CHAPTER
3
ELASTICITY OF DEMAND
LEARNING OUTCOMES
At the end of the chapter, you should be able to:
Calculate price elasticity of demand, and discuss its
concept and determinants.
Calculate and interpret income elasticity of demand.
Calculate and interpret cross-elasticity of demand.
Calculate price elasticity of supply, and discuss its concept
and determinants.
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 2
WHAT IS ELASTICITY…?
We know that –
– Price (increase) = quantity demanded (decrease)
– Price (decrease) = quantity demanded (increase)
But how much does QD will increase or fall…?
3 ways to measures:
– Price Elasticity of Demand (change in price)
– Cross elasticity of demand (change in price
another product)
– Income elasticity of demand (change income)
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 3
TYPES OF ELASTICITY
2 types
i. Elastic – Sensitive to price change
ii. Inelasticity – Insensitive to price change
Example:
– How much the quantity demand for burger if the
price of burger increase by 10 %?
• if quantity demand for burger decrease a lot –
means that price of burger is elastic
• if quantity demand for burger decrease less –
means that price of burger is inelastic
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 4
ELASTIC –
SENSITIVE TO PRICE CHANGE
Elasticity – Sensitive to
PRICE
price change
If Price increase,
quantity demanded will
fall a lot.
If Price decrease,
quantity demanded will
increase a lot.
Apple and Snek
QUANTITY
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 5
INELASTICITY – INSENSITIVE TO
PRICE CHANGE
Inelastic – Insensitive to
price change
If Price increase,
quantity demanded will
fall a little.
If Price decrease,
quantity demanded will
increase a little.
Fuel, Medical
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 6
DIFFERENT BETWEEN
ELASTICITY & INELASTICITY
Inelasticity – Insensitive to price Elasticity – Sensitive to price
PRICE change PRICE change
QUANTITY QUANTITY
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 7
CHARACTERISTIC OF
ELASTIC GOODS
Availability of substitutes
– many substitutes--elastic (Ep > 1)
Large proportion of income spent
Nature of goods (Necessities vs Luxuries)
– luxury goods (Mewah)----- elastic
Elasticity coefficient MORE THAN 1 (Ep > 1)
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 8
CHARACTERISTIC OF
INELASTIC GOODS
Availability of substitutes
– few substitute---inelastic
Small proportion of income spent on a
product
Nature of goods (Necessities vs Luxuries)
– necessity or essential (keperluan)-----inelastic
Elasticity coefficient LESS THAN 1 (Ep < 1)
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 9
TYPES OF ELASTICITY FOR DEMAND
AND SUPPLY
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 10
ELASTICITY OF DEMAND
Price Elasticity of Demand - measure the responsiveness
of quantities demanded to CHANGES IN PRICES.
Cross elasticity of demand - measures the
responsiveness of the quantity demanded of ONE
PRODUCT to changes in the price of ANOTHER
PRODUCT. For example, the quantity demanded of
Coca-Cola to changes in the price of Pepsi.
Income elasticity of demand - measures the
responsiveness of the quantity demanded of a
commodity to changes in CONSUMERS' INCOMES.
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 11
PRICE ELASTICITY OF DEMAND
Price elasticity of demand measures the degree of
responsiveness of the quantity demanded for a
particular good, with respect to the changes in the price.
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 12
EXAMPLE
If price of good AA decrease from RM40 to RM30,
and the quantity demanded increases from 50 to 70
unit, what is the price elasticity of demand for good
AA?
Qdx 2 Qdx1 Px1 70 50 40
=
Qdx1 Px 2 Px1 50 30 40
= 2 (>1 so demand is very sensitive to price
change. As price decrease. 1 %, QD incr. 2%)
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 13
PERFECTLY UNITARY ELASTIC PERFECTLY
INELASTIC, Ɛd = 0 Ɛd = 1 ELASTIC, Ɛd =
INELASTIC, ELASTIC,
0 <Ɛd< 1 >Ɛd>1
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 14
ELASTICITY OF DEMAND (cont.)
Degrees of Responsiveness in Price Elasticity of
Demand
Perfectly Inelastic, Ɛd = 0
Inelastic, 0 <Ɛd< 1
Unitary elastic, Ɛd = 1
Elastic, >Ɛd>1
Perfectly elastic, Ɛd =
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 15
TOTAL REVENUE TEST
Inelasticity (PETROL) Elasticity (COCONUT JUICE)
PRICE PRICE
S
S
D
D
QUANTITY QUANTITY
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 16
TOTAL REVENUE TEST (cont)
Inelasticity (PETROL) Elasticity (COCONUT JUICE)
PRICE S1 PRICE S1
S0 S0
D
D
QUANTITY QUANTITY
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 17
INELASTICITY
(TOTAL REVENUE TEST)
Inelasticity (PETROL)
PRICE S1
PRICE =
S0 TOTAL REVENUE =
PRICE =
TOTAL REVENUE =
D
QUANTITY QUANTITY
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 18
ELASTICITY
(TOTAL REVENUE TEST)
Elasticity (COCONUT JUICE)
PRICE S1
PRICE = S0
TOTAL REVENUE =
PRICE =
TOTAL REVENUE = D
QUANTITY
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 19
ELASTICITY OF DEMAND (cont.)
Price Elasticity of Demand and its Effects on Total Revenue
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 20
INCOME ELASTICITY OF DEMAND
Income Elasticity of Demand
Income elasticity of demand measures the degree of
responsiveness of the quantity demanded for a
particular good, with respect to the changes in income
of the consumer.
Income elasticity of demand is calculated to determine
the type of the particular good, whether it is a normal, a
luxury or an inferior good.
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 21
INCOME ELASTICITY OF
DEMAND
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 22
INCOME ELASTICITY OF
DEMAND
Degrees of Responsiveness in Income Elasticity of Demand
Negative income elasticity, Ɛy< 0
Zero income elasticity, Ɛy = 0
Inelastic income elasticity, 0 <Ɛy< 1
Elastic income elasticity, Ɛy>1
NEGATIVE INCOME ELASTICITY, ZERO INCOME ELASTIC INCOME
Ɛy< 0 ELASTICITY, Ɛy = 0 ELASTICITY, Ɛy>1
INELASTIC INCOME ELASTICITY,
0 <Ɛy< 1
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 23
INCOME ELASTICITY OF
DEMAND
Types Degrees of Income Effect Direction Type Of Goods Example
Responsiven
ess Inc D
Negative Less than 0 Increase Decrease Inferior Good Instant
income Decrease increase Noodle
elasticity
Zero income Equal to 0 Increase Unchanged Essential Goods Rice, bread
elasticity, Ɛy
=0
Decrease Unchanged
=
Inelastic Between 0 Increase Increase Normal Goods Clothing,
income and 1 Decrease (Small) Sport
elasticity, 0 Decrease Shoes
<Ɛy< 1 (Small)
Elastic More than 1 Increase Increase Luxury Goods Sports car
income Decrease (Big)
elasticity, Decrease
Ɛy>1 (Big)
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 24
EXAMPLE
Kasim’s income rises from RM 1,000 to RM 1,600
and his demand for good X increases from 30 unit
to 65 unit per month. Determine the type of good
for Good X?
Qdx 2 Qdx1 Y1 65 30 1000
Qdx1 Y 2 Y1 30 1600 1000
= 1.95 (Elastic income. Therefore, Good X is a luxury
good. A rise of income by 1% will lead to an increase
in QD for good x by 1.95%.
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 25
CROSS-ELASTICITY OF
DEMAND
Cross-elasticity of demand measures the degree of responsiveness
of the quantity demanded for a particular good(e.g. Good Y), with
respect to the change in the price of another good (e.g. Good X).
Cross-elasticity of demand is calculated to determine the relationship
of both products, whether or not they are complements, substitutes
or not related at all.
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 26
CROSS-ELASTICITY OF
DEMAND
Degrees of Responsiveness in Cross-elasticity of
Demand
Negative cross-elasticity, Ɛx< 0 (Complementary)
Zero cross-elasticity, Ɛx = 0 (Independent / Not Related)
Positive cross-elasticity, Ɛx>0 (Substitute)
NEGATIVE CROSS ELASTICITY, ZERO CROSS ELASTICITY, POSITIVE ELASTICITY,
Ɛy< 0 Ɛy = 0 Ɛy>1
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 27
CROSS-ELASTICITY OF
DEMAND
Types Degrees of Effect Effect Type Of Example
Responsivene Good A Good B Goods
ss
Negative Ɛx < 0 Increase Decrease Complement Coffee
cross- Less than 0 Decrease increase ary Goods and
elasticity Creamer
Zero cross- Ɛx = 0 Increase Unchanged Independent Coffee
elasticity Equal to 0 Decrease Unchanged Goods and
Socks
Positive Ɛx>0 Increase Increase Substitute Coffee
cross- More than 1 Decrease Decrease Goods and Tea
elasticity
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 28
EXAMPLE
Last month, the quantity demanded for Good A was 300 units
when the price for Good B was RM 3.50. This month, the
price for Good B increased to RM5 and the quantity
demanded for Good A decreased to 75 units. Calculate the
cross elasticity of demand and state the relationship between
Good A and B.
QdA 2 QdA1 PB1 75 300 3.50
QdA1 PB 2 PB1 300 5 3.50
= -1.8 (<0). Good A and B are Complements. Increase of price
Good B – Decrease the QD for Good A
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 29
GOVERNMENT INTERVENTION IN THE
MARKET (cont.)
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 30
PERFECTLY UNITARY ELASTIC PERFECTLY
INELASTIC, Ɛd = 0 Ɛd = 1 ELASTIC, Ɛd =
INELASTIC, ELASTIC,
0 <Ɛd< 1 >Ɛd>1
TAX BURDEN TAX BURDEN TAX BURDEN TAX BURDEN TAX BURDEN
CONSUMER MOSTLY SHARED BY MOSTLY PRODUCER
PAY ALL CONSUMER CONSUMER & PRODUCER PAY ALL
PAY PRODUCER PAY
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 31
GOVERNMENT INTERVENTION IN THE
MARKET (cont.)
The benefits of subsidy received by consumers and
producers depend on the price elasticity of demand
and supply:
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 32
MEASURES …
Price Elasticity of Demand - Responsiveness of QD to
CHANGES IN PRICES.
Cross elasticity of demand - Responsiveness of QD of
PRODUCT A to changes in the price of PRODUCT A.
Income elasticity of demand - Responsiveness of QD to
changes in CONSUMERS' INCOMES.
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 33
DID YOU NOTICE…
CHANGE THIS
YOU JUST NEED TO
SAME
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 34
IF….
Degrees of Effect 1 Effect 2
Responsiveness
Ɛx < 0 Increase Decrease NEGATIVE
Less than 0 Decrease increase EFFECT
Ɛx = 0 Increase Unchanged
Equal to 0 Decrease Unchanged NO CHANGE
0 <Ɛy< 1 Increase Increase (Small) DIRECT
Between 0 and 1 Decrease Decrease (Small) RELATIONSHIPS
Ɛy>1 Increase Increase little (Big) DIRECT
More than 1 Decrease Decrease little (Big) RELATIONSHIPS
Fundamental of Economics All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2017 3– 35
