CHAPTER 3

ELASTICITY

At the end of the chapter the student should be able to:

1. Measure the magnitude of market responses;
2. Understand the responsiveness of consumers and producers in markets to price changes;
3. Compute and clearly relate elasticities on the operations of supply and demand in the
market on maximizing revenues;

In the previous chapter, we were familiarized with the concept of demand and supply and
how these two forces operate in determining price over a perfectly competitive market, which
brought the existence of demand and supply curve. With the application of ceteris paribus rule
(meaning other things remain constant), we know that if the price of certain goods and services
will increase, lesser quantity of goods and services will be purchased. Similarly, if the price of
goods and services decline, more goods and services will be purchased. But the question is, “by
how much will be the extent of change?”
This chapter will tackle the different types of elasticity and its determinants, as well as
the classification of goods.

ELASTICITY

In economics, the concept of elasticity measures the responsiveness of one variable to a

certain change of another variable. Also, it is the proportional measure or percentage change in the
variables and measures the responsiveness of consumers and producers.
The basic formula used to determine elasticity is:

Percentage Change in Variable Y

𝐄𝐥𝐚𝐬𝐭𝐢𝐜𝐢𝐭𝐲 =
Percentage Change in Variable X

%∆𝑌
Using the mathematical symbol, 𝜀 = %∆𝑋

Where:
ε = Greek letter epsilon used as symbol for elasticity
∆ = letter delta, means “change”
% = percentage

DEMAND ELASTICITY

There are several factors affecting the consumers in deciding how many of the
commodity will be bought. Any change (increase or decrease) in these factors will result to a
reaction on the part of the consumer. An increase in the price (while the other factors are held
constant) will lead to a decrease in the quantity to be purchased. An increase in income of the
consumer (while other factors are held constant) will mean more quantity to be demanded for
normal commodity. The degree of the consumer’s responsiveness or reaction to changes in the
factors affecting demand is known as the demand elasticity.

Price Elasticity of Demand

The price elasticity of demand measures the responsiveness of quantity demanded with
respect to its price. Considering that an increase in the price of a good or service would result to
a decline in quantity demanded, it is expected that the price elasticity of demand is negative
because the relationship between price and quantity demanded in inversely related. However, it

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is the absolute value that is usually taken and the negative sign is omitted. The basic formula
used:

Percentage Change in Quanity Demanded

𝐏𝐫𝐢𝐜𝐞 𝐄𝐥𝐚𝐬𝐭𝐢𝐜𝐢𝐭𝐲 𝐨𝐟 𝐃𝐞𝐦𝐚𝐧𝐝 (𝛆𝐃 ) =
Percentage Change in Price
%∆𝐐𝐝
𝛆𝐃 =
%∆𝐏

When calculating the price elasticity of demand, there are two possible ways:

1. Point elasticity of demand takes the elasticity of demand at a particular point on a

demand curve (or between two points).

∆𝐐𝐝 ∆𝐐𝐝
%∆𝐐𝐝 𝐱 𝟏𝟎𝟎 ∆𝐐𝐝 𝐏 𝐐𝐝𝟐 −𝐐𝐝𝟏 𝐏
𝐐𝐝 𝐐𝐝
𝛆𝐃 = %∆𝐏
= ∆𝐏 = ∆𝐏 = ∆𝐏
𝐱 𝐐𝐝 = 𝐏𝟐 −𝐏𝟏
𝐱 𝐐𝐝𝟏
𝐱 𝟏𝟎𝟎 𝟏
𝐏 𝐏

2. Arc elasticity of demand measures the elasticity of demand at the midpoint between the
two selected points on a demand curve.

∆𝐐𝐝
𝐱 𝟏𝟎𝟎 ∆𝐐𝐝
𝐐𝐝𝟐 + 𝐐𝐝𝟏
%∆𝐐𝐝 𝟐 𝐐𝐝 𝟐 + 𝐐𝐝𝟏 ∆𝐐𝐝 𝐏𝟐 + 𝐏𝟏
Ɛ𝐃 = = = = 𝐱
%∆𝐏 ∆𝐏 ∆𝐏 ∆𝐏 𝐐𝐝𝟐 + 𝐐𝐝𝟏
𝐏𝟐 + 𝐏𝟏 𝐱 𝟏𝟎𝟎 𝐏𝟐 + 𝐏𝟏
𝟐
𝐐𝐝𝟐 − 𝐐𝐝𝟏 𝐏𝟐 + 𝐏𝟏
= 𝐱
𝐏𝟐 − 𝐏𝟏 𝐐𝐝𝟐 + 𝐐𝐝𝟏

However, using the point elasticity formula results to different answers when dealing
with large changes in price. Using the initial values of price (P1) and quantity (Q1) creates a
problem in the calculation. As the difference between the two prices or quantities increases, the
accuracy of the price elasticity of demand given decreases, it can be varied at different points
along the demand curve due to its percentage nature.
To get out the irregularity problem of having a price elasticity of demand depending on
which of the two given points on a demand curve is chosen as the “original” point and which as
the “new” one, compute the percentage change in P and Q relative to the average of the two
prices and the average of the two quantities. Thus, arc elasticity formula must be used.

Example: Using the demand schedule for notebook in Chapter 2 (Table 2.1). Let us compute the
demand elasticity for notebook using point elasticity and arc elasticity from points A
to E and E to A.

Point Price per unit Quantity Demanded per Week

A 10 120
B 15 105
C 25 75
D 30 60
E 35 45

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Solution:
Point Elasticity Arc Elasticity
Qd2 − Q d1 P1 Qd2 − Qd1 P2 + P1
εD = x εD = x
P2 − P1 Qd1 P2 − P1 Qd2 + Qd1

Point A to E 45 − 120 10 45 − 120 35 + 10 −75 45

εD = x εD = x = x
35 − 10 120 35 − 10 45 + 120 25 165
−75 10 −3375
= x εD = = │ − 0.82│ = 𝟎. 𝟖𝟐
25 120 4125
−750
εD = = │ − 0.25│
3000
= 𝟎. 𝟐𝟓
Point E to A 120 − 45 35 75 35 120 − 45 10 + 35 75 45
εD = x = x εD = x = x
10 − 35 45 −25 45 10 − 35 120 + 45 −25 165
2625 3375
εD = = │ − 2.33│ εD = = │ − 0.82│ = 𝟎. 𝟖𝟐
−1125 −4125
= 𝟐. 𝟑𝟑

Classification of Price Elasticity of Demand:

1. Elastic demand (εD > 1) - when the percentage change in quantity demanded is greater
than the percentage change in price or (%∆Qd >%∆P).
P

2. Inelastic demand (εD < 1) – when the percentage change in quantity is less than the
percentage change in price or (%∆Qd < %∆P).
Qd
P

D
Qd

3. Unitary elastic demand (εD = 1) – when the percentage change in quantity is equal to the
percentage change in price or (%∆Qd = %∆P)
P

D
Qd

4. Perfectly elastic demand (εD =∞) – without change in price will have an infinite change
on quantity demanded.

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 P

Qd

5. Perfectly inelastic demand (εD = 0) – any change in price will have no effect on quantity
demanded.

P D

Qd

Determinants of Price Elasticity of Demand:

1. The importance or degree of necessity of the goods.
2. Number of available substitutes
3. The proportion of income in price changes
4. Time period

Effect on Total Revenue

If there is a price change, it is imperative for a firm to understand what effect of such
change in price will do on total revenue.
Any change in price will create two effects:
1. The price effect. This refers to an increase in price that will result to a positive effect on
revenue, and vice versa.
2. The quantity effect. This pertains to an increase in price that will result to less quantity
sold, and vice versa.

Table 3.1 Summary of the Effects of Price Changes to the Total Revenue and Price Elasticity of
Demand
Demand Elasticities Change/s in Price Effects on Total Revenue
(TR)
Inelastic Demand increase increase
Elastic Demand increase decrease
Elastic Demand decrease increase
Inelastic Demand decrease decrease

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Elasticity in the demand curve

Income Elasticity of Demand

Quantity demanded may also change if the consumer’s income changes. Income
elasticity measures the responsiveness of quantity demanded to a change in the consumers’
income. The basic formula used is:

Percentage Change in Quanity Demanded

𝐈𝐧𝐜𝐨𝐦𝐞 𝐄𝐥𝐚𝐬𝐭𝐢𝐜𝐢𝐭𝐲 𝐨𝐟 𝐃𝐞𝐦𝐚𝐧𝐝 (𝛆𝐘 ) =
Percentage Change in Consumers′ Income
%∆𝐐𝐝
=
%∆𝐘

Mathematically, this must be computed in two ways as:

1. Point elasticity of demand

%∆Qd Qd2 − Q d1 Y1
εY = = x
%∆Y Y2 − Y1 Qd1

2. Arc elasticity of demand

%∆Qd Qd2 − Qd1 Y2 + Y1

ƐY = = x
%∆Y Y2 − Y1 Qd2 + Qd1

When the income elasticity of demand assumes a positive value, quantity demanded of
the goods increase as income increases and the good being studied is known as normal good. A
normal good may also be classified as “luxuries” or “necessities” depending on their demand
elasticities. If the income elasticity of demand is greater than 1, the good may be considered a
luxury while if income elasticity of demand is less than 1, the good may be considered a necessity.
On the other hand, if the quantity of a good falls as income increases, the income
elasticity takes a negative value and the good is called inferior good.

Table 3.2 Summary of Income Elasticity Coefficient

Type of Good Income Elasticity Coefficient
Normal good Positive elasticity (εY>0)
Inferior good Negative Elasticity (εY<0)
Normal, Luxury good Positive Elasticity greater than one (εY>1)
Normal, Necessity good Positive Elasticity less than one (εY<1)

Example: April earns a monthly salary of P15,000 and she consumes P1,000 worth of beef per
month. When her income increased by P2,500/month, she started to consume

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 P2,000/month. Is April’s demand for beef meat normal necessity, or normal luxury,
inferior?

Let: Y1 =15,000 Qd1 = 1,000

Y2 = 17,500 Qd2= 2,000

Qd2 − Qd1 Y2 + Y1 2,000 − 1,000 17,500 + 15,000 1,000 32,500

ƐY = x = x = x
Y2 − Y1 Qd2 + Qd1 17,500 − 15,000 2,000 + 1,000 2,500 3,000
= 𝟒. 𝟑𝟑

Therefore, April’s demand for beef meat is a normal, luxury good.

Cross Price Elasticity of Demand

Measures the responsiveness of quantity demanded of a good to a change in the price of
another good. The basic formula used is:

𝐂𝐫𝐨𝐬𝐬 𝐏𝐫𝐢𝐜𝐞 𝐄𝐥𝐚𝐬𝐭𝐢𝐜𝐢𝐭𝐲 𝐨𝐟 𝐃𝐞𝐦𝐚𝐧𝐝 (𝛆𝐗𝐘 )

Percentage Change in Quanity Demanded for Good X %∆𝐐𝐝𝐗
= =
Percentage Change in the Price for Good Y %∆𝐏𝐘

Mathematically, this must be computed in two ways as:

1. Point elasticity of demand

%∆Qd𝑋 QdX2 − Q dX1 PY1

εXY = = x
%∆P𝑌 PY2 − PY1 QdX1

2. Arc elasticity of demand

%∆Qd𝑋 QdX2 − Q dX1 PY2 + PY1

εXY = = x
%∆P𝑌 PY2 − PY1 QdX2 + Q dX1

A good is considered as a complementary good when the result of cross price elasticity
of demand is negative (ƐXY < 0) while, a good is considered as a substitute good when the result
of cross price elasticity of demand is positive (ƐXY > 0).

Example:

Table 3.3 Cross Price Elasticity of Substitute Good

Commodity Before After
Price Quantity Price Quantity
Beef (X) 150 15 150 25
Chicken (Y) 120 20 140 40

QdX2 − Q dX1 PY2 + PY1 25 − 15 140 + 120 10 260

εXY = x = x = x = 𝟑. 𝟐𝟓
PY2 − PY1 QdX2 + Q dX1 140 − 120 25 + 15 20 40

Therefore, beef and chicken are both substitute goods.

Table 3.4 Cross Price Elasticity of Complementary Good

Commodity Before After
Price Quantity Price Quantity
Computer (Y) 6,000 450 10,000 300
CD-ROM (X) 1,500 140 1,500 100

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 QdX2 − Q dX1 PY2 + PY1 100 − 140 10,000 + 6,000 −40 16,000
εXY = x = x = x
PY2 − PY1 QdX2 + Q dX1 10,000 − 6,000 100 + 140 4,000 240
= −𝟎. 𝟔𝟕

Therefore, computer and CD-ROM are both complementary goods.

SUPPLY ELASTICITY
Price Elasticity of Supply
Measures the responsiveness of quantity supplied in response to a percentage change in
the price of a good. The basic formula used is:

Percentage Change in Quanity Supplied %∆𝐐𝐬

𝐏𝐫𝐢𝐜𝐞 𝐄𝐥𝐚𝐬𝐭𝐢𝐜𝐢𝐭𝐲 𝐨𝐟 𝐒𝐮𝐩𝐩𝐥𝐲 (𝛆𝐒 ) = =
Percentage Change in Price %∆𝐏

When calculating price elasticity of supply, there are two possible ways:

1. Point elasticity of supply takes the elasticity of supply at a particular point on a supply
curve (or between two points).

∆𝐐𝐬 ∆𝐐𝐬
%∆𝐐𝐬 𝐱 𝟏𝟎𝟎 ∆𝐐𝐬 𝐏 𝐐𝐬𝟐 −𝐐𝐬𝟏 𝐏𝟏
𝐐𝐬 𝐐𝐬
𝛆𝐒 = = ∆𝐏 = ∆𝐏 = 𝐱 = 𝐱
%∆𝐏 𝐱 𝟏𝟎𝟎 ∆𝐏 𝐐𝐬 𝐏𝟐 −𝐏𝟏 𝐐𝐬𝟏
𝐏 𝐏

2. Arc elasticity of supply measures the elasticity of supply at the midpoint between the
two selected points on a supply curve.

∆𝐐𝐬
𝐐𝐬𝟐 + 𝐐𝐬𝟏 𝐱 𝟏𝟎𝟎 ∆𝐐𝐬
%∆𝐐𝐬 𝟐 𝐐𝐬 𝟐 + 𝐐𝐬𝟏 ∆𝐐𝐬 𝐏𝟐 + 𝐏𝟏 𝐐𝐬𝟐 − 𝐐𝐬𝟏 𝐏𝟐 + 𝐏𝟏
Ɛ𝐒 = = = = 𝐱 = 𝐱
%∆𝐏 ∆𝐏 ∆𝐏 ∆𝐏 𝐐𝐬𝟐 + 𝐐𝐬 𝟏 𝐏𝟐 − 𝐏𝟏 𝐐𝐬𝟐 + 𝐐𝐬𝟏
𝐏𝟐 + 𝐏𝟏 𝐱 𝟏𝟎𝟎 𝐏𝟐 + 𝐏𝟏
𝟐

Example: Using the supply schedule for notebook in Chapter 2 (Table 2.2). Let us compute the
supply elasticity for notebook using point elasticity and arc elasticity from points A
to E and E to A.

Point Price per unit Quantity Supplied per Week

A 10 60
B 15 65
C 25 75
D 30 80
E 35 85
Solution:
Point Elasticity Arc Elasticity
Qs2 − Qs1 P1 Qs2 − Qs1 P2 + P1
εS = x εS = x
P2 − P1 Qs1 P2 − P1 Qs2 + Qs1

Point A to E 85 − 60 10 25 10 85 − 60 35 + 10 25 45
εD = x = x εD = x = x
35 − 10 60 25 60 35 − 10 85 + 60 25 145
250 1125
εD = = 𝟎. 𝟏𝟕 εD = = 𝟎. 𝟑𝟏
1500 3625

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 Point E to A 60 − 85 35 −25 35 60 − 85 10 + 35 −25 45
εD = x = x εD = x = x
10 − 35 85 −25 85 10 − 35 60 − 85 −25 165
−875 −1125
εD = = 𝟎. 𝟒𝟏 εD = = 𝟎. 𝟑𝟏
−2125 −3625

Classification of Price Elasticity of Supply:

1. Elastic supply (εS >1) - a percentage change in quantity supplied is greater than the
percentage change in price.
P

2. Inelastic supply (εS<1) – a percentage change in quantity supplied is less than the
percentage change in price. Qs
P
S

Qs

3. Unitary elastic supply (εS=1) – a percentage change in price is equal to a percentage

change in quantity supplied.
P

Qs

4. Perfectly elastic supply (εS=∞) – without change in price, an infinite change occurs in
quantity supplied.
P

Qs

5. Perfectly inelastic demand (ε=0) – any change in price creates no change in quantity
supplied.
P
S

Qs

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Determinants of Price Elasticity of Supply

1. Monetary or intermediate – in this period supply will be perfectly inelastic and supply is
fixed.
2. Short-run – in this state supply in inelastic. The output of production can increase even
if equipment is fixed.
3. Long-run – in this period, supply is elastic. New firms are expected to enter or the old
one may leave the industry.

References

Bello, Amelia L. et al. 2009. Economics. C and E Publishing, Inc.

Case, Karl E.; Fair, Ray C. 2005. 7TH Edition. Principles and Foundations of Economics.
Pearson Education, Inc.

Gabay, Bon Kristoffer G. et al. 2007. 1st Edition. Economics: Its Concepts and Principles (with
Agrarian Reform and Taxation). Rex Book Store.

Sexton, Robert L. 2005. 3rd Edition. Exploring Economics. South-Western, Thompson

Corporation.

Silon, Elsa T. et al. 2009. Manual for Economics with Work Exercises.

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 Exercise No. 3
ELASTICITY CONCEPT

Name: _______________________________________ Score: __________________

Yr/Crs/Sec: ___________________________________ Date: ___________________

TRUE OR FALSE.
Instruction: Write the word TRUE if the given statement is correct and FALSE, if otherwise.
________1. Price elasticity of demand measures responsiveness of buyers to changes in
prices.
________2. If the demand for a good is of unitary elasticity, the same amount of money is
spent on it regardless of its price.
________3. Inelastic price demand elasticity results when the percentage change in
quantity
demanded is greater than the percentage change in price.
________4. The income elasticity measures the response of the consumers to changes in
the
income.
________5. If the cross price elasticity results to a negative sign, the two goods are said to
be complements.
________6. If the supply is perfectly inelastic, a change in the price has no effect on the
quantity supplied.
________7. Increasing the price of a commodity with inelastic demand will increase profit.
________8. Price supply elasticity measures the seller’s reaction to a change in the price of a
product.
________9. Price demand elasticity for luxury goods tends to be elastic.
________10. A vertical line represents perfectly inelastic demand.

PROBLEM SOLVING
Instruction: Instruction: Answer the following problems and box your final answer.
1. The income of Mr. FG Garcia increased from Php600 to Php900 a day. His demand for
grocery items increased from 300 to 450. Compute for the income elasticity of demand of
Mr. FG Garcia and identify what kind of good.
2. Compute for the cross price elasticity of the following commodities:

Commodity Before After

Price/Unit Quantity Price/Unit Quantity
Printer 5,000 2,000 5,500 1,500
Ink 1,500 1,100 1,500 900

3. Compute for the price elasticity of supply of the following points on the supply schedule.
a. Points A –C c. Points E – F
b. Points C – E d. Points A – F

Points Price Quantity Supplied

A 2 70
B 5 63
C 8 60
D 13 58
E 15 54
F 19 51
G 20 45

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