ELASTICITY CONSUMPTION • Competitive Dynamics – Goods that can only be

produced by one supplier generally have inelastic

Elasticity is an economic concept that measures the demand, while products that exist in a competitive
responsiveness of one variable to changes in another marketplace have elastic demand. This is because
variable. Elasticity explains how much one variable, say a competitive marketplace offers more options for
sales numbers, will change in response to another variable, the buyer.
like the price of the product. In economics, when we talk Examples of Inelastic Demand
about elasticity, we’re referring to how much something will • Gasoline – The demand for gasoline generally is
stretch or change in response to another variable. fairly inelastic, especially in the short run. Car travel
requires gasoline. The substitutes for car travel offer
ELASTICITY OF DEMAND less convenience and control.
Let’s think about elasticity in the context of price and • Specialty Coffee Drinks – Many coffee shops have
quantity demanded. While the law of demand does tell us developed branded drinks and specialized
that more of a good will be bought at a lower price, it does experiences in order to reduce substitutes and build
not tell us how much the quantity demanded will increase customer loyalty.
because of the price change. If a small change in price Examples of Elastic Demand
creates a large change in the quantity demanded, then we • New Textbook Distribution Channels – Increasingly,
would say that the demand is very elastic—that is, the students have new options to buy the same
demand is very sensitive to a change in price. If, on the other textbooks from different distribution channels at
hand, a large change in price results in a very small change different price points. These include textbook rentals
in demand in the quantity demanded, then we would say the and digital versions of the text.
demand is inelastic. As we will see later, elastic and inelastic • Airline Tickets – Airline tickets are sold in a fiercely
are relative concepts. Here’s a way to keep this straight: competitive market. Buyers can easily compare
demand is inelastic when consumers are insensitive to prices, and buyers experience the services provided
changes in price. by competitors as being very similar.
Examples of Elastic and Inelastic Demand
• Substitutes – Price elasticity of demand is CATEGORIES OF ELASTICITY
fundamentally about substitutes. If it’s easy to find a Elasticity
substitute product when the price of the product • It refers to the responsiveness of economic
increases, the demand will be more elastic. If there variables
are few or no alternatives, demand will be less • It describes the responsiveness as (relatively)
elastic. elastic or (relatively) inelastic.
• Necessities vs. Luxuries – A necessity is something • It also described as perfectly elastic or perfectly
you absolutely must have, almost regardless of the inelastic.
price. A luxury is something that would be nice to There are 3 main ranges of elasticity measurements that
have, but it’s not absolutely necessary. Consider the correspond to different parts of linear demand curve:
elasticity of demand for cookies. A buyer may enjoy 1. Elastic – when the computed elasticity is greater
a cookie, but it doesn’t fulfill a critical need the way than 1, demand is considered elastic, reflecting a
a snow shovel after a blizzard or a life-saving drug high responsiveness to changes in price.
does. In general, the greater the necessity of the 2. Inelastic – if the computed elasticity is less than 1,
product, the less elastic, or more inelastic, the demand is considered inelastic, indicating low
demand will be, because substitutes are limited. responsiveness to price changes.
The more luxurious the product is, the more elastic 3. Unitary – indicate a proportional responsiveness of
demand will be. demand, meaning that the percentage change in
• Share of Consumers Budget – If a product takes up quantity demanded is equal to the percentage
a large share of a consumer’s budget, even a small change in price, resulting in an elasticity equals 1.
percentage increase in price may make it These ranges are summarized in the table below. Three
prohibitively expensive to many buyers. Take rental categories of elasticity: elastic, inelastic, and unitary.
housing that’s located close to downtown. Such And it’s
If Then
housing might cost half of one’s budget. A small called
percentage increase in rent could cause renters to % change in quantity > %
Computed Elasticity > 1 Elastic
relocate to cheaper housing in the suburbs, rather change in price
than reduce their spending on food, utilities, and % change in quantity = %
Computed Elasticity = 1 Unitary
other necessities. change in price
• Short Run vs. Long Run – Price elasticity of % change in quantity < %
Computed Elasticity < 1 Inelastic
demand is usually lower in the short run, before change in price
consumers have much time to react, than in the
long run, when they have greater opportunity to find POLAR CASES OF ELASTICITY
substitute goods. Thus, demand is more price There are also 2 extreme cases of elasticity: when
elastic in the long run than in the short run. computed elasticity equals zero and when it’s infinite.
 A perfectly (or infinitely) elastic demand curve is an Note that if we used the point approach, the calculation
extreme case in which the quantity demanded (Qd) would be:
increases by an infinite amount in response to any decrease 103 − 100
= 3%
in price at all. 100
Similarly, quantity demanded drops to zero for any This produces nearly the same result as the slightly
increase in the price. While it’s difficult to think of real-world more complicated midpoint method (3% vs. 2.96%). If you
example of infinite elasticity, it will be important when we need a rough approximation, use the point method. If
study perfectly competitive markets. It’s a situation where you need accuracy, use the midpoint method.
consumers are extremely sensitive to changes in price. For Say, because a product’s price decreases from $10 to
instance, if the price of cruises to the Caribbean decreases, $8, the quantity demanded increases from 40 units to 60
everyone would buy tickets (quantity demanded increases to units.
infinity), while if the price increases, not a single person 60 − 40
40 0.5
would be on the boat (quantity demanded decreases to 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 = = = −2.5%
8 − 10 −0.2
zero). Perfectly elastic demand is an “all or nothing” 10
scenario! Now, let’s use the same data but with a different starting
While perfectly inelastic is an extreme case, necessities point. Assume that the price increases from $8 to $10, and
with no close substitutes are likely to have highly inelastic the quantity demanded decreases from 60 to 40. Then the
demand curves. point elasticity of this case is:
This is especially true for life-saving prescription drugs, 40 − 60
60 −0.33
such as insulin needed by patients with kidney failure to stay = = −1.32%
10 − 8 0.25
alive. In such cases, a specific quantity insulin is prescribed 8
to the patient. If the price of insulin decreases, the patient
can’t stock up and save it for the future. If the price of insulin CALCULATING PRICE ELASTICITIES USING THE
increases, the patient will continue to purchase the same MIDPOINT FORMULA
quantity needed to stay alive. Perfectly inelastic demand Calculating the price elasticity of demand requires a
means that quantity demanded remains the same when price simple formula. However, the calculation produces the same
increases or decreases. Consumers are completely results when you apply it to multiple points on a demand
unresponsive to changes in price. curve. With elasticity midpoint, however, you can calculate
price elasticities accurately by calculating the elasticity
TWO GENERAL METHODS FOR CALCULATING midpoint, you can better understand outcomes from changes
ELASTICITIES: in demand. Then you can identify the optimal level of
1. The point elasticity approach demand.
2. The midpoint (or arc) elasticity approach Elasticity midpoint formula with the midpoint method,
Point elasticity is the price elasticity of demand at a elasticity is much easier to calculate because the formula
specific point on the demand curve instead of over a range of reflects the average percentage change of price and
it. While Arc elasticity of demand measures elasticity quantity. In the formula below, Q reflects quantity, and P
between two points on a curve—using a mid-point between indicates price:
the two curves. The point approach uses the initial price and 𝑄2 − 𝑄1
initial quantity to measure percent change. This makes the 𝑄2 + 𝑄1
2
math easier, but the more accurate approach is the midpoint 𝑃2 − 𝑃1
approach, which uses the average price and average 𝑃2 + 𝑃1
quantity over the price and quantity change. 2
Problem: When using the elasticity of demand midpoint formula,
Katherine advertises to sell cookies for $4 a dozen. She it’s important to remember that the resulting number always
sells 50 dozen, and decides that she can charge more. She appears negative. This outcome happens because by
raises the price to $6 a dozen and sells 40 dozen. What is nature, price and quantity adjust in opposite directions. To
the elasticity of demand? This tells us that it would take a compensate for this issue, take the absolute value of the
relatively large price change in order to cause a relatively calculation.
small change in quantity demanded. In other words, Greater price elasticity means a more significant change
consumer responsiveness to a change in price is relatively in demand as the price adjusts. For example, when an item
small. has a higher price, shoppers may be more responsive—i.e.
Let’s compare the two approaches. Suppose the less likely to buy—as the price increases more. Along the
quantity demanded of a product was 100 at one point on the same lines, lower price elasticity means a smaller change in
demand curve, and then it moved to 103 at another point. demand as the price adjusts. For example, when an item has
The growth rate, or percentage change in quantity a lower price, shoppers may be less responsive to
demanded, would be the change in quantity demanded incremental price increases. That means they may reflect
divided by the average of the two quantities demanded. similar levels of demand at low price points.
In other words, the growth rate: Example 1:
103 − 100 3 Use these data points for the example:
= = 0.0296 = 2.96% Q1: 500
103 + 100 101.5
2 Q2: 100
P1: $1
 P2: $10
Then use the standard formula to calculate the price 60%
= =2
elasticity from point 2 to point 1: 30%
100 − 500 As the price elasticity of supply equals 2, it means that a
100 + 500 change in the price of chocolate bars changes the quantity
2
10 − 1 supplied for chocolate bars by twice as much.
10 + 1
2 INCOME ELASTICITY, CROSS PRICE ELASTICITY &
−1.33
= = −0.81% OTHER TYPES OF ELASTICITIES
1.64
The absolute value of the result is 0.81, which is
between zero and one. That means in this case, the price Income Elasticity of Demand
elasticity is inelastic, and there isn’t a significant change in The income elasticity of demand is the percentage
demand as the price adjusts. change in quantity demanded divided by the percentage
For another example, consider the following data points: change in income
% ∆ 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝐷𝑒𝑚𝑎𝑛𝑑𝑒𝑑
Q1: 10 𝐼𝑛𝑐𝑜𝑚𝑒 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝐷𝑒𝑚𝑎𝑛𝑑 =
% ∆ 𝐼𝑛𝑐𝑜𝑚𝑒
Q2: 100
Example:
P1: $1
Roy’s monthly income rises due to a 10% salary
P2: $10
increase. He decides to purchase some small domestic
Then use the elasticity midpoint formula:
appliances and increases his spending in a particular month
100 − 10
100 + 10 by 20%.
2 20%
10 − 1 = =2
10%
= 10 + 1
2 • Normal goods refer to those goods whose demand
1.64 increases when people’s incomes start to increase,
= = 1%
1.64 giving it a positive income elasticity of demand.
In this case, the value is zero, which reflects a neutral or Normal goods include products such as imported
unitary price elasticity. There is virtually no change in beer, household appliances, quality of clothing, etc.
demand as the price adjusts. • Inferior goods refer to those goods whose demand
decreases with an increase in income, giving it a
PRICE ELASTIC OF SUPPLY negative income elasticity of demand. Inferior
The price elasticity of supply measures how much goods include products such as cheap wine,
quantity supplied changes in response to a change in the discount clothing, canned goods, etc.
price. The calculations and interpretations are analogous to
• Complement goods are goods that are consumed
those we explained above for the price elasticity of demand.
jointly or in joint demand. Examples are mobile
The only difference is we are looking at how producers
phones and sim cards, car and fuels, and
respond to a change in the price instead of how consumers
toothbrush and toothpaste.
respond.
• Substitute goods are goods that consumers
Price elasticity of supply is the percentage change in the
consider to be identical or similar enough for
quantity of a good or service supplied divided by the
interchangeable consumption. Examples are butter
percentage change in the price. Since this elasticity is
or margarine, coke or pepsi, and coffee or tea.
measured along the supply curve, the law of supply holds,
and thus price elasticities of supply are always positive
Cross-Price Elasticity of Demand
numbers. We describe supply elasticities as elastic, unitary
The term “cross-price” refers to the idea that the price of
elastic and inelastic, depending on whether the measured
one good is affecting the quantity demanded of a different
elasticity is greater than, equal to, or less than one.
good. Specifically, the cross-price elasticity of demand is the
Formula:
percentage change in the quantity of good A that is
% ∆ 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑆𝑢𝑝𝑝𝑙𝑖𝑒𝑑
𝑃𝑟𝑖𝑐𝑒 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑆𝑢𝑝𝑝𝑙𝑦 = demanded as a result of a percentage change in the price of
% ∆ 𝑃𝑟𝑖𝑐𝑒
good B.
Example:
𝐶𝑟𝑜𝑠𝑠 − 𝑃𝑟𝑖𝑐𝑒 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝐷𝑒𝑚𝑎𝑛𝑑
Let’s assume that the price of a chocolate bar increases
% ∆ 𝑖𝑛 𝑄𝑑 𝑜𝑓 𝑝𝑜𝑖𝑛𝑡 𝐴
from $1 to $1.30. In response to the price increase of the =
% ∆ 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑝𝑜𝑖𝑛𝑡 𝐵
chocolate bar, firms increased the number of chocolate bars
• Substitute goods have positive cross-price
produced from 100,000 to 160,000.
elasticities of demand: if good A is a substitute for
To calculate the price elasticity of supply for chocolate
good B, like coffee and tea, then a higher price for B
bars, let’s first calculate the percentage change in quantity
will mean a greater quantity of A consumed.
supplied.
160,000 − 100,000 60,000 • Complement goods have negative cross-price
% ∆ 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = = = 60% elasticities: if good A is a complement for good B,
100,000 100,000
like coffee and sugar, then a higher price for B will
Now let’s calculate the percentage change in price. mean a lower quantity of A consumed.
1.30 − 1 0.30 Example
% ∆ 𝑃𝑟𝑖𝑐𝑒 = = = 30%
1 1
 The price of Crest toothpaste goes up by 5%, leading to revenue depends on the market where products are sold and
a contraction of demand. Consumers switch to Colgate produced.
toothpaste, causing an outward shift in the demand curve Formula: Total Revenue = Quantity × Price (TR = Q × P)
and an increase in the quantity demanded by 20%. The number of units you determine here provides the
20% total revenue when you multiply it by the average cost of
= =4
5% your products.
If the goods are substitutes, their cross-price elasticity
of demand is going to be positive.
If the goods are complements, their cross-price
elasticity of demand is going to be negative.

INTRODUCTION TO PRICE ELASTICITY AND TOTAL

REVENUE
The elasticity of demand tells the suppliers how their
total revenue will change if their price changes. Total revenue
equals total quantity sold multiplied by price of good.
Total revenue along a demand curve:
With elastic demand – a rise in price lowers total
revenue and TR increases as price falls.
With inelastic demand – a rise in price increases total
revenue and TR decreases as price falls.

Price elasticity refers to the extent to which changes in

price affect the demand for a product. In other words, it
measures the responsiveness of consumers to changes in
the price of a product. If a product is price elastic, a small
change in price will result in a large change in the demand
for that product.
Why price elasticity is important?
• Price elasticity is the measure of the market’s
response to price changes. Elasticity is important to
pricing decisions because it helps us understand
whether raising prices or lowering prices will enable
us to achieve our pricing objectives.
• Price elasticity measures the responsiveness of the
quantity demanded or supplied of a good to a
change in its price. It is computed as percentage
% ∆ 𝑄𝑑 𝑜𝑟 𝑄𝑠
quantity as: % ∆ 𝑝𝑟𝑖𝑐𝑒
• Price elasticity can vary greatly depending on the
product and the market. For example, necessities
such as food and medicine tend to have low price
elasticity, while luxury products items may have high
price elasticity.
Example of Price Elasticity:
Fast food is another price elastic product example
because it is a discretionary expense that people can easily
avoid if the price becomes too high. When the cost of fast
food increases, consumers may choose to cook at home or
option for cheaper alternatives.

Total revenue in economics refers to the total receipts

from sales of a given quantity of goods or services. It is the
total income of a business and is calculated by multiplying
the quantity of goods sold by the price of the goods. Total
revenue, also known as gross revenue, is the amount of
money your business generates from selling your products or
services during a fixed period.
Total revenue is an important concept in Economics that
refers to the total amount of money that a company earns
through the selling of its goods and services, over a time
period (a day, week, month, or year). The nature of total