Elasticity of Demand
Meaning
 Suppose
we want to study the effects a price
change have on the demand of the goods.
 It is practical to do that in terms of
percentage. 1% change in price, how many
% will demand change?
 The study of how many % any one variable
changes when another variable changes by
one percent is called elasticity.
Types of Elasticity of Demand
 Price
Elasticity of Demand
 Income Elasticity of Demand
 Cross Elasticity of Demand
Price Elasticity of Demand (Ed)




Price elasticity of demand is the degree of responsiveness
of quantity demanded of a good to a change in its price.
How many percent demand changes if the price change
one percent.
When the percentage change in quantity is less than the
percentage change in price, demand is inelastic and a fall
in price lowers the total amount spent on the product.
When the percentage change in quantity is greater than the
percentage change in price, demand is elastic and a fall in
price raises total spending on the product.
Calculating
Price Elasticity=
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
% Q  Q  P 0 
Ed 

 
% P  P  Q 0 
Interpreting an Elasticity Estimate
If Ed were to = - 0.75, what does it tell us?
“For every 1% change in price, Qd will
change 0.75% in the opposite direction”
Example:
P0 = 8
Q0 = 40
P1 = 7
Q1 = 48
Step 1: Q = 48 - 40 = 8
P = 7 - 8 = -1
Step 2: Use the formula for Ed.
Step 3:
Ed = (Qd / P) * P0 / Q0
= (8 /-1) * (8/40) = - 1.6
Step 4:
This means that for every 1 % change in price
that there is a 1.6 % change in quantity
demanded in the opposite direction.
Since we know that an Ed = -1.6 means that a
1 % change in price results in a 1.6%
change in quantity demanded in the
opposite direction,
What would a 20% increase in price result in?
Step 1: Ed =
% Q / %  P
Step 2: %Q = Ed * % P
Step 3: %Q = - 1.6 * 20% = -32%
What would a 20% increase in the quantity
demanded result in?
Step 1: Ed = % Q / %  P
Step 2: % P = 1 / Ed * % Q
Step 3:
%P = (1 / - 1.6) * +20% = - 12.5%
Degrees of Price Elasticity of
Demand
 Where
E > 1.0, demand is elastic.%∆𝑄 > %∆𝑃
 Where E < 1.0, demand is inelastic. .%∆𝑄 < %∆𝑃
 Where E = 1.0 there is unit elasticity. %∆𝑄 = %∆𝑃
 Where E is indefinite, it is perfectly elastic.
%∆𝑄 ≈ 0
 Where
E = 0, it is perfectly inelastic. %∆𝑃 ≈ 0
elastic demand
Price
When the % change in
quantity > % change in
price.
D
Quantity
inelastic demand
When the % change
in quantity < %
change in price.
Price
D
Quantity
perfectly elastic demand


A good with a perfectly flat
demand curve has a price
elasticity of demand of infinity.
This would mean that a small
change in price would lead to an
infinitely large increase in
Demand.
In perfectly competitive
markets, if you can charge
slightly less than your
competitors, and still make a
profit, you will find your
customers will attempt to buy as
much as you can produce.
perfectly inelastic demand


To have a situation where the
Demand curve is a vertical
line is to think of a good
where a certain quantity is
demanded, regardless of the
price.
Heroin would be the closest
''real life'' example of such a
good. Addicts will pay
anything for their ''fix''.
unit elasticity



Unit elasticity is where the
percentage change in demand
exactly responds to the
percentage change in price.
Unit elasticity occurs when a
consumer has only a fixed
sum of money to spend on a
certain product.
If the price per unit of product
rises he buys less of it.
 Example.
Let us suppose that price of a
good falls from 10 $ per unit to 9 $ per unit
in a day. The decline in price causes the
quantity of the good demanded to increase
from 125 units to 150 units per day.
• Calculate Ed
• Interpret the answer
• Draw the curve
Income Elasticity of Demand (EI)
 When
there is a change in the level of
income of a consumer, there is a change in
the quantity demanded of a good, other
factors remaining the same.
 The degree of change or responsiveness of
quantity demanded of a good to a change in
the income of a consumer is called income
elasticity of demand.
Calculating
Income Elasticity =
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒
% Q  Q  I 0 
EI 

 
% I  I  Q 0 
Interpreting an Elasticity Estimate
If EI were to = - 0.8, what does it tell us?
“For every 1% change in income, Qd will
change 0.8% in the opposite direction”. We
also would know that goods is inferior
goods.
Example:
 I0=
4000$/month and purchases 6 kg of beef
per month. I1= 6000$/month and purchases 8
kg of beef per month.
 ΔQ = 8 - 6 = 2
ΔI = 6000 - 4000 = 2000
 Q0 = 6 ; I0 = 4000
 E = ΔQ / ΔI x I0 / Q0
= 2 / 200 x 4000 / 6 = 0.66
 The income elasticity is 0.66. It is necessities
good
Goods are grouped depending on
Income Elasticity
Normal
Goods (EI >0)
• Luxury Goods (EI >= 1)
• Necessities (0 < EI < 1)
Inferior
Goods (EI < 0)
Engel Curve:
Shows the relationship between quantity
demanded and disposable income given a
constant price.
Engel Curve: Normal Good
Disposable
Income
Normal Good is one
buy more if their income
increase
Engel Curve for a
Normal Good
EI > 0
Qd/ut
Luxury Goods
 Luxury
Goods are Normal Goods but they
have an
EI >= 1
 Luxury
Goods: If income increases, one
increases consumption by more percentages
than the income.
 Quantity demanded is very sensitive to
changes in disposable income
“Necessities”
 “Necessities”
are Normal Goods but
0 < EI < 1
 Necessities
good: if income increases, one
buys more of it, but not as many
percentages more as the increase in income.
 Quantity demand is not very sensitive to
changes in disposable income
Engel Curve: Inferior Good
Disposable
Income
Inferior good: a good one buys
less if income increase.
Engel Curve for an
Inferior Good
EI < 0
Qd/ut
 Example.
Let us suppose that income of a
person falls from 100 $ per unit to 90 $ per
month. The decline in income causes the
quantity of the good demanded to decrease
from 50 units to 40 units per month.
• Calculate E
• Interpret the answer
Cross-Price Elasticity of Demand (Ecp)
The concept of cross elasticity of demand is used
for measuring the responsiveness of quantity
demanded of a good to changes in the price of
related goods.
 Cross elasticity of demand is defined as the
percentage change in the demand of one good as a
result of the percentage change in the price of
another good.
 The numerical value of cross elasticity depends on
whether the two goods in question are substitutes,
complements or unrelated.

Calculating
CP Elasticity =
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑋
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑌
% Q 1  Q 1  P 2 
Ecp 

 
% P 2  P 2  Q 1 

If we let E12 = the cross price elasticity for good 1
as the price of commodity 2 changes, ∆Q1= the
change in quantity demanded for commodity 1,
and ∆P2 = the change in price of commodity 2
Cross-Price Elasticity
Ecp >
0  Substitute
Ecp <
0  Compliment
Ecp =
0  Independent
Example:
The Cross-Price Elasticity of Beef and Pork
would be calculated as:
Ecp, Beef, Pork = %  QBeef / %  PPork
Example
The Cross-Price Elasticity of Pork and Beef
would be calculated as:
Ecp, Pork, Beef = %  QPork / %  PBeef
Interpretation
If the Ecp, Pork, Beef = + 0.65
Then for every 1% increase in the price of
beef, the Qd of pork would increase 0.65%.
We also would know that pork and beef are
substitutes
 Example.
Price of chicken decrease from
15000 R to 11000 R per kg. The decline in
price of chicken causes the quantity of fish
demanded to decrease from 20 kg/m to 10
kg/m.
• Calculate E
• Interpret the answer
Features of price elasticity of demand
Feature
Elastic goods
Inelastic goods
PED value
Greater than 1
Less than 1
A rise in price means
A larger fall in
demand
A smaller fall in
demand
Slope of demand curve
Flat
Steep
Number of substitutes
Many
Few
Type of good
Luxury
Necessity
Price of good
Expensive
Cheap
Example
Cars
Gasoline
What government like to tax
 Governments
like to tax goods with inelastic
demand curves.
 Demand for petrol is inelastic: petrol has no close
substitute.
• Motorists can reduce their usage of their car by
driving fewer kilometers, but can not fill their
''tank'' with water! Motorists can convert their
cars to run on liquified petroleum gas (which is
considerably cheaper than petrol), but the
conversion cost is high.
 Other goods with high levels of taxation include
alcohol and cigarettes: both very inelastic.
Practical Importance of Elasticity of
Demand
 Importance
in taxation policy
 Price discrimination by monopolist
 Importance to businessmen
 Help to trade unions
 Use in international trade
 Determination of rate of foreign exchange
 Guideline to the producers
 Use in factor pricing