Chapter 3

Price Elasticity
Price Elasticity of Demand measures the sensitivity /
responsiveness of quantity demanded to a change in its price
Price Elasticity of Demand =
% in quantity demanded
% in Price
=
2 1
(1+2)/2

2 1
1+2 /2
=
2 1
(1+2)/2

(1+2)/2
21
Price Elasticity - Demand
Price Elasticity - Demand
A
B
C
100
60
20
2000 4000 6000
1.3
0.4
Price
Quantity
Price Elasticity Demand on Single Slope
60
20
2000 4000
6000
100
Price
Quantity
Price Elasticity Types of Price Elasticity of Demand
Types of Elasticity Price Elasticity of
Demand, PED
Example
Elastic Demand
<Sensitive to price changes>
PED = b% / a% > 1
Inelastic Demand
<Insensitive to price changes>
PED = b% / a% < 1
a%
b%
a%
b%
P
Qd
P
Qd
Price Elasticity Types of Price Elasticity of Demand
Types of Elasticity Price Elasticity of
Demand, PED
Example
Perfectly Elastic Demand
<At a given price, quantity
demanded is infinite. Thus, a small
change of price can lead to huge
changes in quantity demanded
PED = b% / 0 =
Perfectly Inelastic
Demand
<Quantity demanded is fixed
regardless of Price. No matter how
expensive or cheap the product is>
PED = 0 / a% = 0
a%
P
Qd
b%
P
Qd
Price Elasticity Types of Price Elasticity of Demand
Types of Elasticity Price Elasticity of
Demand, PED
Example
Unitary Elastic Demand
<Price elasticity remains
constant throughout the curve>
PED = b% / a% = 1
b%
a%
P
Qd
Determinant Relationship Explanation
Income Level of
consumers
Richer consumers are less sensitive to
price changes as their affordability
increases
Time dimension as
the duration from price
change
The longer the time dimension, the more
time for consumers to adapt to the price
change. Thus, they can easily switch
demand cause a drop in quantity
demanded over time
Importance /
essential of the
goods demanded
The more important or essential the
goods is, the more inelastic it will be. E.g.
rice, water and electricity
Price Elasticity Determinants of Price Elasticity of Demand
Income Level P. Elasticity of DD
Time Dimension P. Elasticity of DD
Eseential P. Elasticity of DD
Determinant Relationship Explanation
Substitutability of
the goods
The greater the substitutability of the
goods (the easier to find a substitute for
the goods), the more elastic the demand.
Tastes, fashions
and habits by the
consumers
Consumers may have formed certain
distinct tastes, fashions and habits and
willing to spend a lot to sustain such
tastes, fashions and habits (high
attachment). As such the said good
become inelastic. E.g. cigarettes
Complementary
goods due to joint
demand
Joint demand of two goods causes
inelastic individual demand for each
good.
Example, a car runs on petrol. Thus, the
demand for car is less responsive to
changes of car prices given high petrol
price.
Substitutability P. Elasticity of DD
Attachment to
tastes, fashions
and habits
P. Elasticity of DD
Price Elasticity Determinants of Price Elasticity of Demand
, =
Price Elasticity Total Revenue
P
0
Q
0
Total Revenue
Price
Quantity
Price Elasticity P. Elasticity of DD in relation to Total Revenue
Qd
P
0
Q
0
Price
P
1
Q
1
P
2
Q
2
Elastic Demand In Relation to Total Revenue:
Total Revenue :
When Price , P
1
x Q
1
< P
0
x Q
0
, TR
1
< TR
0
When Price , P
2
x Q
2
> P
0
x Q
0
, TR
2
> TR
0
Therefore
1. Price increase when demand is elastic, quantity will
drop at a larger quantum causing a drop of Total
Revenue.
2. Price decrease when demand is inelastic, quantity
will increase at a larger quantum causing an increase
of Total Revenue.
Price Elasticity P. Elasticity of DD in relation to Total Revenue
P
0
Q
0
Price
P
1
Q
1
P
2
Q
2 Qd
Inelastic Demand In Relation to Total Revenue:
Total Revenue :
When Price , P
1
x Q
1
> P
0
x Q
0
, TR
1
> TR
0
When Price , P
2
x Q
2
< P
0
x Q
0
, TR
2
< TR
0
Therefore
1. Price increase when demand is inelastic, quantity will
drop at a smaller quantum causing an increase of
Total Revenue.
2. Price decrease when demand is inelastic, quantity
will increase at a smaller quantum causing a drop of
Total Revenue.
When Price Elasticity of Demand is UNITARY, TR does not change in
response of prices
Price Elasticity P. Elasticity of DD in relation to Total Revenue
Total Revenue :
When Price , P
1
x Q
1
= P
0
x Q
0
, TR
1
= TR
0
When Price , P
2
x Q
2
= P
0
x Q
0
, TR
2
= TR
0
Other Elasticity of Demand Income Elasticity of Demand
Income Elasticity of Demand measures the sensitivity /
responsiveness of quantity demanded to a change in income
Income Elasticity of Demand =
% in quantity demanded
% in Income
=
2 1
(1+2)/2

2 1
(1+2)/2
=
2 1
(1+2)/2

(1+2)/2
21
Where, Y = income
Other Elasticity of Demand Income Elasticity of Demand
Type of Income Elasticity of
Demand
Income Elasticity of
Demand, IED
Charts Example
Inelastic Income Elasticity of
Demand
(Less responsive to income
changes)
IED = a%/b% < 1 Normal goods
(food, clothes)
Elastic Income Elasticity of
Demand
(Responsive to income
changes)
IED = a%/b% > 1 Luxury goods
(branded items, jewellery)
Income
Qtty DD
a%
b%
b%
a%
Income
Qtty DD
Other Elasticity of Demand Income Elasticity of Demand
Type of Income Elasticity of
Demand
Income Elasticity of
Demand, IED
Charts Example
Negative Income Elasticity of
Demand
(As income increases,
quantity demanded
decreases)
IED = a%/b% < 0
-1% > a1%/b1% < 0
-1% < a2%/b2% < 0
Giffen goods
(Used cars, low grade potatoes)
Perfectly Income Inelasticity
of Demand
(Quantity demanded NOT
responsive to income at all)
IED = a%/b% = 0 Necessity goods
(rice, vegetables, flour)
Income
Qtty DD
a1%
b1%
b%
a%
Income
Qtty DD
a2%
b2%
Purposes of Income Elasticity of Demand are:
a) Sales Forecasting
Business owners can forecast the quantity demanded of certain product given any changes in income to plan
their supply.
b) Segment Targeting
Knowing the income elasticity of demand of the product, business owners then can target the right segment to
market the product e.g. luxury goods for higher income group, inferior product for lower income group
Other Elasticity of Demand Income Elasticity of Demand
Other Elasticity of Demand Cross Elasticity of Demand
Cross Elasticity of Demand measures the sensitivity / responsiveness
of quantity demanded for one product following a change in price for related product
Income Elasticity of Demand =
% in quantity demanded for product A
% in Price for product B
=

2 1

1
=

2 1

1
Other Elasticity of Demand Cross Elasticity of Demand
Type of Income Elasticity of
Demand
Income Elasticity of
Demand, IED
Charts Example
Negative Cross Elasticity of
Demand
CED < 0 Complimentary goods
Positive Cross Elasticity of
Demand
CED > 0% Substitute goods
Zero Cross Elasticity of
Demand
CED = 0% No relationship between the
two goods
Price of B
Qtty DD for A
Price of B
Qtty DD for A
Price of B
Qtty DD for A
Price Elasticity - Supply
Price Elasticity of Supply measures the sensitivity /
responsiveness of quantity supply to a change in its price
Price Elasticity of Supply =
% in quantity supplied
% in Price
=
2 1
1

2 1
1
=
2 1
1

1
21
Where Q = quantity supplied
Price Elasticity Types of Price Elasticity of Supply
Types of Elasticity Price Elasticity of
Supply, PES
Example
Elastic Supply
<Sensitive to price changes>
PES = b% / a% > 1
Inelastic Supply
<Insensitive to price changes>
PED = b% / a% < 1
a%
b%
a%
b%
P
QS
P
QS
SS
SS
Price Elasticity Types of Price Elasticity of Supply
Types of Elasticity Price Elasticity of
Supply, PES
Example
Unitary Elastic Supply
<% change in price produces
the same % change in quantity
supply>
PES = b% / a% = 1
Perfectly Inelastic
Supply
<Price changes has no effect
on quantity supply>
PED = b% / a% = 0
a%
b%
a%
b%
P
QS
P
QS
SS
SS
45%
Price Elasticity Types of Price Elasticity of Supply
Types of Elasticity Price Elasticity of
Supply, PES
Example
Perfectly Elastic
Supply
<An almost zero % change in
prices produces large or
infinite change in quantity
supplied>
PES = b% / a% =
b%
P
QS
SS
Determinant Relationship Explanation
Technology used in
production
The more advance technology used, the
more elastic the supply is as producers
can easily increase production.
Time dimension as
the duration from price
change
Factors of production cannot change
within a short period of time. Thus,
though price increases but during the
short-term, quantity supplied may not
respond due to the restriction of factors
of production
Availability and
mobility of factors of
production
The more mobile and better availability
the factors of production is, the elastic
the quantity supplied it will be.
Price Elasticity Determinants of Price Elasticity of Supply
Technology P. Elasticity of SS
Time Dimension P. Elasticity of SS
Availability of FP P. Elasticity of SS
Determinant Relationship Explanation
Perishability of the
product
Perishable products such as agriculture
products are mostly inelastic supply as
they are not storable. Therefore, increase
of price has minimal effect on quantity
supply
Price Elasticity Determinants of Price Elasticity of Supply
Perishability P. Elasticity of SS
Price Elasticity Application of Price Elasticity
Using the price elasticity of demand and supply and their effect on total revenue, comprehend and analyze the
situations below:
1. OPEC countries to cut down on oil production to raise the oil prices
2. Drug interdiction by government to reduce the availability of drugs in the country
3. New technology for paddy plantation that can increase the quantity
1) The slope of a demand curve depends on
A) the units used to measure price and the units used to measure quantity.
B) the units used to measure price but not the units used to measure quantity.
C) the units used to measure quantity but not the units used to measure price.
D) neither the units used to measure price nor the units used to measure quantity
2) The price elasticity of demand depends on
A) the units used to measure price and the units used to measure quantity.
B) the units used to measure price but not the units used to measure quantity.
C) the units used to measure quantity but not the units used to measure price.
D) neither the units used to measure price nor the units used to measure quantity
3) The price elasticity of demand measures
A) how often the price of a good changes.
B) the slope of a budget curve.
C) how sensitive the quantity demanded is to changes in demand.
D) the responsiveness of the quantity demanded to changes in price.
4) If a rightward shift of the supply curve leads to a 6 percent decrease in the price and a 5 percent increase in the
quantity demanded, the price elasticity
of demand is
A) 0.30.
B) 0.60.
C) 0.83.
D) 1.20
5) A 10 percent increase in the quantity of spinach demanded results from a 20 percent decline in its price. The price
elasticity of demand for spinach is
A) 0.5.
B) 2.0.
C) 10.0.
D) 20.0.
6) A 20 percent increase in the quantity of pizza demanded results from a 10 percent decline in its price. The price
elasticity of demand for pizza is
A) 0.5.
B) 2.0.
C) 10.0.
D) 20.0.
7) A fall in the price of lemons from $10.50 to $9.50 per bushel increases the quantity demanded from 19,200 to 20,800
bushels. The price elasticity of demand is
A) 0.80.
B) 1.20.
C) 1.25.
D) 8.00.
8) Suppose that the quantity of root beer demanded declines from 103,000 gallons per week to 97,000 gallons per week as a
consequence of a 10 percent increase in the price of root beer. The price elasticity of demand is
A) 0.60.
B) 1.40.
C) 1.66.
D) 6.00.
9) The price elasticity of demand is 5.0 if a 10 percent increase in the price results in a ____ decrease in the quantity
demanded.
A) 2 percent
B) 5 percent
C) 10 percent
D) 50 percent
Price (dollars per bushel) Quantity demanded (bushels)
8 2,000
7 4,000
6 6,000
5 8,000
4 10,000
3 12,000
11) The table above gives the demand schedule for snow peas. The price elasticity of demand between $6.00 and $7.00 per
bushel is
A) 1.0.
B) 2.0.
C) 2.6.
D) 5.0.
10) A shift of the supply curve of oil raises the price of oil from $9.50 a barrel to $10.50 a barrel and reduces the quantity
demanded from 41 million to 39 million barrels a day. The price elasticity of demand for oil is
A) 2 million barrels a day per dollar.
B) $1 per 2 million barrels a day.
C) 0.5.
D) 2.0.
13) The demand curve in the figure above illustrates the demand for a product with
A) zero price elasticity of demand at all prices.
B) infinite price elasticity of demand.
C) unit price elasticity of demand at all prices.
D) a price elasticity of demand that is different at all prices.
Price of A
(RM)
Quantity
Demanded
for A (kg)
Quantity
Demanded
for B (kg)
4 150 100
5 120 80
6 100 70
7 80 50
15) Based on the schedule above, answer the following questions:
a) Calculate the price elasticity of demand if the price of A increases from RM5 to RM7. State whether
the demand for A is elastic or inelastic
b) Explain any two factors which influence the price elasticity of demand
c) Calculate the cross elasticity of demand for B when the price of A decreases from RM6 to RM4.
What is the relationship between A and B
14) A shift of the supply curve of oil raises the price from $10 a barrel to $30 a barrel and reduces the
quantity demanded from 40 million to 23 million barrels a day. You can conclude that the
A) demand for oil is elastic.
B) demand for oil is inelastic.
C) supply of oil is elastic.
D) supply of oil is inelastic.
16) The figure above represents the behavior of total revenue as price falls along a straight-line demand
curve. What is the price elasticity of demand if total revenue is given by point f?
A) Demand is inelastic.
B) Demand is unit elastic.
C) Demand is elastic.
D) It is impossible to determine.
17) The demand for a good is elastic if
A) an increase in its price results in an increase in total revenue.
B) a decrease in its price results in a decrease in total revenue.
C) an increase in its price results in a decrease in total revenue.
D) the good is a necessity.
18) If the demand for a good is unit elastic,
A) a 5 percent increase in price results in a 5 percent increase in total revenue.
B) a 5 percent increase in price results in a 5 percent decrease in total revenue.
C) a 5 percent increase in price does not change total revenue.
D) the demand curve is a straight line with slope of -1
Question 2
Consumer X Consumer Y Consumer Z Producer A Producer B Producer C
10 40 40 60 20 20 20
20 35 35 50 25 30 25
30 30 30 40 30 40 30
40 25 25 30 35 50 35
50 20 20 20 40 60 40
60 15 15 10 45 70 45
Demand Schedule
Price
Supply Schedule
Tutorial / Practical
a) Compute the market demand and supply
b) Plot the demand and supply curve
c) Extrapolate the Quantity and Price Equilibrium
d) Assume that for every Price point, demand increases by 10 units (demand curve shifts to the right!), what
is the new Quantity and Price Equilibrium
e) Compute the Price Elasticity of Demand on the initial demand curve and state the type of elasticity for the
below two sections:
When Price increases from RM10 to RM30
When Price increases from RM30 to RM60