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CHAPTER 6
ELASTICITY ANALYSIS
1st Semester, S.Y 2015 – 2016
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
The Concept of Elasticity
Elasticity is a measure of the degree of
responsiveness or sensitivity of one variable
to changes in another variable.
The greater the elasticity, the greater the
responsiveness.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Importance of Elasticity
 Relationship between changes in price and
total revenue
 Importance in determining what goods to tax
(tax revenue)
 Importance in analysing time lags in
production.
 Influences the behaviour of a firm.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Elasticity
• The responsiveness of one variable to
changes in another.
• When price rises, what happens
to demand?
• Demand falls.
• BUT!
• How much does demand fall?
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Elasticity
• If price decreases by 10% - what happens
to demand?
• We know demand will increase
• By more than 10%?
• By less than 10%?
• Elasticity measures the extent to which
demand will change
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Four Types of Elasticity




Price Elasticity of Demand
Income Elasticity of Demand
Cross-price Elasticity
Price Elasticity of supply
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Four Types of Elasticity
Price Elasticity of Demand
 The responsiveness of demand to changes in price
Income Elasticity of Demand
 The responsiveness of demand to changes in incomes
Cross-price Elasticity
 The responsiveness of demand of one good to changes
in the price of a related good – either a substitute or a
complement
Price Elasticity of Supply
 The responsiveness of demand to changes in price
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Price Elasticity of Demand
Price Elasticity of Demand
 the responsiveness of demand to changes in
price
 the percentage change in quantity demanded
divided by the percentage change in price.
 % change in quantity demanded is greater
than % change in price – elastic
 % change in quantity demanded is less than
% change in price - inelastic
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Price Elasticity of Demand
The Formula:
𝐸𝑝 =
% Change in Quantity Demanded
___________________________
% Change in Price
Where 𝑄1 − Original Quantity Demanded
𝑄2 − New Quantity Demanded
𝑃1 − Original Price
𝑃2 − − New Price
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Interpreting the Price Elasticity of
Demand
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Elastic Demand
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Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Inelastic Demand
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BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Unit Elastic Demand
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Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Perfectly Elastic Demand
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Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Perfectly Inelastic Demand
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Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Price Elasticity of Demand - Summary
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Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Selected Goods – Price Elasticities of
Demand
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Let’s Check Your Understanding
1. When the price of gasoline per liter rises from P40 to
P50, a taxi driver reduces it demand from 90 liters to
85 liters a week. Based on the data, compute for the
price elasticity of demand. Interpret the computed
elasticity value.
2. The price of Baguio strawberries falls from P150 to
P100 per carton and the quantity demanded goes
from 1,000 to 2,000 cartons. Compute for the price
elasticity of demand. Interpret the computed
elasticity value.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Let’s Check Your Understanding
Identify the following goods as either elastic or inelastic.
1. Pandesal
2. Mango
3. Grapes
4. Detergent
5. Tide Detergent
6. Coffee
7. LPG
8. Digital camera
9. Condominiums
10. Household appliances
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Total Revenue and the Price
Elasticity of Demand
Total revenue (TR)
 defined as the total value of sales of a good or
service
 is the total amount the seller receives from the
sale of a product in a particular time period; it is
calculated by multiplying the product price (P) by
the quantity sold (Q). In equation form:
𝑇𝑅 = 𝑃𝑟𝑖𝑐𝑒 𝑥 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Graphical Illustration – Total Revenue
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Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Total Revenue Test
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Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Total Revenue Test
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Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Price Change Impact on Total Revenue
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Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Price Elasticity and the Total-Revenue
Curve
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Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
The Price Elasticity of Demand Changes
Along the Demand Curve
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Income Elasticity of Demand
Income elasticity of demand
measures the degree to which
consumers respond to a change in their incomes by buying more or less of a
particular good. The coefficient of income elasticity of demand Eiis determined
with the formula
% 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝐷𝑒𝑚𝑎𝑛𝑑𝑒𝑑
𝐸𝑖 =
% 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐼𝑛𝑐𝑜𝑚𝑒
Normal Goods
For most goods, the income-elasticity coefficient Eiis
positive, meaning that more of them are demanded as incomes rise. Such goods
are called normal goods. But the value of Eivaries greatly among normal goods.
Inferior Goods
A negative income-elasticity coefficient designates an inferior
good. Retread tires, cabbage, long-distance bus tickets, used clothing, and
muscatel wine are likely candidates. Consumers decrease their purchases of
inferior goods as incomes rise.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Interpreting the Income Elasticity of
Demand
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Interpreting the Income Elasticity of
Demand
For example:
 𝐸𝑖 = −0.6 Good is an inferior good but inelastic – a
rise in income of 3% would lead to demand falling
by 1.8%
 𝐸𝑖 = 0.4 Good is a normal good but inelastic –
a rise in incomes of 3% would lead to demand rising
by 1.2%
 𝐸𝑖 = 1.6 . Good is a normal good and elastic –
a rise in incomes of 3% would lead to demand rising
by 4.8%
 𝐸𝑖 = −2.1 , Good is an inferior good and elastic –
a rise in incomes of 3% would lead to a fall in demand
of 6.3%
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Let’s Check Your Understanding!
Given the demand data for carinderia meals
subject to the change in income, calculate the
income elasticity for carinderia meals. Is demand
elastic, inelastic or unitary? Is the good normal
or inferior?
Income
(per month)
Quantity Demanded
(No. of Meals)
P8,000
6
P12,000
5
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Cross Price Elasticity of Demand
Cross Elasticity Of Demand
 The responsiveness of demand of one good to changes in
the price of a related good – either a substitute or a
complement/
 Measures how sensitive consumer purchases of one product
(say, X) are to a change in the price of some other product
(say, Y). It is expressed by the formula.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Cross-Price Elasticity of Demand
Goods which are complements:
 Cross Elasticity will have negative sign
(inverse relationship between the two)
Goods which are substitutes:
 Cross Elasticity will have a positive sign
(positive relationship between the two)
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Interpreting the Cross-Price Elasticity
of Demand
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Price Elasticity of Supply
Price Elasticity of Supply
 The responsiveness of supply to changes in price.
 If 𝐸𝑠 is inelastic - it will be difficult for suppliers to
react swiftly to changes in price.
 If 𝐸𝑠 is elastic – supply can react quickly to
changes in price.
 The formula is expressed by
% 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑆𝑢𝑝𝑝𝑙𝑖𝑒𝑑
𝐸𝑠 =
% 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Elastic Supply
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Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Inelastic Supply
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Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Unit Elastic Supply
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Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Perfectly Elastic Supply
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Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Perfectly Inelastic Supply
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Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS