Equilibrium & Elasticity

Economics 11B
Topic: Equilibrium in the Market

In the market, equilibrium occurs at the intersection of the demand and supply curves. It is
where demand is equal to supply.
The intersection of DD and SS shows equilibrium, indicated by the point e. The corresponding
price at e is the equilibrium price (Pe) and the corresponding quantity is the equilibrium quantity
(Qe), or the amount traded. The equilibrium price is $3 and, at this price, the quantity 100 kg of
bananas is traded. It is also called the market-clearing price. At that price, all that is produced for
sale is sold. There is no surplus and no unsatisfied demand or shortage. In the example, 100 kg of
bananas are produced and bought up at a price of $3.
At prices above the equilibrium price, quantity supplied exceeds quantity demanded. A surplus is
said to occur. A surplus occurs when there is excess supply at the prevailing price. At a price of
$4, there is a surplus of 100 kg of bananas. At prices below the equilibrium price, quantity
demanded exceeds quantity supplied. A shortage is said to occur. A shortage occurs when there
is excess demand in the market at the prevailing price. At a price of $2, there is a shortage of 80
kg bananas.
The Third Law of Demand and Supply states that:
I. An increase in demand, ceteris paribus, will tend to increase both equilibrium price
and the equilibrium quantity traded; and
II. A decrease in demand, ceteris paribus, will tend to decrease both equilibrium price
and the equilibrium quantity traded.
The Fourth Law of Demand and Supply states that:
I. An increase in supply, ceteris paribus, will tend to lower equilibrium price and
increase the equilibrium quantity traded; and
II. A decrease in supply, ceteris paribus, will tend to increase equilibrium price and
lower the equilibrium quantity traded.
Topic: Elasticity
Price elasticity of demand (PED) measures the responsiveness of quantity demanded to a
change in the price of the good.
For example, if the price of butter falls, the quantity demanded will rise. What elasticity of
demand attempts to predict is the amount by which the quantity demanded will rise. How
responsive is quantity demanded to this fall in price? Will quantity demanded be very responsive
or not responsive at all?
Let us continue with the butter example. Say that, when the price of a 500 g tub of butter is $10,
the quantity demanded is 8 tubs. Then, if price increases to $12, the quantity demanded falls to 6
tubs. The information is summarised in Table 11.1.
In both examples, the elasticity coefficient is negative. In the first example, prices rose and
quantity demanded fell. This made the percentage change in quantity demanded negative. This,
in turn, caused the elasticity coefficient to be negative. In the second example, price fell. This
made the percentage change in price negative even though the percentage change in quantity
demanded was positive (representing an increase). The fall in price led to a negative elasticity
coefficient.
We can therefore conclude that the price elasticity of demand coefficient will always be negative
once there is a negative or inverse relationship between price and quantity demanded. Every time
price falls, the percentage change in price will be negative, leading to a negative elasticity
coefficient. The percentage change in quantity demanded will be positive. Every time price rises,
quantity demanded will fall and the percentage change in quantity demanded will be negative,
leading to a negative elasticity coefficient.
Topic: Degrees of Elasticity of demand
The degree of elasticity describes how responsive quantity demanded is to changes in price. It is
the range of possible elasticity of demand coefficients for a good or service. If quantity
demanded is very responsive to a change in price, quantity demanded is elastic. If quantity
demanded is very unresponsive to changes in price, quantity demanded is inelastic.
Figure 11.1 represents perfectly inelastic demand. Price increases from P to P1 (or decreases
from P1 to P) and quantity demanded remains the same, at Q. Quantity demanded is therefore
totally unresponsive to changes in price. PED is equal to zero.
Figure 11.2 represents fairly inelastic demand. Price increases from P to P1 (or decreases from
P1 to P) and quantity demanded decreases (increases) by a less than proportionate amount.
Quantity demanded is therefore not very responsive to changes in price.
Figure 11.3 represents unitary elasticity. Price increases from P to P1 (or decreases from P1 to P)
and quantity demanded decreases (increases) by the same proportion. Quantity demanded
therefore responds to price by the same proportion as the change in price.
Figure 11.4 represents fairly elastic demand. Price increases from P to P1 (or decreases from P1
to P) and quantity demanded decreases (increases) by a more than proportionate amount.
Quantity demanded is therefore fairly, or even very responsive to changes in price.
Figure 11.5 represents perfectly elastic demand. Quantity demanded changes (Q to Q1 ) without
there being a change in price. Quantity demanded therefore changes totally irrespective of
changes in price.
Factors affecting price elasticity of demand
 Price of the good.
 Number and closeness of substitutes for the commodity.
 Price of the commodity as a percentage of total expenditure.
 Adjustment time.
 Habit
 The degree of necessity of the good.
 The number of uses of the good.
 The definition of the good.
Topic: Income Elasticity of Demand

Income elasticity of demand (YED) measures the responsiveness of quantity demanded to a
change in income. The formula for income elasticity of demand is:
Normal goods are goods the demand for which increases as income increases, and vice versa.
Topic: Cross Elasticity of Demand

Cross elasticity of demand (XED) measures the responsiveness of quantity demanded of one
good to a change in the price of another good.
Example One
Example Two
Topic: Price Elasticity of Supply
Price elasticity of supply (PES) measures the responsiveness of quantity supplied to a change in
price of the good.
Degrees of Elasticity of Supply

 A perfectly vertical supply curve has a price elasticity of demand of zero, perfectly
inelastic – supply curve 1 in Figure 11.6.
 If the supply curve starts from the quantity axis, price elasticity of supply is inelastic –
supply curve 2.
 Any supply curve that starts from the origin has a unitary price elasticity of supply –
supply curves labelled 3.
 If the supply curve starts from the price axis, price elasticity of supply is elastic – supply
curve 4.
 A perfectly horizontal supply curve has a price elasticity of supply of infinity, perfectly
elastic – supply curve 5.
Example

Equilibrium & Elasticity

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Economics 11B

Topic: Equilibrium in the Market

Topic: Income Elasticity of Demand

Topic: Cross Elasticity of Demand

Degrees of Elasticity of Supply

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