Elasticity
Ch 04
Concept of Elasticity
 Elasticity means “Responsiveness”
• Elasticity, refers to the response of a "dependent" variable to
changes in the "independent" variable.
– A good way to remember this is that the "dependent"
variable depends upon the "independent" variable.
 “Elasticity is a measure of just how much the quantity demanded
/supplied will be affected by a change in price or income or change
in price of related goods”.
 “In business and economics, elasticity refers to the degree to
which individuals, consumers, or producers change their demand
or the amount supplied in response to price or income changes. It
is predominantly used to assess the change in consumer demand
as a result of a change in a good or service's price.”
Types of Elasticities
 There are four types of elasticity that we will study in this unit:
i. Price Elasticity of Demand (PED): Measures the responsiveness
of consumers of a particular good to a change in the good’s
price.
ii. Income Elasticity of Demand (YED): Measures the
responsiveness of consumers of a particular good to a change in
their income.
iii. Cross-price elasticity of Demand (XED): Measures the
responsiveness of consumers of one good to a change in the
price of a related good (either a substitute or a complement).
iv. Price elasticity of Supply (PES): Measures the responsiveness of
producers of a particular good to a change in the price of that
good.
What is Price Elasticity of Demand (PED)?
 “Price elasticity of demand (PED)----is a measure of how much demand
for a good or service responds (responsiveness) to a change in its price”.
 “Price elasticity of demand (PED) explains the relationship between
change in quantity demanded and changes in price (how much the
quantity demanded changes when the price changes.)”
– If price increases, we know that quantity demanded will
decrease (that is the law of demand).
– The question in this context is by how much will quantity
demanded decrease if price goes up?
• Price and demand are usually in inverse relationship. In other words, as
price falls, demand increases; and as price increases, demand falls.
 Example:
• Think of the example of the 2004 flu shot panic. In order for Flunomics, a hypothetical flu
vaccine distributor, to know whether it could raise its revenue by significantly raising the price
of its flu vaccine during the 2004 flu vaccine panic, it would have to know whether the price
increase would decrease the quantity demanded by a lot or a little.
• That is, it would have to know the price elasticity of demand for flu vaccinations.
Elastic and Inelastic Demand
 Price Elastic : if there is a large responsiveness of quantity demanded, demand is
referred to as being price elastic
•
•
Elastic is the term used for goods that see a much more dramatic change in demand compared to the
price. Goods that are not necessary to daily life tend to be more elastic. If the cost of an espresso
machine doubled, the demand would plummet because people do not need one, so they will not
purchase them if the price increases too much.
Demand is said to be price elastic if there is a relatively large change in the quantity demanded of a
product following a change in its price: that is, buyers are very responsive to changes in price.
– For example, a small rise in the price of Pepsi Cola is likely to reduce its demand quite drastically
as customers switch to buying rival brands such as Coca-Cola
 Price Inelastic: if there is a small responsiveness of quantity demanded, demand
is price inelastic.
•
•
Inelastic is the term for a good that does not see a dramatic change in demand with a change in price.
Gas is a good example of an inelastic good. People need a certain amount of gas to commute and run
errands. If the price rises, they still need the same amount of gas. If the price lowers, it is not a
product that people can stock up on very easily.
If a price change causes a relatively small change in the quantity demanded, then demand is said to
be price inelastic: that is, buyers are not highly responsive to changes in price.
– For example, products such as oil, tobacco and tap water often have inelastic prices because the
products are necessary, highly valued by or cannot be replaced by a different product.
Consumers will not stop drinking or using water if rates rise, and higher tobacco prices aren’t
likely to make them stop smoking. Similarly, they will not greatly change their driving behavior
even if gasoline prices rise.
 When the price of a good increases, individuals and businesses will buy less. But how
much less? A lot or a little?
 The elasticity of demand measures how responsive the quantity demanded is to a change
in price—the more responsive quantity demanded is to a change in the price, the more
elastic is the demand curve.
Elastic Demand Vs Inelastic Demand
 Price Elastic Demand
• Definition: Demand is price elastic if a
change in price leads to a bigger %
change in demand; therefore the PED
will, therefore, be greater than 1.
 Price Inelastic Demand
• These are goods where a change in
price leads to a smaller % change in
demand; therefore PED <1 e.g. – 0.5
• Inelastic demand PED <1 – Perfectly
inelastic PED =0
Price elasticity of demand measures how much the demand for a good changes with its
price.
 If the demand changes with price, the demand is elastic,
 while if it doesn’t change, it is inelastic.
PED Calculation Formula
• Price elasticity of demand (PED) shows the relationship between price and
quantity demanded and provides a precise calculation of the effect of a change
in price on quantity demanded.
 Price elasticity of demand is calculated and defined as:
• If you don't have the percentage changes in quantity and price, use the
following formula instead:
PED Calculation Example 1
 Calculating PED without
Percentage given
 If, for example, we know that an
increase in the price of bananas
from $4 to $6 caused the quantity
demanded to fall from 1,000
bananas to 800 bananas, we can
calculate the PED for bananas.
%∆𝑄𝑑= 800−1000 * 100 = -20%
1000
%∆𝑃= 6−4 * 100 = 50%
4
𝑷𝑬𝑫= −𝟐𝟎/ 𝟓𝟎 =−𝟎.𝟒
 Notice that since we did not KNOW
the percentage changes in P and Q,
we had to calculate them. The full
PED formula is
 𝑷𝑬𝑫= 𝑸𝟐−𝑸𝟏 /𝑸𝟏 ÷ 𝑷𝟐−𝑷𝟏/ 𝑷𝟏
 Calculating PED with Percentage
given
• Let us take the simple example of
gasoline. Now let us assume that a
surge of 60% in gasoline price
resulted in a decline in the purchase
of gasoline by 15%. Using the
formula as mentioned above, the
calculation of price elasticity of
demand can be done as:
•
Price Elasticity of Demand = Percentage
change in quantity / Percentage change
in price
• Price Elasticity of Demand = - 15%
60%
• Price Elasticity of Demand = -1/4 or
-0.25
 Demand curve is downward sloping,
the elasticity will always be
negative.
PED Calculation Example 2
 At a lower price, the result is
quite different. Suppose that
price is initially 10p, at which
price the quantity demanded
is 80. If the price falls to 9p,
demand increases to 82.
• The percentage change in
quantity is now 100 × 2/80 = 2.5,
and
• the percentage change in price is
100 × −1/ 10 = −10,
• So, the elasticity is calculated as
2.5/–10 = −0.25,
• demand is now price inelastic.
 When the price of a pencil is
40p, the quantity demanded
will be 20. If the price falls to
35p, the quantity demanded
will rise to 30.
 The percentage change in quantity
(%ΔQD) is 100 × 10/20 = 50
and
 The percentage change in price
(%Δ P) is 100 × –5/40 = –12.5.
 So, the elasticity can be calculated
as:
 %ΔQD/%ΔP = 50 = −4
-12.5
 At this price, demand is highly price
elastic.
PED Calculation Example 3
Interpreting PED Calculations
• The cinema ticker example suggests that the demand for cinema tickers is
price inelastic (i.e. relatively unresponsive to changes in price). This is
because a 10 per cent increase in the price (from $10 to $11) only caused
quantity demanded to drop by 5 per cent (from 3500 tickers per week
to3325 ).
• The value of PED is negative due to the law of demand - an increase in the
price of a product will rend to reduce its quantity demanded. The inverse
relationship between price and quantity demanded also applies in the case
of a price reduction ---that is, a price fall rends to lead to an increase in the
quantity demanded.
• The calculation of PED generally has two possible outcomes:
 If the PED for a product is less than l (ignoring the minus sign), then
demand is price inelastic (i.e. demand is relatively unresponsive to
changes in price).This is because the percentage change in quantity
demanded is smaller than the percentage change in the price (see Figure
4.1).
 If the PED for a product is greater than 1 (ignoring the minus sign), then
demand is price elastic (i.e. demand is relatively responsive to changes in
price). This is because the percentage change in quantity demanded is
larger than the percentage change in the price of the product (see Figure
4.2)
PED Calculation Example 4
•
•
If the price of oil increases by 10% and over a period of several years the quantity demanded
falls by 5%, then the long-run elasticity of demand for oil is
PED= -5% = - 0.5, or 0.5 in absolute terms
10%
•
If the price of Minute Maid orange juice falls by 10% and the quantity of Minute Maid orange
juice demanded increases by 17.5%, then the elasticity of demand for Minute Maid OJ is
• PED = 17.5% = - 1.75, or 1.75 in absolute terms
-10%.
• The result of any calculation of price elasticity normally results in a negative elasticity. In
practice, the negative sign is usually excluded (ignored).
 Interpretation of PED Calculation
• So in our calculations above, oil has inelastic demand and Minute Maid orange juice has
elastic demand.
– When the absolute value of the elasticity is less than 1, the demand is not very elastic or
economists say the demand is inelastic;
– if it is greater than 1, economists say that demand is elastic;
– and if it is exactly equal to 1, economists say that demand is unit elastic.
 The numerical value of PED can therefore vary from zero to infinity. In general, the
larger the value of PED, the greater the responsiveness of quantity demanded.
 PED for most goods and services is greater than zero and less than infinite, and other
than exactly one.
 The cases of unit elastic, perfectly inelastic and perfectly elastic demand are rarely
encountered in practice; however, they have important applications in economic
theory.
Demand Curves and PED
Summary of Price Elasticity of Demand
If demand is…
then the absolute value
of price elasticity is…
1<PED<∞
Quantity
Demanded is
relatively
responsive to
price
0<PED< 1
Quantity
demanded is
relatively
unresponsive to
price
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Summary of Price Elasticity of Demand
If demand is…
then the absolute value
of price elasticity is…
PED=1
Percentage
change in
Quantity
demanded is
equal to
percentage
change in Price
PED= ∞
Quantity
Demanded is
infinitely
responsive to
price
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Summary of Price Elasticity of Demand—part 3
If demand is…
then the absolute value
of price elasticity is…
PED=0
Quantity
Demanded is
completely
unresponsive
to Price
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Do People Respond to Changes in the Price of Gasoline?
•We can now use our knowledge to answer this question in economic
terms.
• Gasoline demand is inelastic: the quantity demanded does not change
much as the price of gasoline changes.
• It is not perfectly inelastic: it is somewhat responsive to price.
•Which panel shows this?
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What Determines the Price Elasticity of Demand?
• Why do some goods have a high price elasticity of demand, while others
have a low price elasticity of demand?
• There are several characteristics of the good, of the market, etc. that
determine this.
1. The availability of close substitutes
• If a product has more substitutes available, it will have more elastic
demand.
 Example: There are few substitutes for gasoline, so its price elasticity of
demand is low.
 Example: There are many substitutes for Nikes (Reeboks, Adidas, etc.), so
their price elasticity of demand is high.
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Determinants of the Price Elasticity of Demand
2. The passage of time
• Over time, people can adjust their buying habits more easily. Elasticity is
higher in the long run than the short run.
 Example: If the price of gasoline rises, it takes a while for people to adjust
their gasoline consumption. How might they do that?
• Buying a more fuel-efficient car
• Moving closer to work
3. Whether the good is a luxury or a necessity
• People are more flexible with luxuries than necessities, so price elasticity
of demand is higher for luxuries.
 Example: Many people consider milk and bread necessities; they will buy
them every week almost regardless of the price.
 And if the price goes down, they won’t drastically increase their
consumption of bread or milk.
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Determinants of the Price Elasticity of Demand
4. The definition of the market
• The more narrowly defined the market, the more substitutes are
available, and hence the more elastic is demand.
 Example: You might believe there is no good substitute for jeans, so your
demand for jeans is very inelastic.
 But if you consider different brands of jeans, you might be more sensitive
to the price of a particular brand.
5. The share of a good in a consumer’s budget
• If a good is a small portion of your budget, you will likely not be very
sensitive to its price.
 Example: You might buy table salt once a year or less; changes in its price
will not affect very much how much you buy.
 Example: Changes in the price of housing do affect where people choose
to live.
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Some Real-World Price Elasticities of Demand
Product
Estimated
Elasticity
Product
Estimated
Elasticity
Books (Barnes & Noble)
–4.00
Bread
–0.40
Books (Amazon)
–0.60
Water (residential use)
–0.38
DVDs (Amazon)
–3.10
Chicken
–0.37
Post Raisin Bran
–2.50
Cocaine
–0.28
Automobiles
–1.95
Cigarettes
–0.25
Tide (liquid detergent)
–3.92
Beer
–0.29
Coca-Cola
–1.22
Catholic school attendance
–0.19
Grapes
–1.18
Residential natural gas
–0.09
Restaurant meals
–0.67
Gasoline
–0.06
Health insurance (low-income
households)
–0.65
Milk
–0.04
Sugar
–0.04
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•Estimated real-world price elasticities of demand
29
Applications of PED
• PED formula is useful for more than just telling us how much consumers
respond to price changes. It can be very useful to businesses and government
decision making.
 Businesses
 Businesses benefit from knowing how responsive their consumers are to price
changes at any given time.
– If a seller knows demand is HIGHLY elastic, he may wish to lower the price
and capture many new customers.
– If a seller knows demand is highly inelastic, he may wish to raise his price as
he will not lose many sellers but will enjoy higher revenues.
 Government
• The government needs to know how consumers will respond to taxes imposed
on particular goods. For example, if the government wishes to raise revenues
from taxing goods, it should know that:
– A tax on restaurant meals (relatively elastic) will not raise much revenue
because people will just stop going to restaurants.
– A tax on cigarettes (relatively inelastic) will raise lots of revenue because
most people will continue smoking and thus have to pay the tax.
Income Elasticity of Demand (YED)
 The Income Elasticity Of Demand (YED) – “measures how sensitive consumer
demand is when there is a change in BUYERS’ income.”
• It shows us what happens to our demand when our incomes go up or down.
• Income elasticity of demand can be defined as the impact of consumer income
on product demand.
• Businesses use this metric to predict future demand and to understand
consumer buying behaviors. In addition, income elasticity signifies the nature of
a product.
• The income elasticity of demand is a fundamental concept in economics; it
signifies consumer demand.
Income Elasticity OF Demand (YED) Formula
• Income elasticity is measured using the income elasticity formula: the
percentage change in aggregate demand is divided by the percentage change in
income.
• Income Elasticity (YED) =
(New Quantity Demand – Old Quantity Demand)
(Old Quantity Demand)
(New Income – Old Income)
(Old Income)
Examples of Calculating YED
•
•
•
•
•
•
•
•
First, we determine individual values
required for the income elasticity
formula. We compute the percentage
change in demand as follows:
Percentage change in demand = [(275200)/ 200] x 100
– Percentage change in demand =
37.5%
Then, we compute the percentage
change in income:
Percentage change in income = [(50004000)/ 4000] x 100
– Percentage change in income = 25%
Now, we apply the values in the income
elasticity formula:
Income elasticity = 37.5% / 25%
Income elasticity ( YED) = 1.5
Thus, income elasticity is high.
•
•
•
•
•
•
Let’s take an example of a shop that
sells widgets. They estimate that when
the average real income of its
customers falls from $60,000 to
$40,000, the demand for its widgets
falls from 5,000 to 4,000 units sold, with
all other things remaining the same.
Using the income elasticity of demand
formula,
YED = (New Quantity Demand – Old
Quantity Demand)/(Old Quantity
Demand)
(New Income – Old Income)/(Old
Income)
YED = (4,000 – 5,000)/(5,000)
(40,000-60,000)/(60,000)
YED = ~0.67
This produces an elasticity of 0.67,
which indicates customers are not
particularly sensitive to changes in their
income when it comes to buying these
widgets. The demand does not fall
significantly with a fall in income.
Summary of Income Elasticity of Demand
If the income elasticity
of demand is…
then the good is…
Example
positive but less than 1
normal and a necessity
Bread
positive and greater than 1 normal and a luxury
negative
inferior
Caviar
food )
Ramen
noodles
•Necessity: A normal good with a quantity demanded that responds less
than proportionally to a price change.
•Luxury: A normal good with a quantity demanded that responds more
than proportionally to a price change.
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Income elasticity of demand along a number line
Inferior Good
Normal Good
Perfectly
Inelastic
-∞
Elastic
Inferior
good
-1 Inelastic
0
Inferior Good
Necessary
Inelastic
normal
good
Luxury/superior
+1
Elastic
Normal
Good
∞
Normal goods: The demand for normal goods increases with consumer income levels, and
vice versa. The income elasticity is positive for normal goods.
Inferior goods: The demand for inferior goods decreases with consumer income levels. The
income elasticity is negative for inferior goods.
Although own-price elasticity of demand (PED) will almost always be negative, income
elasticity of demand can be negative, positive, or zero.
KEY VALUES
For YED the sign is important. If the value is positive, i.e. greater than 0, the product is a normal good.
This means a rise in income will lead to an increase in demand. If the value is negative, i.e. less than 0,
the product is an inferior good. This means a rise in income will lead to a fall in demand.
 Income elastic demand
• When demand for a
product is income elastic,
the value of YED is greater
than +1.
• Example — a 10% increase
in real income leads to a
20% increase in demand for
foreign holidays. So:
 Income inelastic demand
• When demand for a product is
income inelastic, the value of
YED is between 0 and +1.
• Example — a 10% increase in
real income leads to a 2%
increase in demand for cartons
of milk. So:
•
•
The increase in real income
has led to a greater
percentage increase in
demand. Income elastic
products are often referred
to as luxury goods.
The increase in real income has
led to a smaller percentage
increase in demand. Income
inelastic products are often
referred to as basic goods or
necessities
Negative income elasticity
When demand for a product
is negative income elastic,
the value of YED is negative,
i.e. less than 0.
Example — a 20% increase
in real income leads to a 10%
fall in demand for a
supermarket’s value brand of
baked beans. So:
•
The increase in income
has led to a fall in
demand. Negative
income elastic products
are referred to as inferior
goods.
Cross-Price Elasticity Of Demand (XED)
o When we examined demand in Chapter 3, we discussed substitutes and
complements
o Substitutes: Goods and services that can be used for the same purpose.
o Complements: Goods and services that are used together.
 Cross-price elasticity of demand measures the strength of substitute or
complement relationships between goods:
 The cross-price elasticity of demand, defined as the ratio of the percent change in the
quantity demanded of one good to the percent change in the price of another.
 Cross elasticity of demand measures the responsiveness of the demand for a product
following a change in price of another product ( means it measures how sensitive the demand
for good A is to changes in the price of some other good, B).
 For example: if there is an increase in the price of tea by 10%. and the quantity demanded for
coffee increases by 2%, then the cross elasticity of demand = 2/10 = +0.2
Cross-Price Elasticity OF Demand (XED) Formula
Interpretation Of XED values
 The Sign Of XED: unlike PED, whose minus sign is ignored, cross-price elasticity of
o
o

o
o
o
o
o
demand is either positive or negative, and the sign is very important for its interpretation
Substitute goods will have a positive cross-elasticity of demand .
– A positive value indicates that products A and B are substitutes, i.e. a rise in the price
of product B leads to an increase in demand for product A.
Complements will have a negative cross elasticity of demand
– A negative value indicates that products A and B are complements, i.e. a rise in price
of product B leads to a fall in the demand for product A.
The Value Of XED: how small or large is its absolute value (the absolute value of a
number is its numerical value without its sign).
XED Positive and Elastic (Above 1) e.g. XED = +5
– The goods are strong substitutes
XED Positive and Inelastic (0-1) : e.g. XED = +0.5
– The goods are weak substitutes
XED Negative and Elastic (Above 1) e.g. XED = -5
– The goods are strong complements
XED Negative and Inelastic (0-1) e.g. XED = -0.5 :
– The goods are weak complements
XED = 0 : No relationship
Cross price elasticity of demand along a number line
Substitute Goods
Complementary Goods
Close/strong
-1
Perfectly Elastic
Not
Close/Weak
Not
Close/Weak
0
Perfectly
Inelastic
Un-related
Close/Strong
+1
Perfectly Elastic
Summary of the Cross-Price Elasticity of Demand
If the
products are…
then the crossprice elasticity of
demand will be…
Example
substitutes
positive
Two brands of tablet
computers
complements
negative
Tablet computers and
applications downloaded from
online stores
zero
Tablet computers and peanut
butter
unrelated
•
© 2015 Pearson Education, Inc.
Table 6.4
•Summary of cross-price
elasticity of demand
43
Example of Calculating XED
•
•
Calculating XED in the case of
substitutes
Suppose the price of coffee increases
from $10 per kilogram (kg) to $12 per kg
and the amount of tea purchased
increases from 1500 kg to 1650 kg. What
is the XED?
•
•
•
• XED is +0.5; the positive sign tells us
that coffee and tea are substitutes.
• Two goods with XED of 0.8 are close
substitutes than two goods with a
XED of 0.5
•
Calculating XED in the case of
complements
Suppose the price of pencils increases
from $1.00 per pencil to $1.30 and the
quantity of erasers purchased falls from
1000 erasers to 800. What is the XED?
XED is –0.67; the negative sign tells us
that pencils and erasers are
complements.
Two goods with a XED of −0.8 are
stronger complements than two goods
with a XED of −0.5.
Coca-Cola® and Pepsi® are substitutes. Let’s
consider what happens to the demand for Pepsi,
as the price of Coca-Cola changes. If the price of
Coca-Cola increases, the quantity of Coca-Cola
demanded falls, and the demand for Pepsi
increases as consumers switch from Coca-Cola to
Pepsi, and there results a rightward shift in the
demand curve for Pepsi. If the price of Coca-Cola
falls, the quantity of Coca-Cola demanded
increases, and the demand for Pepsi falls as
consumers now switch from Pepsi to Coca-Cola;
there results a leftward shift in Pepsi’s demand
curve.
If the price of tennis rackets increases, the quantity
of tennis rackets demanded falls, and since tennis
rackets are used together with tennis balls, the
demand for tennis balls also falls; there will
therefore be a leftward shift in the demand curve
for tennis balls. If there is a fall in the price of
tennis rackets, the quantity of tennis rackets
demanded increases, and the demand for tennis
balls also increases; the demand curve for tennis
balls will shift to the right.
Substitute Goods and XED
Substitute Goods and XED
 Explanation of XED (Tea and coffee)
– % change in Q.D. = (210-200)/200 = 10/200 = 5%
– % change in price (1.5-1.2)/1.2 = 0.3/1.2 = 25%
• Weak substitutes like tea and coffee will have a low cross elasticity of
demand. If the price of tea increases, it will encourage some people to
switch to coffee. But for most people, their preference for a particular
drink is more important than a small difference in price
• For two alternative brands, for example, Starbucks Coffee and Costa
Coffee, these goods are closer substitutes as the difference is much
smaller. If the price of Costa Coffee increases, more consumers will
switch to an alternative brand such as Starbucks. With close
substitutes, the XED will be higher.
• The aim of advertising is to increase brand loyalty and make consumers
less willing to switch to another brand – even if price rises.
Complementary Goods and XED
These are goods which are used together, therefore the cross elasticity of
demand is negative. If the price of one goes up, you will buy less of both goods.
Complementary Goods and XED
• These are goods which are used together, therefore the cross
elasticity of demand is negative. If the price of one goes up, you
will buy less of both goods.
• If the price of tea increases, there will only be a very small fall in
demand for milk. It will have a negative cross elasticity of
demand, but it will be a low figure.
• However, for two goods like Android Phones and Android Apps,
there is a stronger relationship. If the price of Android Phones
increases, this will reduce the demand for Android Phones and
therefore, there will be less demand for Android Apps.
NOW Test yourself
 In each of the following cases, calculate the income elasticity of
demand and comment upon your answer:
(a) A 7% increase in real incomes causes a 21% fall in demand for a
supermarket’s own brand of chocolate biscuits.
Answer:
−3 (inferior).
(b) A 10% increase in real incomes causes a 25% increase in demand for
holidays to Barbados.
Answer:
2.5 (normal/luxury).
(c) An 8% fall in real incomes leads to a 32% fall in demand for fillet steak.
Answer:
4 (normal/luxury).
 In each of the following cases calculate the cross elasticity of demand
and comment upon your answer:
(a) A 20% rise in the price of butter leads to a 15% rise in the demand for
margarine.
Answer:
0.75 (substitutes).
(b) A 10% rise in the price of strawberries leads to an 8% fall in the demand
for fresh cream.
Answer:
−0.8 (complements).
The Price Elasticity of Supply and Its
Measurement
•
6
LEARNING
OBJECTIVE
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6
Define price elasticity of supply and understand its main determinants and how it is
measured.
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Price Elasticity of Supply (PES)
 Price elasticity of supply is very much analogous (similar) to price
elasticity of demand:
Price elasticity of supply 
Percentage change in quantity supplied
Percentage change in price
 Price Elasticity of Demand
Price elasticity of demand 
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Percentage change in quantity demanded
Percentage change in price
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Price Elasticity of Supply (PES)
• Until now, we have been studying demand elasticities, all of which
involve consumer responses. We now turn to examine price elasticity of
supply, which concerns firm (business) responses to changes in price.
• According to the law of supply, there is a positive relationship between
price and quantity supplied: when price increases, quantity supplied
increases and vice versa. But by how much does quantity supplied
change?
 The law of supply states that when there is an increase in price (ceteris paribus),
producers will increase the quantity supplied & vice versa
– Economists are interested in how much the quantity supplied will increase
 Price elasticity of supply (PES) reveals how responsive the change in quantity
supplied is to a change in price
– The responsiveness is different for different types of products
 “Price elasticity of supply (PES) measures the responsiveness of the quantity supplied of
a product following a change in its price”.
• In other words, an increase in the market price will induce firms to supply more output to
the market.
oSupply Elastic: Supply is said to be price elastic if producers can quite easily increase
supply without a time delay if there is an increase in the price of the product. This can
help to give such firms a competitive advantage, as they are able to respond to changes
in price.
oSupply Inelastic: By contrast, supply is price inelastic if firms find it difficult to change
production in a given time period when the market price changes.
Interpreting PES Values
Value
Name
Explanation
0
Perfectly
In-elastic
The QS is completely
unresponsive to a change in P
(e.g. fixed number of seats in a
theatre)
PES = 0
The Quantity Supplied doesn’t
change as the price changes.
0-1
Relatively
In-elastic
The %∆ in QS is less
than proportional to the %∆ in
P (e.g. agricultural products)
0 < PES < 1
Quantity Supplied changes by
a lower percentage than a
percentage change in price
Diagram
Interpreting PES Values
Value
Name
Explanation
1→ ∞
Relatively
Elastic
The %∆ in QS is more
than proportional to
the %∆ in P (e.g. tshirts)
∞
Perfectly
Elastic
The %∆ in QS will fall
to zero with any %∆ in
P. However, supply is
unlimited at a
particular price. This is
a very theoretical
scenario
Diagram
Interpreting PES Values
Value Name
1
Unitary
Elastic
Explanation
Any supply curve that
starts at the origin (e.g.
S1, S2 or S3) has a PES
value equal to 1.
The %∆ in P = %∆ in QS
PES = 1, Quantity
Supplied changes by
the same percentage
as the change in price
Diagram
o Inelastic supply – a change in price causes a smaller proportional change in quantity
supply
o Elastic supply – a change in price causes a bigger proportional change in supply
 If the price of a cappuccino increases by 10%, and the supply increases by 20%. We say
the PES is 2.0.
 If the price of bananas falls 12% and the quantity supplied falls 2%. We say the PES =
2/12 = 0.16
Inelastic supply: This means that an increase in price leads to a smaller % change in
supply. Therefore PES <1
In this case the PES =
% change in Q.S. = (64-60)/60 = 0.06666
% change in price = (106-80)/80 = 0.325
PES = 0.2
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Supply could be inelastic for the following reasons
Firms operating close to full capacity.
Firms have low levels of stocks, therefore there are no surplus goods to sell.
In the short term, capital is fixed in the short run e.g. firms do not have time to
build a bigger factory.
If it is difficult to employ factors of production, e.g. if highly skilled labour is
needed
With agricultural products, supply is inelastic in the short run, because it takes
at least six months to grow new crops. In September the farmer cannot
suddenly produce more potatoes if the price goes up.
Examples of goods with inelastic supply
Nuclear reactors – It takes considerable time and expertise to build a new
reactor. If there is high demand, few firms would be able to increase output in
quick time
Grapes – Harvest is once a year, so in short-term, supply would be very
inelastic.
Flood defences – If there is heavy rainfall and flooding, there would be high
demand for flood defences. But, to supply barriers against the floods cannot
occur overnight. It will take many months of construction to build.
During an economic boom when demand for the goods is very high and firm is
running out.
• Elastic supply :This occurs when an increase in price leads to a bigger %
increase in supply, therefore PES >1
PES
% change in Q.S. = 110-60/60 = 0.8333
% change in Price = 106-80/80 = 0.325
PES = 2.56
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Supply could be elastic for the following reasons
If there is spare capacity in the factory.
If there are stocks available.
In the long run, supply will be more elastic because capital can be varied.
If it is easy to employ more factors of production.
If a product can be sold from the internet which increases the scope of
international competition and increases options for supply.
Examples of goods with elastic supply
Fidget spinners. These goods are relatively easy to make, requiring only
basic raw materials of plastic. Many manufacturing firms could easily
adapt production to increase supply.
Taxi services. It is relatively easy for people to work as a taxi driver.
People can work part-time and only need a qualified driving license.
With mobile apps like Uber, it has also become easier to fit consumers
with a broader range of options. If price rises, Uber can offer higher
wages and encourage more people to come out to work. There are still
some supply constraints on very popular days. But, mostly, supply is
quite elastic.
During recession and excess supply. In a recession with a fall in demand,
the firm will have unsold goods and a large stock.
Importance of elasticity of supply
If supply is elastic, an increase in
demand will cause only a small rise in
price, but a significant increase in
demand.
If supply is inelastic, an increase in
demand will cause a large rise in price
but only a small increase in demand.
Calculating PES
 This is a measure of the responsiveness of producers to price
changes. Since there is always a direct relationship between price
and quantity supplied, the PES coefficient will always be positive.
• PES can be calculated using the same formula as the other types
of elasticity:
 𝑃𝐸𝑆= 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑠𝑢𝑝𝑝𝑙𝑖𝑒𝑑
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑝𝑟𝑖𝑐𝑒
 PES = %∆ 𝑄𝑆
%∆𝑃
 PES will always be positive, since there is a direct relationship
between the price of a good and the quantity firms wish to supply.
Example of Calculating PES
Example 2:
The price of tablet computers rises from $400 to $500In the week that follows, the
quantity rises from 1 million to 1.1 million. In the three months that follow, the quantity
rise from 1 million to 2 million.
PES in the short-run (1 week after price change)
𝑃𝐸𝑆 𝑆𝑅 = 1.1−1 ÷
500-400 = 0.1 = 0.4
1
400
0.25
PES in the long-run (3 months after price change)
𝑃𝐸𝑆 𝐿𝑅 = 2−1 ÷ 500−400 =
1
= 4
1
400
0.25
Example 2 of Calculating PES
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In recent months, the price of avocados has increased from £0.90 to £1.45. Bewdley
Farm Shop in Wales have sought to maximize their profits by increasing the quantity
supplied to market. They have been able to increase the supply of avocados from 110
units a week to 120 units a week. Calculate the PES of avocados & explain one reason
for the value.
Step 1: Calculate the % change in QS
Step 2: Calculate the % change in P
Step 3: Insert the above values in the PES formula
Step 4: Explain one reason for the value
The PES value of 0.15 indicates that avocados are very price inelastic in supply. Even
with a significant increase in price, suppliers are unable to supply more likely due to the
time it takes to grow additional avocados.
The Determinants of PES
• The factors that determine the responsiveness are called the determinants
of PES & include:
1. Mobility of the factors of production: if producers can quickly switch
their resources between products, then the PES will be more elastic. For
example, if prices of hiking boots increase & shoe manufacturers can
switch resources from producing trainers to boots, then boots will
be price elastic in supply
2. Availability of raw materials: if raw materials are scarce then PES will be
low (inelastic). If they are abundant, PES will be higher (elastic)
3. Ability to store goods: if products can be easily stored then PES will be
higher (elastic) as producers can quickly increase supply (for example,
tinned food products). An inability to store products results in lower
PES (inelastic)
4. Spare capacity: if prices increase for a product & there is capacity to
produce more in the factories that make those products, then supply will
be elastic. If there is no spare capacity to increase production, then
supply will be inelastic
5. Time period: In the short run, producers may find it harder to respond to
an increase in prices as it takes time to produce the product (e.g.,
avocados). However, in the long run they can change any of their factors
of production so as to produce more
The Significance of PES for Stakeholders
 Businesses (Firms; Producers)
• If producers have a high PES (elastic) then they are able to respond to increases in
price very quickly
– This is desirable as it means producers can increase revenues & profits if they can
supply more
– Firms can increase their PES by:
• Creating more spare capacity on their production lines
• Maintaining larger inventories
• Using more modern technology
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If producers have a low PES (inelastic) then they are less able to respond to increases in
price
This shortage in supply will mean that prices continue to rise, possibly
causing inflation in the economy
 Governments
• Governments are very interested in the PES of key markets in the economy as they
want to ensure that these markets can respond quickly to rising demand
– One e.g. is the housing market. If the PES of housing is low (inelastic), property
prices will become unaffordable with any increase in demand
– Another e.g. is the labour market. If the PES of labour is low (inelastic) then
production costs of firms will rise quickly during periods of increasing demand
when firms need to hire additional workers
Summary of Elasticities
Cross-Price Elasticity of Demand
Formula :
Percentage change in quantity demanded of one good
Percentage change in price of another good
Types of Products
Value of Cross-Price Elasticity
Substitutes
Positive
Complements
Negative
Unrelated
Zero
Income Elasticity of Demand
Formula :
Percentage change in quantity demanded
Percentage change in income
Types of Products
Value of Income Elasticity
Normal and a necessity
Positive but less than 1
Normal and a luxury
Positive and greater than 1
Inferior
Negative
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Table 6.7
•Summary of elasticities
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Summary of Elasticities
Price Elasticity of Supply
Formula :
Percentage change in quantity supplied
Percentage change in price
Value of Price Elasticity
Elastic
Greater than 1
Inelastic
Less than 1
Unit elastic
Equal to 1
Table 6.7
© 2015 Pearson Education, Inc.
Summary of elasticities
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