University of Balamand

Faculty of Business & Management

Survey of Economics

Elasticity:

 Price Elasticity of Demand:

eD shows the responsiveness/reaction/sensitivity of QD to a given % of change in P.

%∆𝑄
eD = %∆𝑃 no unit of measurement

 Formats of the formula:

%∆𝑄
1. eD = %∆𝑃

2. If new and old known:

𝑄𝑛𝑒𝑤−𝑄𝑜𝑙𝑑
%∆𝑄 𝑄𝑜𝑙𝑑
eD = %∆𝑃 = 𝑃𝑛𝑒𝑤−𝑃𝑜𝑙𝑑 arc elasticity with new and old given (eD going from A to B)
𝑃𝑜𝑙𝑑

3. If new and old unknown:

𝑄2−𝑄1
𝑄2+𝑄1
%∆𝑄 2
eD = %∆𝑃 = 𝑃2−𝑃1 arc elasticity – midpoint or average formula (eD between A and B)
𝑃2+𝑃1
2

%∆𝑄 ∆𝑄 ∆𝑃 ∆𝑄 𝑃 ∆𝑄 𝑃
4. eD = = ⁄𝑃 = x ∆𝑃 = x𝑄 point-price elasticity (get eD at A)
%∆𝑃 𝑄 𝑄 ∆𝑃

∆𝑌
Slope of D function ∆𝑋

 eD is always negative due to the law of demand:

−
As P increases, Q decreases: eD = + = -
+
As p decreases, Q increases: eD = − = -

When interpreting, we always take it in an absolute value.

University of Balamand
Faculty of Business & Management
Survey of Economics

 5 cases of Elasticity:
1. |eD| > 1: Elastic Demand
QD is greatly affected by the % change in P
P
%∆P = +10% and %∆Q= -20%
−20%
eD = +10% = |-2| > 1
Q
As P increases by 1%, QD decreases by 2%

2. |eD| < 1: Inelastic Demand

QD is slightly affected by the % change in P P
%∆P = +10% and %∆Q= -5%
−5%
eD = +10% = |-0.5| < 1
Q
As P increases by 1%, QD decreases by 0.5%

3. |eD| = 1: Unitary or Unit Elastic Demand

The % change in Q equals the % change in P
%∆P = +10% and %∆Q= -10%
−10%
eD = +10% = |-1| = 1

As P increases by 1%, QD decreases by 1%

P
4. |eD| = 0: Perfectly Inelastic Demand
QD is not affected by the % change in P
Q

5. |eD| = ∞: Perfectly Elastic Demand

A slight % change in P leads to an infinitely big % change in Q

Q
University of Balamand
Faculty of Business & Management
Survey of Economics

 Determinants of eD:

1. Nature of the good:

Necessities tend to have inelastic demand while luxuries tend to have elastic
demand (ex: business travel vs tourism).

2. Presence of substitutes:
A good with many substitutes is more elastic than a good with fewer
substitutes.
The narrower the definition of a good, the more elastic the demand will be.
(ex: general definition: car / narrow definition: BMW)

3. The relative price or the portion of income dedicated to the purchase of the
good:
The more the good is expensive (the higher the portion of income dedicated
to its purchase), the more elastic its demand will be.

4. Length of time:
In the short run, consumers don’t have enough time to react to price
changes.
In the long run, consumers have enough time to adjust their consumer
behavior.
 In the long run, elasticity is higher.

 All determinants are at play determining the eD of a good.

University of Balamand
Faculty of Business & Management
Survey of Economics

 Total Revenue and eD:

TR = P x Q = TE
TR: Total Revenue / Point of View of the Supplier
TE: Total Expenditure / Point of View of the Consumer

1. |eD| > 1
P increases => TR = P (x%) x Q (>x%) => TR

P decreases => TR = P (x%) x Q (>x%) => TR

2. |eD| < 1
P increases => TR = P (x%) x Q (<x%) => TR

P decreases => TR = P (x%) x Q (<x%) => TR

3. |eD| = 1
P increases => TR = P (x%) x Q (x%) => TR –

P decreases => TR = P (x%) x Q (x%) => TR –

University of Balamand
Faculty of Business & Management
Survey of Economics

 Income-Elasticity of Demand:
 eM shows the responsiveness of D and hence QD to a given % change in M.
%∆𝑄
 eM = %∆𝑀

 eM deals with shifts of D (while eD deals with movements along the D curve).
 The 4 formats of the formula also apply here.
 eM tells us about the nature of the good.
eM < 0 => inferior good
eM > 0 => normal good => eM > 1 Income-Elastic or Luxury
eM < 1 Income-Inelastic or Necessity

1. |eM| < 0: Inferior good

If M, people will buy less of the inferior good => D and QD
%∆𝑄 −
eM = %∆𝑀 = =-
+

2. |eM| > 0: Normal good

If M, people will have more money to spend on normal goods => D and
QD
%∆𝑄 +
eM = %∆𝑀 = =+
+

3. |eM| < 1: Necessity or Income Inelastic

If M by x%, people will decrease their consumption of necessities just a
little bit so less than x%
<𝑥%
eM = <1
𝑥%

4. |eM| > 1: Luxury or Income Elastic

If M by x%, people will start spending a lot on luxury => D and QD  by
more than x%
>𝑥%
eM = >1
𝑥%
University of Balamand
Faculty of Business & Management
Survey of Economics

 Cross-Elasticity of Demand:
 ex, y shows the responsiveness of D and QD of x to a given % change in P of y
%∆𝑄𝑥
 ex, y = %∆𝑃𝑦

 ex, y also deals with shifts of the D curve

 the 4 formats of the formula apply here
%∆𝑄𝑦
 ey, x =
%∆𝑃𝑥

 ex, y tells us about the relationship between the 2 goods

1. If ex, y > 0: x and y are substitutes

PPepsi => people will consume more Coca-Cola instead => D and QD of Coca-
Cola
%∆𝑄𝑐𝑜𝑐𝑎−𝑐𝑜𝑙𝑎 +
eCoca-Cola, Pepsi = = = +
%∆𝑃𝑝𝑒𝑝𝑠𝑖 +

2. If ex, y < 0: x and y are complements

PNescafé => people will buy less Nescafé and thus less Coffee Mate => D and
QD of Coffee Mate
%∆𝑄𝑐𝑜𝑓𝑓𝑒𝑒𝑚𝑎𝑡𝑒 −
eCoffeeMate,Nescafé = = = -
%∆𝑃𝑛𝑒𝑠𝑐𝑎𝑓é +

3. If ex, y = 0: x and y are not related or independent

PTables => nothing happens to the D or QD of cars
%∆𝑄𝑐𝑎𝑟𝑠 0
eCars,Tables = = = 0
%∆𝑃𝑡𝑎𝑏𝑙𝑒𝑠 +
University of Balamand
Faculty of Business & Management
Survey of Economics

 Price-Elasticity of Supply:
 eS shows the sensitivity of QS to a given % change in P
%∆𝑄𝑠
 eS = %∆𝑃

 the 4 formulas of the formula also apply here

 es is always + due to the law of supply => no need to take it in absolute value
when interpreting

1. eS > 1: Elastic Supply

QS is greatly affected by the % change in P

2. eS < 1: Inelastic Supply

3. eS = 1: Unitary Elastic Supply

4. eS = ∞: Perfectly Elastic Supply

A tiny change in P leads to an infinitely big change in QS

5. eS = 0: Perfectly Inelastic Supply

QS is not affected at all by any given change in P