the values we wrote

down, we get:
[110 - 150] / 150 = (-40/150) x
100%= -26.67%
(We leave this in decimal terms. In
percentage terms this would be
-26.67%).

 Calculating the Percentage

Change in Price
Similar to before, the formula used to
calculate the percentage change in
price is:
[Price(NEW) - Price(OLD)] /
Price(OLD)

 By filling in the values we wrote down,

we get:
[10 - 9] / 9 = (1/9) x 100%= 11.11%
We have both the percentage change in
quantity demand and the percentage
change in price, so we can calculate the
price elasticity of demand.

Final Step of Calculating

the Price Elasticity of
Demand
We go back to our formula of:
PEoD = (% Change in Quantity
Demanded)/(% Change in Price)
We can now fill in the two
percentages in this equation using
the figures we calculated earlier.
PEoD = (-26.67%)/(11.11%) =
-2.4005

 When we analyzepriceelasticities
we're concerned with their absolute
value, so we ignore the negative
value. We conclude that the price
elasticity of demand when the price
increases from Ph9 to Ph10 is
2.4005.

How Do We Interpret the

Price Elasticity of Demand?
A good economist is not just
interested in calculating numbers.
The number is a means to an end; in
the case of price elasticity of demand
it is used to see how sensitive the
demand for a good is to a price
change.

 The higher the price elasticity, the more

sensitive consumers are to price changes.
A very high price elasticity suggests that
when the price of a good goes up,
consumers will buy a great deal less of it
and when the price of that good goes
down, consumers will buy a great deal
more.
A very low price elasticity implies just the
opposite, that changes in price have little
influence on demand.

 Often an assignment or a test will ask you

a follow up question such as "Is the good
price elastic or inelastic between Ph9 and
Ph10". To answer that question, you use
the following rule of thumb:
If PEoD > 1 then Demand is Price Elastic
(Demand is sensitive to price changes)
If PEoD = 1 then Demand is Unit Elastic
If PEoD < 1 then Demand is Price Inelastic
(Demand is not sensitive to price changes)

 Recall that we always ignore the

negative
sign
when
analyzingpriceelasticity, so PEoD
is always positive.
In the case of our good, we
calculated the price elasticity of
demand to be 2.4005, so our good
is price elastic and thus demand is
very sensitive to price changes.

The Income Elasticity of

Demand
It measures the rate of response of
quantity demand due to a raise (or
lowering) in a consumers income.
The formula for the Income Elasticity
of Demand (IEoD) is given by:
IEoD = (% Change in Qty
Demanded)/(% Change in
Income)

Calculating the Income

Elasticity of Demand
Given the following data, calculate
the income elasticity of demand
when a consumer's income changes
from Ph40,000 to Ph50,000. Using
the chart on the bottom of the page,
I'll walk you through answering this
question.

 The first thing we'll do is find the data we

need. We know that the original income is
Ph40,000 and the new price is Ph50,000
so we have Income(OLD)=Ph40,000 and
Income(NEW)=Ph50,000. From the chart
we see that the quantity demanded when
income is Ph40,000 is 150 and when the
price is Ph50,000 is 180. Since we're
going from Ph40,000 to Ph50,000 we
have Qd(OLD)=150 and Qd(NEW)=180,
where "Qd" is short for "Quantity
Demanded".

 So you should have these four

figures written down:
Income(OLD)=40,000
Income(NEW)=50,000
Qd(OLD)=150
Qd(NEW)=180

 To calculate the price elasticity, we

need to know what the percentage
change in quantity demand is and
what the percentage change in price
is. It's best to calculate these one at
a time.

Calculating the Percentage

Change in Quantity
Demanded

The formula used to calculate the

percentage change in quantity
demanded is:
[Qd(NEW) - Qd(OLD)] / Qd(OLD)

By filling in the values we wrote

down, we get:
[180 - 150] / 150 = (30/150) = 0.2

 So we note that% Change in

Quantity Demanded = 0.2(We
leave this in decimal terms. In
percentage terms this would be 20%)
and we save this figure for later. Now
we need to calculate the percentage
change in price.

Calculating the Percentage

Change in Income
Similar to before, the formula used to
calculate the percentage change in income
is:
[Income(NEW) - Income(OLD)] /
Income(OLD)
By filling in the values we wrote down, we
get:
[50,000 - 40,000] / 40,000 =
(10,000/40,000) x 100% = 25%

 We have both the percentage change

in quantity demand and the
percentage change in income, so we
can calculate the income elasticity of
demand.

Final Step of Calculating

the Income Elasticity of
Demand

We go back to our formula of:

IEoD = (% Change in Quantity
Demanded)/(% Change in
Income)
We can now fill in the two
percentages in this equation using
the figures we calculated earlier.
IEoD = (0.20)/(0.25) = 0.80

 Unlike price elasticities, we do care

about negative values, sodo not
drop the negative sign if you get one.
Here we have a positive price
elasticity, and we conclude that the
income elasticity of demand when
income increases from Ph40,000 to
Ph50,000 is 0.8.

 How Do We Interpret the Income

Elasticity of Demand?
Income elasticity of demand is used
to see how sensitive the demand for
a good is to an income change. The
higher the income elasticity, the
more sensitive demand for a good is
to income changes.

 A very high income elasticity suggests

that when a consumer's income goes up,
consumers will buy a great deal more of
that good.
A very low price elasticity implies just the
opposite, that changes in a consumer's
income has little influence on demand.
Often an assignment or a test will ask
you the follow up question "Is the good a
luxury good, a normal good, or an inferior
good between the income range of
Ph40,000 and Ph50,000?"

To answer that use the following rule of

thumb:
If IEoD > 1 then the good is a Luxury Good
and Income Elastic
If IEoD < 1 and IEOD > 0 then the good is a
Normal Good and Income Inelastic
If IEoD < 0 then the good is an Inferior Good
and Negative Income Inelastic
In our case, we calculated the income
elasticity of demand to be 0.8 so our good is
income inelastic and a normal good and thus
demand is not very sensitive to income
changes.

Past or Previous
Quantity

Price

Present
Quantity

Price

23

10

35

11

20

13

15

13