Elasticity

SpecialTopic in Basic Microeconomics
Jean Lee C. Patindol

 Elasticity is a general concept that
can be used to quantify the
response in one variable when
another variable changes.
e l a s t i c i t y o f A w i t h r e s p e c t t o B
A
B
=
%
%
∆
∆

 a measure of the responsiveness of quantity
to the percentage changes in what affects it
% c h a n g e i n q u a n t i t y d e m a n d e d x 1 0 0 %2
=
−Q Q
Q
1
1
% c h a n g e i n p r i c e x 1 0 0 %2
=
−P P
P
1
1

 A more accurate way of
computing elasticity than
percentage changes is the
midpoint formula:
%
%
( ) /
( ) /
∆
∆
Q
P
Q Q
Q Q
P P
P P
d
=
−
+
−
+
2 1
1 2
2 1
1 2
2
1 0 0 %
2
x
x 1 0 0 %
%
%
( ) /
( ) /
. .
∆
∆
Q
P
d
=
−
+
−
+
= = −
1 0 5
5 1 0 2
1 0 0 %
2 3
3 2 2
5
7 5 1 6 7
x
x 1 0 0 %
x 1 0 0 %
- 1
2 .5
x 1 0 0 %
=
6 6 .7 %
- 4 0 .0 %

 Price Elasticity (of Demand) – the ratio
between the percentage change in quantity
demanded to a corresponding percentage
change in price.
e = % ∆ Q/ Q or [(Q2 – Q1)/ Q1 ] x 100
________ ____________________
% ∆ P/ P [(P2 - P1) / P1 ] x 100

 Unitary (= 1): a percentage change in price is equal to
the same percentage change in quantity demanded.
The total revenue obtained remains constant despite
the price change.
 Elastic (> 1): a change in price will result in a more
than proportionate change in quantity demanded.
Higher total revenues are obtained by lowering prices.
This is usually true for non-necessary items.
 Inelastic ( < 1): a change in price will result to a less
than proportionate change in quantity demanded.
Higher total revenues are obtained by increasing
prices. This is usually true for basic products like
staple food, medicine, and other necessary items.

 When demand does not
respond at all to a change
in price, demand is
perfectly inelastic.
 Demand is perfectly elastic
when quantity demanded
drops to zero at the slightest
increase in price.

Here is how to interpret two different values of
elasticity:
 When ε = 0.2, a 10% increase in price leads to
a 2% decrease in quantity demanded.
 When ε = 2.0, a 10% increase in price leads to
a 20% decrease in quantity demanded.

Table 1. Demand Schedule for Rice
Price (P) Quantity
Demanded
(Qd )
Total Revenue
(P x Qd )
50 8 P400
40 9 360
30 10 300
20 11 220
10 12 120
• What is the price elasticity of demand for rice if you
decrease your price from P40 to P20? Should you go ahead
with the price decrease?

e = % ∆ Q/ Q or [(Q2
– Q1
) / Q1
] x 100
_______ ________________________
% ∆ P/ P [(P2
- P1
) / P1
] x 100
= [(11- 9) / 9] x 100
___________________
[ (20 – 40) / 40 ] x 100
= 22.22 / - 50
= - 0.44

 At -0.44 elasticity (less than 1), this means that
the price elasticity of demand for rice is inelastic.
 Lowering the price from P40 to P20 results in only
a 0.44% increase (thus, the negative sign, to
show the inversely proportional relationship
between P and Qd) in quantity demanded.
 Also, the total revenue to be obtained is
decreased from P360 to P220. Thus, it is not
advisable to decrease the price.

Hypothetical Demand Elasticities for Four Products
PRODUCT
% CHANGE
IN PRICE
(%∆P)
% CHANGE IN
QUANTITY DEMANDED
(%∆QD)
ELASTICITY
(%∆QD  %∆P)
Insulin +10% 0% 0.0 Perfectly inelastic
Basic telephone service +10% -1% -0.1 Inelastic
Beef +10% -10% -1.0 Unitarily elastic
Bananas +10% -30% -3.0 Elastic

When demand is inelastic, price and total revenues are directly
related. Price increases generate higher revenues.
When demand is elastic, price and total revenues are indirectly
related. Price increases generate lower revenues.
Type of
demand Value of Ed
Change in quantity
versus change in
price
Effect of an
increase in
price on total
revenue
Effect of a
decrease in price
on total revenue
Elastic Greater than
1.0
Larger percentage change
in quantity
Total revenue
decreases
Total revenue
increases
Inelastic Less than 1.0 Smaller percentage
change in quantity
Total revenue
increases
Total revenue
decreases
Unitary
elastic
Equal to 1.0 Same percentage change
in quantity and price
Total revenue
does not change
Total revenue does
not change
T R P Q= ×

Table 1. Demand Schedule for Rice
Price (P) Quantity
Demanded
(Qd )
Total Revenue
(P x Qd )
50 8 P400
40 9 360
30 10 300
20 11 220
10 12 120
•What is the price elasticity of demand for rice if you
increase your price from P20 to P30? Should you go
ahead with your price increase?

e = % ∆ Q/ Q or [(Q2
– Q1
) / Q1
] x 100
________ ________________________
% ∆ P/ P [(P2
- P1
) / P1
] x 100
= [(10- 11) / 11] x 100
____________________
[(30 – 20) / 20 ] x 100
= - 9.09
______
50
= -0.18

 Availability of substitutes -- demand is more
elastic when there are more substitutes for
the product.
 Importance of the item in the budget --
demand is more elastic when the item is a
more significant portion of the consumer’s
budget.
 Time dimension -- demand becomes more
elastic over time.

 the ratio between the percentage change in
quantity demanded to a corresponding
percentage change in income.
ey = % ∆ Q/ Q
__________
% ∆ Y/ Y

 the ratio of the relationship between the
percentage change in the quantity demanded
for one product and the percentage change in
price of its substitute product
e = % ∆ Qx / Qx
____________
% ∆ Py/ Py

 the ratio between the percentage change in
quantity supplied to a corresponding
percentage change in price; tends to increase
in the long-run than in the short-run because
ability of Supply to shift resources to
production
e = % ∆ Qs / Qs
__________
% ∆ P/ P

Table 2.
Income and Price Elasticities of Demand of Southeast Asian Travellers to
the Philippines
Country of Origin Income Elasticity of
Demand
Price Elasticity of
Demand
Indonesia 1.20 -0.21
Malaysia 1.98 -0.37
Singapore 1.75 -0.44
Thailand 0.65 -0.25
•Describe the income elasticities of demand of each country. Which
country’s people are the most likely to travel to the Philippines with
increases in their income? The least likely?
•Describe the price elasticities of demand for travel services of each
country. Do these countries’ people consider traveling to the Philippines
ncessary or not?

Table 3. Demand Schedule for Super Cologne, P = P70
Price (P) Quantity Demanded
(Qd )
Total Revenue
(P x Qd )
70 3
60 6
50 9
40 12
30 15
•What is the price elasticity of demand for Super Cologne if you
decrease your price from P60 to P40? Should you go ahead with
your price decrease?
• ANSWER WITH (5): elasticity coefficient; type of elasticity;
interpretation in terms of 10% change in price; interpretation in
terms of effect on TR; decision on price decrease or not

Elasticity

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Elasticity