CHAPTER 6
Elasticity
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
CHAPTER OUTLINE
LEARNING OUTCOMES
6.1 INTRODUCTION
6.2 THE PRICE ELASTICITY OF DEMAND
6.3 OTHER DEMAND ELASTICITIES
6.4 THE PRICE ELASTICITY OF SUPPLY
6.5 ELASTICITY: A SUMMARY
IMPORTANT CONCEPTS
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
LEARNING OUTCOMES
Once you have studied this chapter you should be able to
• Define elasticity
• Explain the meaning and significance of price elasticity of demand
• Distinguish between five categories of price elasticity of demand
• Explain the determinants of price elasticity of demand
• Define income elasticity and cross elasticity of demand
• Explain the meaning and significance of price elasticity of supply
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.1 Introduction
6.1 INTRODUCTION
We have analysed the direction of
change when demand or supply
changes. Now let’s analyse the size of
those changes.
By how much will price and quantity change if
demand or supply changes?
How will a change in the price of a good or service
affect the total amount that consumers plan to
spend on that particular good or service?
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.1 Introduction (cont.)
LO: Define elasticity
A general definition of elasticity
The percentage change in a dependent variable (the variable that
is affected) if the relevant independent variable (the one that
causes the change) changes by one per cent.
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.1 Introduction (cont.)
LO: Define elasticity
Four types of elasticity
Price elasticity
of demand
Price
elasticity
of supply
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
Cross
elasticity
of demand
Income
elasticity
of demand
6.2 The price elasticity of demand
LO: Explain the meaning and significance of price elasticity of demand
6.2 THE PRICE ELASTICITY OF DEMAND
Price elasticity of demand
The ratio between the percentage change in the quantity supplied of a good
(the dependent variable) and the percentage change in the price of the
good (the independent variable), ceteris paribus.
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.2 The price elasticity of demand (cont.)
LO: Explain the meaning and significance of price elasticity of
demand
Figure 6-1 The impact of different demand elasticities on the equilibrium price and quantity (p. 115)
(a) Relatively elastic demand curve
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
(b) Relatively inelastic demand curve
6.2 The price elasticity of demand (cont.)
LO: Explain the meaning and significance of price elasticity of
demand
Some important aspects regarding elasticity:
• Calculated using percentage changes (relative changes) not absolute
changes
• Enables us to compare how consumers react to changes in the
prices of different goods and services
• Strictly speaking, the measured price elasticity of demand has a
negative sign
In this book, the negative
sign is omitted
 we focus on absolute
value
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.2 The price elasticity of demand (cont.)
LO: Explain the meaning and significance of price elasticity of demand
Calculating elasticity
Point elasticity
• Measures elasticity at one specific point
• Ideal for measuring small changes
Arc elasticity
• Measures elasticity between two points
• Ideal for measuring larger fluctuations
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.2 The price elasticity of demand (cont.)
LO: Explain the meaning and significance of price elasticity of
demand
Calculating price elasticity of demand
Point elasticity
• Measures elasticity at one specific point
• Ideal for measuring small changes
∆𝑄
𝑃
𝑒𝑝 =
×
∆𝑃
𝑄
Arc elasticity
• Measures elasticity between two points
• Ideal for measuring larger fluctuations
(𝑄2 − 𝑄1 )/(𝑄1 + 𝑄2 )
𝑒𝑝 =
(𝑃2 − 𝑃1 )/(𝑃1 + 𝑃2 )
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
See Box 6-1 Summary: Price
elasticity of demand (p. 121)
6.2 The price elasticity of demand (cont.)
LO: Explain the meaning and significance of price elasticity of demand
Price elasticity of demand and total revenue (total expenditure)
Price elasticity of demand
The ratio of the percentage change in the quantity demanded of a good to
the percentage change in the price of that good, ceteris paribus.
Total revenue (or expenditure)
The price (P) of a good or service multiplied by the quantity (Q) of that good
or service sold. TR = PQ.
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
LO: Explain the meaning and significance of price elasticity of
demand
6.2 The price elasticity of demand (cont.)
A numerical example
Figure 6-2 The relationship
between price elasticity of demand
and total revenue (p. 118)
Table 6-1 The demand for cappuccinos and
total revenue from cappuccino sales (p. 117)
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.2 The price elasticity of demand (cont.)
LO: Explain the meaning and significance of price elasticity of
demand
Table 6-1 The demand for cappuccinos
and total revenue from cappuccino
sales (p. 117)
Click on the numbers below to work through the graph’s explanation
1
Plot the demand curve for the first units of coffee demanded.
2
Using the same scale for the x-axis, plot revenue against quantity
demanded below.
3
As the price decreases and the quantity demanded increases, total
revenue increases. Will this pattern continue?
4
If we continue to plot, our graphs change. At a certain point, total
revenue starts to decrease as prices fall further, despite the
quantity demanded increasing.
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
Figure 6-2 The relationship between
price elasticity of demand and total
revenue (p. 118)
RESET
6.2 The price elasticity of demand (cont.)
5
LO: Explain the meaning and significance of price elasticity of
demand
Now let’s calculate the price elasticity of demand and compare the
price elasticity of demand to total revenue. In this example, the
formula for point price elasticity is used.
6
For example:
𝑒𝑝 =
=
∆𝑄
𝑃
×
∆𝑃
𝑄
2000−4000
18
×
18−16
2000
−2000
18
×
2
2000
= -1000 × 0,009
=
=9
Remember to
ignore the
negative sign!
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
RESET
6.2 The price elasticity of demand (cont.)
LO: Explain the meaning and significance of price elasticity of
demand
7
When ep is greater than one, total revenue increases as
the quantity of cappuccinos increases.
8
When ep is equal to one, total revenue is at a maximum.
ep > 1
ep = 1
ep < 1
9
When ep is less than one, total revenue falls as the
quantity of cappuccinos increases.
This relationship holds for all downward-sloping linear
demand curves.
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
RESET
6.2 The price elasticity of demand (cont.)
LO: Distinguish between five categories of price elasticity of
demand
Different categories of price elasticity of demand
Click on the “D” for
more information
about each
category.
D
Effect on total revenue
Effect on total revenue (TR = PQ)
Meaning
(TR = PQ) when price (P)
Meaning
when price (P) changes
Effect
on
total
revenue
((TR
== =
changes
Effect
on
total
revenue
(TR
Effect
on
total
revenue
TR
Meaning
Meaning
Meaning
PQ
))when
price
((PP)()Pchanges
PQ
) when
price
) changes
PQ
when
price
changes
TR
changes
in
the
same
with Pelastic
in the demand
same or
Unitarily
Percentage change in TR changes
Percentage
change
in Q
Perfectly elastic demand
direction
as
change
inthus
P;
Perfectly
inelastic
Q does
not
change
direction
as
P;
there
is
an
Indeterminate
quantity
unitary
elasticity
of
demand
TR
changes
inunchanged
the opposite
Q is smaller than
TR
remains
is
equal
to
percentage
(e
Percentage
change
in
Q
there is for
thus
an
incentive
demand
(e
=
0)
p = ∞) Q falls
when
P
changes
incentive
suppliers
to
raise
p
(Q)
demanded
at
given
When
P
increases,
(e
=
1)
direction
to
change
in P;
percentage change in
p in P
change
isprice
greater
for suppliers
to raise
prices
(P); than
nothing
to zero;
TR therefore
also
there
is thus
an incentive
P
percentage
change
in
P
prices
demanded at a
fallstotolower
zero prices
for suppliers
fractionallyelastic
higher demand
price
Unitarily
or
0
∞
1elasticity of demand
unitary
Perfectly inelastic demand
Perfectly elastic∞
demand
0
1 (ep = 1)
(ep = 0)Inelastic
Elastic demand (e = ∞) ∞
0
1
p
(1 < ep < ∞)
demand
Inelastic
demand
Elastic demand
(0 < ep < 1)
(0
<
e
<
1)
p
00
∞∞
11
(1 < ep < ∞)
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
RESET
6.2 The price elasticity of demand (cont.)
LO: Distinguish between five categories of price elasticity of
demand
Table 6-2 Price elasticity of demand: a summary (p. 118)
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.2 The price elasticity of demand (cont.)
LO: Distinguish between five categories of price elasticity of
demand
Figure 6-3 (a) & (b) The different categories of price elasticity of demand (p. 119)
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.2 The price elasticity of demand (cont.)
LO: Distinguish between five categories of price elasticity of
demand
Figure 6-3 (c) & (d) The different categories of price elasticity of demand cont. (p. 119)
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.2 The price elasticity of demand (cont.)
LO: Distinguish between five categories of price elasticity of
demand
Figure 6-3 (e) The different categories of price elasticity of demand cont. (p. 119)
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.2 The price elasticity of demand (cont.)
LO: Distinguish between five categories of price elasticity of
demand
Determinants of the price elasticity of demand
• Substitution possibilities
• Degree of complementarity
• Type of want satisfied
• Time period
• Proportion of income spent
• Definition of the product
• Advertising
• Durability
• Number of uses
• Addiction
• Combined effect of determinants
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
See Box 6-1 Summary: Price
elasticity of demand (p. 121)
6.3 Other demand elasticities
LO: Define income elasticity and cross elasticity of demand
6.3 OTHER DEMAND ELASTICITIES
Income elasticity of demand
A measure of the responsiveness of the quantity demanded of a good to
changes in consumer income, ceteris paribus
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.3 Other demand elasticities (cont.)
LO: Define income elasticity and cross elasticity of demand
Income elasticity of demand
Q↓
Q↑
Income ↑
Income ↓
Q↓
Income ↑
Income ↓
Normal good
(0 < ey)
Luxury good
(1 < ey < ∞)
Essential good
(0 < ey < 1)
Inferior good
(ey < 0)
-∞
Q↑
0
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
1
∞
6.3 Other demand elasticities (cont.)
LO: Define income elasticity and cross elasticity of demand
Extract from Table 6-3 Some estimated income elasticities of demand in South Africa, 2003 (p. 123)
See Box 6-2 Summary: Income elasticity of demand (p. 123)
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.3 Other demand elasticities (cont.)
LO: Define income elasticity and cross elasticity of demand
Cross elasticity of demand
The responsiveness of the quantity demanded of a particular good to
changes in the price of a related good
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.3 Other demand elasticities (cont.)
LO: Define income elasticity and cross elasticity of demand
Cross elasticity of demand
Q↓
Q↑
Q↑
Q↓
Price of
related
good ↑
Price of
related
good ↓
Price of
related
good ↑
Price of
related
good ↓
Complements
(ec < 0)
-∞
Substitutes
(0 < ec)
0
See Box 6-3 Summary: Cross elasticity of demand (p. 125)
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
∞
6.4 The price elasticity of supply
LO: Explain the meaning and significance of price elasticity of
supply
6.4 THE PRICE ELASTICITY OF SUPPLY
Price elasticity of supply
The ratio between the percentage change in the quantity supplied of a
good (the dependent variable) and the percentage change in the price of
the good (the independent variable), ceteris paribus.
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
LO: Explain the meaning and significance of price elasticity of
supply
6.4 The price elasticity of supply (cont.)
Click on the “S” for more
information
about each
category.
Different categories of supply elasticity
Meaning
Meaning
Meaning
Meaning
Percentage changeMeaning
in Q is
Percentage
change
in
Q
is
Unitarily
elastic
supply or change in
Percentage
change
in
Q
Q
does
not
change
when
P
equal
to
percentage
Perfectly elastic supply
Perfectly inelastic
supply
smaller
than percentage
unitary elasticity of
supply
Any
quantity (Q) can
be
than
P
(es = ∞)
changes
(es = 0) is greater
change
in P in P(es = 1)
supplied at a given price (P)
percentage
change
Unitarily elastic supply
or elastic supply
Perfectly
Perfectly
inelastic
supply
0
∞
1elasticity of supply (e = ∞)
unitary
s
0 (es = 0)
∞
1
0
∞
1 (es = 1)
0
00
Inelastic supply
(0 < es <supply
1)
Inelastic
(0 < es < 1)
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
1
11
Elastic supply
(1 < es < ∞)
Elastic supply
(1 < es < ∞)
RESET
∞
∞∞
6.4 The price elasticity of supply (cont.)
LO: Explain the meaning and significance of price elasticity of
supply
Figure 6-4 (a) & (b) Different categories of price elasticity of supply (p. 127)
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.4 The price elasticity of supply (cont.)
LO: Explain the meaning and significance of price elasticity of
supply
Figure 6-4 (c) & (d) Different categories of price elasticity of supply (p. 127)
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.4 The price elasticity of supply (cont.)
LO: Explain the meaning and significance of price elasticity of
supply
Figure 6-4 (e) Different categories of price elasticity of supply (p. 127)
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.4 The price elasticity of supply (cont.)
LO: Explain the meaning and significance of price elasticity of
supply
The determinants of the price elasticity of supply
• The time period under consideration
• Price expectations
• Possibility of stockpiling the product
• Existence of excess capacity
• Availability of inputs
See Box 6-4 Summary: Price elasticity of supply (p. 126)
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.5 Elasticity: a summary
6.5 ELASTICITY: A SUMMARY
Table 6-4 Different elasticities: a summary (p. 128)
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
6.5 Elasticity: a summary (cont.)
Table 6-4 Different elasticities: a summary cont. (p. 128)
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
IMPORTANT CONCEPTS
• Elasticity
• Price elasticity of demand
• Elasticity coefficient
•
•
•
•
Arc elasticity
Total revenue (or expenditure)
Perfectly inelastic demand
Inelastic demand
• Unitarily elastic demand
• Elastic demand
Chapter 6 Elasticity
ECONOMICS FOR SOUTH AFRICAN STUDENTS 6e
• Perfectly elastic demand
• Slope and inverse of slope
• Determinants of price elasticity
• Income elasticity of demand
• Normal and inferior goods
• Essential and luxury goods
• Cross elasticity of demand
• Price elasticity of supply
• Elastic and inelastic supply