ELASTICITY

OF DEMAND
 As a consumer, you are usually demanding more of
goods when its price is lower, when your incomes are
higher, when the value of substitute goods is higher, or
when the rate of the complement goods is cheaper.

It is your natural reaction as a consumer but, it is not

happening all the time. The level of the consumers
responsiveness varies greatly, and it can measure by
the price of clasticity of demand.
 You can classify the demand
elasticity according to the factors
that cause the change; the price
elasticity, the income elasticity,
and the cross-price elasticity:
Definition
of
terms
DEFINITION OF TERMS:
•Elasticity - use to determine how changes in product
demand and supply related to changes in consumer
income or the producer price

•Elastic Demand - slight change in the price will lead to a

drastic change in the demand for the product.

•Inelastic Demand - an elastic product is one that consumers

continue to purchase even after a change
in price.
DEFINITION OF TERMS:
•Complement Goods
-two goods for which an increase in the price of
one leads to a decrease in the demand for the other.

•Substitute Goods
- two goods for which an increase in the price of
one leads to an increase in the demand for the other.
 1. Price
eLASTICITY
OF DEMAND
The Price Elasticity of Demand
- Price elasticity of demand is the
responsiveness of quantity demanded, or how
much quantity demanded changes, given a
change in the price of goods or services. *The
mathematical value is negative. A negative value
indicates an inverse relationship between price
and the quantity demanded. But the negative
sign is ignored (Judge, S. 2020).
The Price Elasticity of Demand
Price elasticity measures the responsiveness of
the quantity demanded or supplied of a good to
a change in its price. Elasticity can be
described as: a) elastic or very responsive
and b) unit elastic, or inelastic or not very
responsive. (source: Investopedia).
What is price elasticity demand?
Price elasticity of demand is the ratio of the
percentage change in quantity demanded of
a product to the percentage change in price.
Economists employ it to understand how
supply and demand change when a
product’s price changes.
What makes a product elastic?
If a price change for a product causes a
substantial change in either its supply or its
demand, it is considered elastic. Generally, it
means that there are acceptable substitutes
for the product. Examples would be cookies,
luxury automobiles, and coffee.
What makes a product inelastic?
If a price change for a product doesn’t lead
to much, if any, change in its supply or
demand, it is considered inelastic. Generally,
it means that the product is considered to be
a necessity or a luxury item for addictive
constituents. Examples would be gasoline,
milk, and iPhones
Price Elasticity of Demand (PED)
= % change in quantity demanded
Divided by the % Change in price
 a) Elastic Demand (PED> 1)
-The percentage change in price brings about a more than
proportionate change in quantity demanded.

-When the percentage change in quantity demanded is

greater than the percentage change in price, and the
coefficient of the elasticity is greater than
Examples:
Real estate housing. There are many different housing choices.
People may live in a townhouses, condos, apartments, or resorts.
The options make easy for people to not pay more than they demand.
b) Inelastic Demand (coefficient of
the elasticity is less than 1)
- is when an increase in price causes a smaller % fall in
demand.
-When the percentage change in quantity demanded is less
than the percentage change in price, and the coefficient of
the elasticity is less than
Examples:
Gasoline - gasoline has few alternatives, people with cars consider it as a
necessity and they need to buy gasoline. There are weak substitutes, such
as train riding, walking and buses.If the price of gasoline goes up, demand
is very inelastic. Other Examples: Diamonds, aircon, Iphone, Cigarettes
c) Unitary Elastic Demand

-When the percentage change in demand

is equal to the percentage change in price, the
product is said to have Unitary Elastic demand.
Unitary elastic-PED or the price elasticity of demand
is 1
 d) Perfectly Elastic
- a small percentage change in price brings about a
-change in quantity demanded from zero to infinity.
Perfectly elastic - the coefficient of elasticity is equal to
infinity (0)
e) Perfectly Inelastic
- the PED is 0 any change in price will not have
any effect on the demand of the product.
-Perfectly inelastic - the percentage change in
demand will be equal to zero (0)
POINT ELASTICITY
a) The midpoint elasticity is less than 1. (Ed < 1). Price
reduction leads to reduction in the total revenue of the
firm.

b) The demand curve is linear (straight line), it has a

unitary elasticity at the midpoint. The total revenue is
maximum at this point.

c) Any point above the midpoint has elasticity greater

than 1, (Ed > 1).
2. Cross Price
eLASTICITY
OF DEMAND
WHAT IS CROSS ELASTICITY OF DEMAND?
The cross elasticity of demand is an economic
concept that measures the responsiveness in the
quantity demanded of one good when the price
for another good changes. Also called cross-price
elasticity of demand, this measurement is
calculated by taking the percentage change in
the quantity demanded of one good and dividing
it by the percentage change in the price of the
other good.
KEY TAKEWAYS
•The cross elasticity of demand is an economic
concept that measures the responsiveness in the
quantity demanded of one good when the price
for another one changes.
•The cross elasticity of demand for substitute
goods is always positive because the demand for
one good increases when the price for the
substitute good increases.
•Alternatively, the cross elasticity of demand for
complementary goods is negative.

•When dealing with unrelated goods, there is

generally no cross-elasticity of demand.

•Companies often use the cross elasticity of

demand to determine and set prices of their
goods and services.
How to Calculate Cross Elasticity of Demand
Now that you have the formula for cross price
elasticity of demand, it's important to know how
to use it to make your calculations. Here's a step-
by-step run-through of how to do so.
1. Figure out the total quantity demanded of X
and the initial price of Y.

2. Determine the final quantity demanded of X

and the ending price of Y.
3. For the numerator in the formula above, calculate the
percentage change in the quantity demanded of X. Do this by
subtracting the last and first quantities and dividing that by the
total sum of the initial and final quantities.

4. Now you'll need to calculate the denominator, which is the

percentage change in price. You can do this by dividing the
final and initial prices by the total sum of the last and initial
prices.

5. Calculate the cross-price elasticity of demand by dividing

the percentage change in quantity by the percentage change in
price.
Understanding Cross Elasticity of Demand
In economics, the cross elasticity of demand refers to
how sensitive the demand for a product is to changes in
the price of another product. This means it determines
the relationship between the quantity demanded of one
good when the price for another good or product
changes. Put simply, it measures how demand for one
good changes when the price of another (usually related
one) does.
You can use the formula to make comparisons of products
that are considered perfect substitutes for one another or
those that are complementary to one another. For substitute
goods, the cross elasticity of demand remains positive, which
means prices increase when demand for one good rises.
Demand for complementary goods drops when the price rises
for another good. This is called negative cross elasticity of
demand.

Unrelated products do not affect one another. For instance,

an increase in the price of eggs does not directly relate to an
increase in demand for olives.
SUBSTITUTE GOODS
The cross elasticity of demand for substitute goods is always
positive because the demand for one good increases when
the price for the substitute good increases. For example, if
coffee prices increase, then the quantity demanded for tea (a
substitute beverage) increases as consumers switch to a less
expensive yet substitutable alternative. This is reflected in
the cross elasticity of the demand formula, as both the
numerator (percentage change in the demand for tea) and
denominator (the price of coffee) show positive increases
Items with a coefficient of 0 are unrelated items and are goods
independent of each other. Items may be weak substitutes, in
which the two products have a positive but low cross elasticity
of demand. This is often the case for different product
substitutes, such as tea versus coffee. Items that are strong
substitutes have a higher cross-elasticity of demand. Consider
different brands of tea; a price increase in one company’s green
tea has a higher impact on another company’s green tea
demand.
Toothpaste is an example of a substitute good; if the price of
one brand of toothpaste increases, the demand for a
competitor's brand of toothpaste increases in turn.
COMPLEMENTARY GOODS
Alternatively, the cross elasticity of demand for complementary
goods is negative. As the price for one item increases, an item
closely associated with that item and necessary for its
consumption decreases because the demand for the main good
has also dropped.

For example, if the price of coffee increases, the quantity

demanded for coffee stir sticks drops as consumers are drinking
less coffee and need to purchase fewer sticks. In the formula, the
numerator (quantity demanded of stir sticks) is negative and the
denominator (the price of coffee) is positive. This results in a
negative cross elasticity.
Cross elasticity of demand helps companies establish
prices for their goods, allowing for higher prices for
products without substitutes. This is done by analyzing
incremental price changes for substitutes and strategically
pricing complementary goods, based on future demand.
3. INCOME
eLASTICITY
OF DEMAND
INCOME ELASTICITY OF DEMAND
- refers to the sensitivity of the quantity
demanded for a certain good to a change
in the real income of consumers who buy
this good.
The formula for calculating income elasticity of demand
is the percent change in quantity demanded divided by
the percent change in income. .

Income Elasticity of Demand = (D1 – D0) / (D1 + D0) / (I1

– I0) / (I1 + I0)
Income Elasticity of Demand Formula – Example #1
Let us take the example of cheap garments. The
weekly demand for cheap garments went down from
4,000 pieces to 2,500 pieces as the level of real
income in the economy increased from 75 per day to
125 per day. The reason is the shift in preference due
to the availability of extra money on the back of
increased income level. Calculate the income
elasticity of demand based on the given information.
Types of Income Elasticity of Demand
There are five types of income elasticity of demand:
1.High: A rise in income comes with bigger increases in the quantity demanded.

2.Unitary: The rise in income is proportionate to the increase in the quantity

demanded
.
3.Low: A jump in income is less than proportionate to the increase in the quantity
demanded.

4.Zero: The quantity bought/demanded is the same even if income changes

5.Negative: An increase in income comes with a decrease in the quantity demanded.

Normal goods have a positive income elasticity of
demand; as incomes rise, more goods are demanded at
each price level.
Normal goods whose income elasticity of demand is
between zero and one are typically referred to as
necessity goods, which are products and services that
consumers will buy regardless of changes in their
income levels. Examples of necessity goods and services
include tobacco products, haircuts, water, and
electricity.
Inferior goods have a negative income elasticity of
demand; as consumers' income rises, they buy fewer
inferior goods. A typical example of such a type of
product is margarine, which is much cheaper than
butter.