Applied Economics B1

Elasticities
of Demand of Supply
We have learned how demand and supply
respond to changes in their determinants.
Goods, however, differ in terms of how
demand and supply respond to changes in
these determinants.
The degree of their response to a change is
referred to as Elasticity.
“It is a measure of how much buyers and

sellers respond to changes in market
conditions.”
The Coefficient of Elasticity is the number
obtained when the percentage change in
demand is divided by the percentage
change in the determinants.
In terms of how responsive demand and
supply are, degrees of elasticity may
either be:
ELASTIC
A change in a determinant will lead to a proportionately
greater change in demand or supply. The absolute value of
the coefficient of elasticity is >1.
“If the price of LPG increases by 10% and as a result

the quantity demanded goes down by 12%, then we say
that the demand for LPG is elastic”
INELASTIC
A change in a determinant will lead to a proportionately
lesser change in demand or supply. The absolute value of
the coefficient of elasticity is <1.
“Suppose the price of cellphone load goes up to 5% and

the quantity demanded goes down by 3%, then we say
that the demand for cellphone load is inelastic”
UNITARY ELASTIC
A change in a determinant will lead to a proportionately equal
change in demand or supply. The absolute value of the
coefficient of elasticity is =1.
“The price of of string beans goes down by 6% and as a

result the quantity demanded goes down by 6% also, we
describe the demand for string beans as unitary elastic.”
There are three main factors that
influence a demand's price
elasticity:
THE AVAILABILITY OF
SUBSTITUTES
This is probably the most important factor influencing
the elasticity of a good or service. In general, the more
substitutes, the more elastic the demand will be.
“if the price of a cup of coffee went up by Php1 consumers could replace their
morning caffeine with a cup of tea. This means that coffee is an elastic good because
an increase in its price will cause a large decrease in demand as consumers start
buying more tea instead of coffee.”
“However, if the price of caffeine were to go up as a whole, we would probably see

little change in the consumption of coffee or tea because there are few substitutes for
caffeine. Most people are not willing to give up their morning cup of caffeine no
matter what the price. We would say, therefore, that caffeine is an inelastic product
because of its lack of substitutes. Thus, while a product within an industry is elastic
due to the availability of substitutes, the industry itself tends to be inelastic.”
AMOUNT OF INCOME
AVAILABLE TO SPEND ON THE
GOOD
This factor affecting demand elasticity refers to how
much a person can spend on a particular good or service.
“If the price of a can of Coke goes up from Php10 to Php20 and
income stays the same, the income that is available to spend on coke,
which is Php40, is now enough for only two rather than four cans of
Coke. In other words, the consumer is forced to reduce his or her
demand of Coke.
Thus if there is an increase in price and no change in the amount of

income available to spend on the good, there will be an elastic
reaction in demand; demand will be sensitive to a change in price if
there is no change in income.”
TIME
“If the price of cigarettes goes up Php40 per pack, a smoker with very few
available substitutes will most likely continue buying his or her daily
cigarettes. This means that tobacco is inelastic because the change in price
will not have a significant influence on the quantity demanded.
However, if that smoker finds that he or she cannot afford to spend the extra
Php40 per day and begins to kick the habit over a period of time, the price
elasticity of cigarettes for that consumer becomes elastic in the long run.”
Types of
Elasticity of Demand
PRICE ELASTICITY OF
DEMAND
This measures the responsiveness of demand to a change
in the price of the good. The concept of elasticity is
measured in percentage changes. It can be measured in
two ways:
ARC ELASTICITY
The value of elasticity is computed by choosing two points on the demand curve and
comparing the percentage changes in the quantity and the price on those two points.
Where:
Q2= new quantity demanded
Q1= original quantity demanded
P2= new price of the good
P1= original price of the good
Example:
Chicken sells at a price of Php170/kg. An increase in its price by 10%
causes the demand to decrease from 10 to 7 kgs. per month.
Where:
POINT ELASTICITY
Measures the degree of elasticity on a single point on the demand curve. Changes on
a single point are infinitesimally small.
Where:
Example:
Chicken sells at a price of Php170/kg. An increase in its price by 10%
causes the demand to decrease from 10 to 7 kgs. per month.
Where:
INCOME ELASTICITY OF DEMAND
The percentage change in the quantity demanded compared to the percentage change in income.
It can be seen that if price increases while income stays the same, demand will decrease. It follows,
then, that if there is an increase in income, demand tends to increase as well. The degree to which
an increase in income will cause an increase in demand is called income elasticity of demand,
which can be expressed in the following equation:
Where: .
I2= new price of the good
I1= original price of the good
INCOME ELASTICITY OF DEMAND
If EDy is greater than one, demand for the item is considered to have a high
income elasticity. If however EDy is less than one, demand is considered to
be income inelastic. Luxury items usually have higher income elasticity
because when people have a higher income, they don't have to forfeit as
much to buy these luxury items. Let's look at an example of a luxury good:
air travel.
Example:
Bob has just received a Php10,000 increase in his salary, giving him a total of Php80,000 per
annum. With this higher purchasing power, he decides that he can now afford air travel twice a
year instead of his previous once a year. With the following equation we can calculate income
demand elasticity:
Where:
Q2= 2
Q1= 1
I2= Php 80,000
I1= Php 70,000
Example:
An increase in Joey’s income from P600 to P850 causes his demand
for Good Z to change from 5 to 8 kilos.
Example:
An increase in Mary’s income from P18000/month to P20 000/month
causes her demand for Good B to change from 50 to 20 units per
month.
CROSS ELASTICITY OF DEMAND
This is the percentage change in the demand for one item in response to a percentage change in the
price of another item. It is 'positive' where the two items are mutual substitutes, and any increase in
the price of one (say butter) will increase the demand for the other (say margarine). It is 'negative'
when the items are complementary and any increase in the price of one (say cars) will decrease the
demand for the other (say tires). This measures the % change in QD for a good after the change in
price of another.
EC
CROSS ELASTICITY OF DEMAND
Substitute goods are goods which are used to take the place of another good. The positive sign of
the coefficients means Goods A and B are substitute goods. Complementary goods are goods
which
Where:are used together. The negative sign of the coefficients means Goods A and B are
D2X= new quantity demanded complementary goods.
D1X= original quantity demanded
P2Y= new price of the good EC
P1Y= original price of the good
Example:
An increase in the price of Good Y from P25 to P35 causes the
quantity demanded for Good X to decrease by 25% from level of 120
units.
Example:
A decrease in the price of Good A from P100 to P75 causes the
quantity demanded for Good B to decrease by 15% from level of 200
units.

Applied Economics B1

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Elasticities

“It is a measure of how much buyers and

“If the price of LPG increases by 10% and as a result

“Suppose the price of cellphone load goes up to 5% and

“The price of of string beans goes down by 6% and as a

“However, if the price of caffeine were to go up as a whole, we would probably see

Thus if there is an increase in price and no change in the amount of

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