Elasticities of Demand and Supply

ELASTICITY OF DEMAND

PRICE ELASTICITY OF DEMAND

1. The attribute of demand by virtue of which it stretches or contracts under
pressure of change in price is known as elasticity of demand [MET:110]
2. Price elasticity of demand is ratio of change in price vs change in demand
3. It is measure of responsiveness of demand relating to price
4. Mathematically:
PEoD = Change in quantity demanded / Change in price
5. When price falls, demand goes up and when price rises demand fall therefore
elasticity has negative value but negative sign is normally ignored

CLASSES OF ELASTICITY

1. Perfectly Elastic
◦ Also known as Infinite Elasticity
◦ When price elasticity of demand is perfectly elastic, any increase in
the price, no matter how small, will cause demand for the good to
drop to zero.
◦ Demand curve is horizontal straight line
 2. Perfectly Inelastic Demand
◦ When price elasticity of demand is perfectly inelastic, changes in the
price do not affect the quantity demanded for the good.
◦ The demand curve is a vertical straight line
 3. Unit Elasticity
◦ When the price elasticity of demand for a good is Unit Elastic (or
unitary elastic), the percentage change in quantity is equal to that in
price.
◦ Demand curve is diagonal line
 4. Relatively Elastic
◦ When the price elasticity of demand for a good is Elastic, the
percentage change in quantity demanded is greater than that in price.
◦ Hence, when the price is raised, the total revenue of producers falls,
and vice versa.
 5. Relatively Inelastic
◦ When the price elasticity of demand for a good is Inelastic, the
percentage change in quantity demanded is smaller than that in price.
◦ Hence, when the price is raised, the total revenue of producers rises,
and vice versa.
 ARC ELASTICITY
1. The elasticity figure you come up with is different depending on what you use
as the start point and what you use as the end point.
2. Elasticity between two points is arc elasticity
3. Mathematically

POINT ELASTICITY
1. Responsiveness of demand at particular point in the demand curve is Point
Elasticity
2. Mathematically:
 P.E. = ∆Q / ∆

NEGATIVE PRICE ELASTICITIES

1. Giffen Goods have negative elasticities because as price of a giffen commodity
rises, ratio of that commodity in budget also rises

FACTORS INFLUENCING PRICE

ELASTICITY OF DEMAND FOR A GOOD
1. Demand for necessities of life is less elastic or inelastic
2. Demand for luxuries is elastic
◦ as price rises consumer will feel himself relatively poor
3. Elasticity of goods having substitutes is high
4. Elasticity depends on uses of commodity
◦ If price of water rises it will mostly be used for drinking, not for other
uses ultimately reducing its consumption
5. Elasticity depends on necessity of goods
◦ The more necessary a good is, the lower the elasticity, as people will
attempt to buy it no matter the price, such as the case of insulin for
those that need it.
6. Change in non-significant price will not exhibit elasticity
◦ Changing in price of car from Rs. 1.1 million to 1 million will not as
much difference as price of chocolate from Rs.20 to 5 will exhibit even
though difference in price of car is greater
7. Percentage of income
◦ The higher the percentage that the product's price is of the consumers
income, the higher the elasticity, as people will be careful with
purchasing the good because of its cost
8. Breadth of definition
◦ The broader the definition, the lower the elasticity. For example,
Company X's fried dumplings will have a relatively high elasticity,
where as food in general will have an extremely low elasticity (see
Substitutes, Necessity above)
 INCOME ELASTICITY
1. Income elasticity is measure of responsiveness of potential buyers to change in
an income
2. Mathematically
IEoD = (% Change in Quantity Demanded)/(% Change in Income)

Types Of Income Elasticity

1. A Negative income elasticity of demand is associated with inferior goods; an
increase in income will lead to a fall in the demand and may lead to changes
to more luxurious substitutes.
2. A Positive income elasticity of demand is associated with normal goods; an
increase in income will lead to a rise in demand. If income elasticity of
demand of a commodity is less than 1, it is a necessity good. If the elasticity
of demand is greater than 1, it is a luxury good or a superior good.
3. A Zero income elasticity (or inelastic) demand occurs when an increase in
income is not associated with a change in the demand of a good. These would
be sticky goods.

CROSS ELASTICITY
1. In economics, the cross elasticity of demand and cross price elasticity of
demand measures the responsiveness of the demand of a good to a change in
the price of another good.
2. It is measured as the percentage change in demand for the first good that
occurs in response to a percentage change in price of the second good.
3. For example, if, in response to a 10% increase in the price of fuel, the demand
of new cars that are fuel inefficient decreased by 20%, the cross elasticity of
demand would be
−20%/10% = −2.
 ELASTICITY OF SUPPLY
1. Elasticity of supply indicates responsiveness of supply to a change in price
2. Price elasticity of supply is defined as a numerical measure of the
responsiveness of the quantity supplied of product (A) to a change in price of
product (A) alone. It is the measure of the way quantity supplied reacts to a
change in price.
3. Mathematically

4. Like elasticity of demand, elasticity of supply also have Unit Elasticity,

Inelastic Supply and Elastic Supply.
FACTORS AFFECTING ELASTICITY OF
SUPPLY
1. Spare Capacity
◦ if there is plenty of spare capacity, the firm should be able to increase
output quite quickly without a rise in costs and therefore supply will be
elastic
2. Stocks of factors of production
◦ if stocks of raw materials, components and finished products are high
then the firm is able to respond to a change in demand quickly by
supplying these stocks onto the market - supply will be elastic
3. Time Period
◦ Supply is likely to be more elastic, the longer the time period a firm
has to adjust its production. In the short run, the firm may not be able
to change its factor inputs.