Welcome to

Economics (MCR001)

Lecture:
A: Thursday 8.30am
B: Thursday 2.30pm
C: Thursday 6pm

UBSS Sydney CBD Campus

Level 10 & 11 233 Castlereagh Street
Sydney NSW2000

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 Economics (MCR001)

Lecture 3

Elasticity and its applications

Assistant Professor Harry TSE

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 Today’s Plan - Lecture 3 (Week 4)
♦ Announcement :
Assessment 1 (Test 1 – 20%) in Week 5 (Next week) in-class Online (45 minutes)
Please attempt Sample Test 1 on “Moodle” under the ‘Assessment Tile’.
Request: “Complements” vs “Substitutes”; “normal goods” vs “inferior goods”
Recap last week’s (S-D Model & it’s applications)

♦ Your question “Q” time :

Have you read the 5 minutes pre-class reading for “Elasticity ?
Additional Ex for D-S posted on Moodle

♦ Lecture 3 (Lecture structure:)

Part 1 : Simultaneous (Concurrent) changes in S & D (4 different scenarios) – for Advanced
students
Part 2: Own price elasticity (PED, Ep, ep); (elastic vs inelastic) & the effects on P & TR
Part 3 : Income elasticity (IED, Ey, ey); (normal goods vs inferior goods)
Part 4: Cross elasticity (CED, Exy); (substitutes vs complementary goods)
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Final Recap from Lecture 2 (The D/S Model & it’s application)
1. Differentiate between movements along the demand and supply curves and
Parallel shifts of the demand and supply curves.

2. Show and explain how non-price determinants parallel shift / change the
supply and demand curves and explain how the shifts affect price (Pe) and
quantity (Qe).

3. *Apply theoretical principals (D/S Model) to real-life case studies by

identifying non-price determinants of demand and supply in news articles and
describing the effect on the market price (Pe) and quantity (Qe) with the aid
of a diagram.

4. Are there any questions before we move on!

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 Pre-class self-revision (S-D Model)
The Supply (S) & Demand (D) Model:
Distinguish the difference between Qd & Demand (D)

If the price (P) falls from $15 per unit to $10 per unit, is it affecting the
Demand (D) or Qty demanded (Qd)?

If the weather is getting warmer, how would it affect the demand curve and
the Qty demanded (Qd) for bottle water ?

If there is a simultaneous (concurrent):

- increase in supply and a decreases in demand,
Use the S/D model to show the ultimate change in Price (P) & Qty output
(Qty).
Special Request: “Complements” & “substitutes”
♦
Use the S/D Model to show the change in D, S and therefore the new
equilibrium (Pe, Qe).

Beer & Chips

♦

If the price of beer goes up, how this would affect the demand for chips?
If the price of potatoes goes up, how this would affect the chips market?
♦

♦
Lobsters & crabs
If price of lobsters goes down, how this would affect the crabs market?

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Part 1 :

Simultaneous (Concurrent) changes in S & D (4 different scenarios)

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#3 A change in market equilibrium caused by concurrent changes in demand and
supply can be confusing ... **4 different scenarios:
1. An increase in demand and an increase in Supply ---- P ??? Q up
2. An increase in demand and a decrease in Supply --- P up, Q???
3. A decrease in demand and an increase in Supply --- Price down, Q ???
4. A decrease in demand and a decrease in Supply --- Price ???, Q down

Supply (S)
No change Increase Decrease
Demand (D)

No change P Q P Q P Q

Increase P Q ?P Q P ?Q

Decrease P Q P ?Q ?P Q

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 Class Exercise 1: Concurrent changes in S & D

Note:
Demand up (increases) -- P up & Q up
Demand down (decreases) -- P down & Q down
Supply up (increases) -- Price down & Q up
Supply down (decreases) -- Price up & Q down

What will happen to ultimate Pe and Qe?

when there is a concurrent change :
Increase in Demand & and increase in Supply

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 Class Exercise 2: Concurrent changes in S & D

What will happen to ultimate Pe and Qe?

when there is a concurrent change :

Decrease in Demand & and Increase in Supply

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 Part 2, 3 & 4: Elasticity of Demand

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Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
 Topic 3: Learning Outcomes 12

Why Should we study Elasticity?

1. Own-price elasticity (Ep , PED) helps managers understand the impact that price
changes will have on their sales (qty demand Qd) & (total) revenue (TR).

2. Income elasticity (Ey, Ei, ei , IED)can help managers understand what income groups to
target their product to.

3. Cross-price elasticity (Exy ,CED) can help managers understand who their closest
competitors are.

For advanced (accelerated) learners:

4. LO4. Price Elasticity of Supply (Es, PES). Explain and calculate the price elasticity
of supply (PES) and explain what determines the PES for a certain good.

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 1. Own-Price Elasticity (PED, Ep , ep) of Demand
♦Measured as the percentage change in quantity demanded (Qd)
of a given good, relative to a percentage change in its (own)
price, all else constant.
PED =

% △ 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑿 (𝑄𝑑)

PED = % △ 𝑃𝑟𝑖𝑐𝑒 𝑿 (𝑃 )
**PED

Or, PED (Ep ,ep ) = %ΔQx ÷ %ΔPx

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Own-Price Elasticity of Demand (PED, Ep , ep ):
Graphical Representation
P % △ 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑿 (𝑄𝑑)
PED =
% △ 𝑃𝑟𝑖𝑐𝑒 𝑿 ( 𝑃 )

**PED
A
P1

%∆P PED (Ep , ep ) = %ΔQx ÷ %ΔPx

P2 B

Q1 Q
Q2

%∆Q
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Class Exercise:
♦ If the price (P) of bananas rises by 10%, the quantity demanded (Qd) falls by 15%,

Calculate the price elasticity (PED) of bananas?

PED =

PED = = 1.5 > 1 (Price elastic)

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 Own-Price Elasticity (PED) of Demand calculation: “arc price” elasticity
(or the mid-point theorem)

**PED =

Or
**PED (Ep, ep ) = [(Q2 – Q1) ÷ (Q2 + Q1)] x [(P2 + P1) ÷ (P2 – P1)]

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Own-Price Elasticity of Demand calculation: “arc price” elasticity
(using the mid-point theorem).

Class Exercise : P1 P2 Q1 Q2 TR1 TR2

$10 $9 2 3 ?? ??

TR = P *Q
**PED (Ep, ep ) = [(Q2 – Q1) ÷ (Q2 + Q1)] x [(P2 + P1) ÷ (P2 – P1)]

*PED =
Own Price elasticity
(Ep) is Always (3 − 2) (9 +10 )
Negative ( -ve) ¿ +
( 3 +2 ) ( 9 − 10 )

PED = -- 3.8 = | 3.8 | > 1, therefore Price elastic

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 Demand is inelastic if PED < 1 and elastic if PED >
#1 1
(A) Inelastic (PED < 1) – “steep” D curve (B) Elastic (PED > 1) – “flat” D curve
P
P

P0 P0

P1 P1
D

D
Qd Qd

%ΔQD < %ΔP %ΔQD > %ΔP

PED %ΔQD PED %ΔQD

<1 >1
= %ΔP = %ΔP 1-18
 PED has important implications for:
#1 the equilibrium price (Pe) and equilibrium quantity (Qd) in a market
(refer to slide no.9)

P *Steep demand curve, P *Flat demand curve,

Price inelastic S Price elastic
S
S
1 1
2
S
2

D
Q Q
(A) Inelastic demand (B) Elastic demand 1-19
 Examples of Own-Price Elasticity (PED) 20

Class discussions :

Is it price elastic (PED (Ep) >1) or price

♦Cereal: -0.55 (absolute value 0.55) <1 (eg diet - curry powder to South-East
countries, absolute value less than 1, therefore ???
(Is cereal price elastic or price inelastic ?)

♦Fish: -0.29 (absolute value 0.29) <1 (eg for Greek, rice for Asian; therefore, is rice
price elastic or price inelastic ?)

♦GM Holden cars: -2.32 (absolute value 2.32)>1

ie plenty to substitutes, competitors (therefore for a particular brand product is price
elastic or price inelastic ?)

♦Orange juice: -1.39 (is Orange juice price elastic or price inelastic ? Why ?
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 Three special cases of the price elasticity of demand
#1 (PED)
(A) Perfectly inelastic (B) Unit elastic (C) Perfectly elastic
P P P
D

D
D

Q Q Q
%ΔQd = 0 %ΔQd = %ΔP %ΔP = 0
0 %ΔQd %ΔQd
PED =
%ΔP
=0 PED =
%ΔP
=1 PED =
0
= ∞
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 22
Other functions related to demand curve (Price curve):

♦Total revenue (TR) : price * quantity: TR = P*Q

♦Average revenue (AR) : revenue per unit of product:

AR ie price

♦Marginal revenue (MR) : change in revenue for

additional unit of product: MR

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 Own price elasticity and (total revenue TR)

♦A change in price (P) will also change the

quantity sold (Qs) and thus affect the total
revenue (TR). (TR = P x Q)

♦In which direction? ( is the TR up or TR down ? )

… (the * “Total Revenue Test”...)

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 **PED tells us how
#1 total revenue (TR) will change if price (P) changes
Total revenue
TR = P x Q

?? TR ?? = P  x Q

If P decreases then Q increases, but does TR increase or decrease?

PED tells us that if ...

**... Demand is elastic then, **... Demand is inelastic then,

a P decrease will increase TR a P decrease will decrease TR

**Note: If PED > 1, P and TR move in the opposite direction

If PED < 1, P and TR move in the same direction 1-24
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Graphical Representation of Relationship Between
Price Elasticity and Total Revenue (TR)

P TR
|ep| > 1
Elastic
part
|ep| = 1

Inelastic
part
|ep| = 1
D Elastic Inelastic
Demand Demand
Q Q Q Q
Note: When price goes down,
Price elasticity of demand decreases 1-25
Four factors determine the price elasticity of demand for a good or
service

#1 1. Essential (necessities) versus 2. Closeness of substitutes

luxurious items: (more elastic when easily
substituted),
Necessities inelastic No substitutes - inelastic
Luxurious items more elastic

3. Proportion of income 4. Time period

(High Proportion of income (SR inelastic)

more elastic and vice versa) (LR more elastic)

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 Price Elasticity of Demand
Learning #1
Outcome #1 (PED)
Can you:
Can You ? • Define and explain what is meant by PED?
To be attempted • Calculate and interpret PED?
outside class
• Classify PED as being inelastic, unit elastic or elastic?
• Draw demand curves illustrating perfect inelasticity, inelasticity,
unit elasticity, elasticity and perfect elasticity?
• Explain why PED decreases as we move down a demand curve?
• Calculate total revenue (TR) at different points on the demand curve and draw a
TR curve?
• Explain the relationship between PED and TR, and state when
price (P) should be increased or decreased to increase TR?
• List and explain the four factors that determine PED?
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2. Income Elasticity

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 Income Elasticity (IED, Ey, ei ) of Demand
(slide 22+)
♦The percentage change in the quantity demanded (Qx) of a given
good, X, relative to a percentage change in consumer income (I)(Y),
assuming all other factors constant.
IED = (Ey, ei ) = %ΔQx ÷ %ΔI (Y)
% 𝑐h𝑎𝑛𝑔𝑒 𝑄𝑥
**IED = % 𝑐h𝑎𝑛𝑔𝑒 𝐼𝑛𝑐𝑜𝑚𝑒(𝐼 , 𝑌 )

**IED =

**IED (Ey ,ey ) = [(Q2 – Q1) ÷ (Q2 + Q1)] x [(Y2 + Y1) ÷(Y2 – Y1)]
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 Normal Good
♦Good X is a normal good if the demand for good X
moves in the same direction as a change in income
(I)(Y) (income elasticity is positive).

♦eg brand shops, consumer goods, overseas holidays,

expensive restaurants, Jewelries…
♦Cream ei = + 1.72
♦Apples ei = + 1.32
♦Potatoes ei = + 0.15
Do you agree ? 1-30
Inferior Good
♦Good X is an inferior good if the demand for good X
moves in the opposite direction of a change in income
(income elasticity is negative).

Textbook example:
♦Chicken
CED (ei ) = -- 0.106
(replacing by beef, lamb, lobsters… when income rises)

What do you think ?

entertainment business, Church goers, post-graduate courses; voluntary
services, non-profitable organisations such as the Red Cross ….
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 Class exercises :
32

Income Elasticity of demand

(IED, Ey, ei ) calculation
Income ($) Good X (Qty) Good Y (Qty)
$30 000 2 20
$50 000 5 10

Using the midpoint method, calculate the income elasticity of good Y?

Is Good Y a) normal goods or b) inferior goods?

Is Good X a) normal goods or b) inferior goods ?

Explain. **IED =

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Cross-Price Elasticity
(CED, Exy , exy) of Demand
♦The percentage change in the quantity demanded of a given good B, relative to a
percentage change in the price of good A, assuming all other factors constant.

**CED = (EBA) eBA = %ΔQB ÷ %ΔPA

% 𝑐h𝑎𝑛𝑔𝑒 𝑄 𝑩
or CED = % 𝑐h𝑎𝑛𝑔𝑒 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑨

*CED =

*CED (EBA ) = [(Q B2 – QB1)÷(QB2 + QB1)] x (PA2 + PA1)÷(PA2 – PA1)]

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Substitutes
♦Two goods with a positive cross-price elasticity of demand coefficient
are said to be substitute goods. (i.e., when cross elasticity is positive) ;
eg bananas vs apples, scallops vs prawns, beef vs chicken,

Textbook example :
♦Boiler chickens and beef
eAB = 0.20
♦Boiler chickens and pork
exy = 0.28
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 Complements
♦If two goods have a negative cross-price elasticity of demand
coefficient, they are called complementary goods. (ie when cross
elasticity is negative); two goods are consumed together.

Eg: Big Mac & Coke, beer & potato chips, computer & printers, cars
& GPS, TV and Blu-Ray, Price of gasoline & cars,
Textbook example :
♦Bread and eggs
●e = - 0.03
xy
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 Class exercises : 36

Cross Elasticity of demand

(CED, exy, Exy) calculation
Price of X Price of X Qty demand for Y Qty demand for Y
(Px1) (PX2) (Qy1) (Qy2)

$2 $3 100 200

Using the midpoint method, calculate the cross elasticity (Exy) between good x
and good y?

Is Good X and good Y ?

a) substitute or b) complements good c) normal good ? d) inferior good e) price elastic f) price inelastic
Explain.

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** Class exercise: 37

♦ If the price of mutton increases from $15/kg to $18/kg, the demand for beef rises from
100 kg to 150kg while the quantity demand of mutton reduces from 50kg to 30kg.
i) Calculate the cross-elasticity for mutton & beef
ii) Therefore, mutton & beef are : a) complement b) normal goods c) substitute d) inferior
goods
iii) Calculate the price elasticity of mutton.
iv) Is mutton price elastic or inelastic ?
v) Use the S/D model to show :
a) the change in equilibrium price and quantity for the beef market
b) the change in equilibrium price and quantity for the mutton market
vi) Calculate the total revenue (TR) for mutton when the price is $15 and $18 ?
vii) Base on (vi) Can you conclude if mutton is price elastic or price inelastic ?

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Topic 4: What you need to get out from this lecture
1. Explain and calculate Price Elasticity of Demand (PED) using:
• Midpoint formula (for calculation)
• Total Revenue (TR) Test
2. Explain what determines the PED for a certain good
3. Draw elastic, inelastic, perfectly inelastic and perfectly elastic demand curves
and show how elasticity of demand affects a market where curves shift
4. Calculate and interpret cross elasticity of demand (CED)
5. Calculate and interpret income elasticity of demand (IED)
6. Explain and calculate Price Elasticity of Supply (PES)
7. Explain what determines the PES for a certain good
8. Draw elastic, inelastic, perfectly inelastic and perfectly elastic supply curves and
show how elasticity of supply affects a market where curves shift

Take notes of 1) key concepts 2) what your lecturer says where you see the symbol so
you can do the workshop after the lecture. 1-38
#2 Summary:
In addition to PED, we can also consider:
cross elasticities of demand (CED)and
income elasticities of demand (IED) (and supply)
An elasticity measures the sensitivity of one variable with respect to another

PED IED CED PES

PED PES
IED CED
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 ** PED, IED and CED (summary)

Price Elasticity (PED), Cross elasticity of demand (CED) & Income Elasticity of Demand (IED)

Value of Coefficient Description Type of Good(s)

Price elasticity Take the absolute value, | |, PED> | 1 | Price Elastic
Always Negative (PED<1) PED< | 1 | Price Inelastic
Cross elasticity: Quantity demanded of B changes in same direction Substitutes
as change in price of A
Positive + (CED > 0)
Quantity demanded of B changes in opposite Complements
Negative - (CED < 0) direction from change in price of A

Income elasticity: Quantity demanded (Qd) of the product changes in Normal or superior
same direction as change in income (Y, I)
Positive + (IED > 0)
Quantity demanded (Qd) of the product changes in Inferior
Negative - (IED < 0) opposite direction from change in income (Y, I)

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 Elasticity of Supply (PES)
For the accelerated learners:

• The elasticity of supply (PES) measures the responsiveness of the

quantity supplied (Qs) to a change in the price (P) of a good when all
other influences on selling plans remain the same.
• The elasticity of supply (PES) is calculated by using the formula:
• PES:
PES = Percentage change in quantity supplied (Qs)
Percentage change in price (P)
PES =

or PES = %DQs ÷ %DP

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The END

Materials are adapted from the following textbooks:

Farnham P G., Economics for Managers, 3rd edition, Pearson, 2021. Ch.3
Parkin M and Bade R., Microeconomics, 2nd edition, Pearson, 2020. Ch 5
Stevenson B., Wolfers J., Principles of Economics, 1st Ed, MacMillian International,
2020. Ch 5

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