1.2 Elasticity
Sub-topic demand and its determinants
SL/HL Core – Assessment Objectives
Price Elasticity of Demand (PED)
Price elasticity of
Price elasticity of demand involves responsiveness of quantity demanded to a change in price, along a given demand curve.
AO4 – Calculate PED using the following equation.
PED = percentage change in quantity demanded /percentage change in price
(Example $5 to $4.50, and 200,000 to 300,000. Remember, (b-a)/a *100 = % change.
& PED value is treated as if it were positive although its value is usually negative.)
4.5
-
5.0
=
.1*100
=
10%
5.0
Change in price.
300, 000
-
200, 000
=
.5 *100
=
50%
200, 000
Change in demand
50%
=
5
10%
PED
AO2 –Explain, using diagrams and PED values, the concepts of price elastic demand, price inelastic demand, unit elastic demand, perfectly elastic demand and perfectly inelastic demand. transtutors.com
Price elasticity of demand is a measure of how much the quantity demanded for a product changes when there is a change in price of the product. (Not as steep of a slope, bottom right)
Price inelastic demand is when the change in price of the product leads to a proportionally smaller change in the quantity demanded of it. (Steeper slope on graph, bottom left)
Unit elastic demand is when the change in the price of the product leads to a proportionate, opposite, change in the quantity demanded of it. (not as steep of a slope, top middle)
Perfectly elastic demand is when the price stays the same while the quantity demanded increases, for infinity. (The graph on the top left)
Perfectly inelastic demand is when the quantity stays the same while the price keeps increasing, for infinity. (The graph to the top right)
AO2 –Explain the determinants of PED, including the number and closeness of substitutes, the degree of necessity, time and the proportion of income spent on the good.
The determinants of PED are the factors that affect on how the elasticity is defined.
The number of closeness and substitutes: The number and closeness of substitutes that are available is certainly the most important determinant of PED. The more substitutes there are for a product, the more elastic will be the demand for it. Also, the closer the substitutes available, the more elastic will be the demand.
The degree of necessity: Food is a necessary product. Indeed, if we don’t have food we will die, so it is very necessary. Thus we would expect the demand for food is to be very inelastic, which it is.
However if we define food more narrowly and considered meat, we would expect the demand for it to be less inelastic, since there are many substitutes like vegetables. If we need a product to live like water or food the PED would be very inelastic, however things like golden watches or sunglasses will be much more elastic as there are objects that are not necessary.

Time and the proportion of income spent on the good: As the price of a product changes, it often takes time for consumers to change their buying and consumption habits. PED thus tends to be more inelastic in the short term and then becomes more elastic, the longer the time period it is measured over. Also consumers will think about buying a expensive good more than of one that is cheaper, as they will need to be sure to have enough money to live. This means that they wont think about buying toilet paper for a long time as it is cheap and necessary, however about a car they will think for a longer period of time as it does take a fairly amount of their income to buy it.
AO2 –Explain why PED varies along a straight-line demand curve and is not represented by the slope of the demand curve. studypoints.blogspot.com
This is a common mistake for students to assume that elasticity is a measure of slope of the demand curve and that the value is always the same at any point of the curve. This is not the case. For a straight-line downward-sloping demand curve, the value of PED falls as price falls. Low-priced products have a more inelastic demand than high-priced products, because consumers are less concerned about when the price of an inexpensive product rises than they are when the price of an expensive product rises.
Applications of price elasticity of demand
AO2 – Examine the role of PED for firms in making decisions regarding price changes and their effect on total revenue.
The role of PED for firms is to inform them that if they choose to change the price of their product, then the % change in quantity demanded it would give them, and the revenue they will have. If a firm sees that if they raise the price and therefore sell less products, however still make a profit in the total revenue they will take the step of raising the price. But if they raise the price and they see that the total revenue would be less, then they would be logical and wont raise the price.
AO2 – Explain why the PED for many primary commodities is relatively low and the PED for manufactured products is relatively high.
* The demand for manufactured goods tends to be more elastic as there are many more substitutes available to consumers.
* Commodities is another word for raw materials, such as cotton or coffee. Such products tend to have inelastic demand as they are necessities to the consumers who buy them and they have few or no substitutes.
AO2 – Examine the significance of PED for government in relation to indirect taxes.
Governments need to be aware of the possible consequences when they impose indirect taxes, such as sales taxes, on products. If a government puts a tax on a product, then its price will usually rise.
This means that the quantity demanded of the product in question is likely to fall and this will have consequences for the employment in the industry concerned.
Cross price elasticity of demand (XED)
Cross price elasticity of
Cross price elasticity of demand involves responsiveness of demand for one good (and hence a shifting demand curve) to a change in the price of another good. demand and its determinants
AO4 – Calculate XED using the following equation.
XED = percentage change in quantity demanded of good x /percentage change in price of good y.
(Example: Quantity + 5%, Price – 10%)
5%
-
10%
= -
0.5
XED

Substitute goods have a positive value of XED and complementary goods have a negative value of
XED. The (absolute) value of XED depends on the closeness of the relationship between two goods.
Application of price elasticity of demand
AO2 – Examine the implications of XED for businesses if prices of substitutes or complements change.
The business will see how much the demand for their product might change if the prices of the substitutes or complementary goods of that product change. This means if one burger place lowers their price, the pizza place will have less demand for their product, as the people would rather buy cheaper burgers now.
Income elasticity of demand (YED)
Income Income elasticity of demand involves responsiveness of demand (and hence a shifting demand curve) elasticity of demand and its determinants to a change in income.
AO4 – Calculate YED using the following equation.
YED = percentage change in quantity demanded /percentage change in income
(Example: Income rises from 50,000 to 55,000, demand rises 7%)
55, 000
-
50, 000
=
.1*100
=
10%
50, 000
7%
=
.7
10%
YED
AO2 –Explain, using YED values, the concepts of inferior good, normal good, necessity (income inelastic) good, and luxury (income elastic) good.
Inferior goods: The value is negative, because the demand decreases as the income increases.
Normal goods: The value is positive, as the demand increases as income increases.
Necessity goods: The value is between 0 and 1, as they are products with low-income elasticity. The demand for them will change very little if income rises.
Luxury goods: The value is over greater than 1, as these are products that have high-income elasticity. The demand for them changes significantly if income rises. The more income people have, the more they start spending on products that satisfy their needs in greater number.
AO2 – Examine the implications for producers and for the economy of a relatively low YED for primary products, a relatively higher YED for manufactured products and an even higher
Applications of income elasticity of demand
Price elasticity of supply and its determinants
YED for services.
They would notice that their products are not being bought that frequently anymore, and need to rethink their pricing. The manufactures would notice that their products are suddenly getting bought even more, and might put the price up a bit more so that they wouldn’t run out of quantity as fast anymore. The same would be for the services, they would make a lot of money however they should increase the price on their services so that the consumers would not all use the services as much and focus more on the primary products.
Price elasticity of Supply (PES)
Price elasticity of involves responsiveness of quantity supplied to a change in price along a given supply curve.
AO4 – Calculate PES using the following equation.
PES = percentage change in quantity supplied /percentage change in price (Example: Price +2%,
Quantity +4%)

4%
2%
=
2
PES
AO2 – Explain, using diagrams and PES values, the concepts of elastic supply, inelastic supply, unit elastic supply, perfectly elastic supply and perfectly inelastic supply. kalyan-city.blogspot.com
Elastic supply: The value of PES is greater than one and less than infinity. If a product has elastic supply, then a change in the price of the product leads to greater than proportionate change in the quantity supplied of it, and so the value of PES is greater than one and less than infinity. (Top right)
Inelastic supply: The value of PES is less than one and greater than zero. If a product has inelastic supply, then a change in the price of the product leads to a less than proportionate change in the quantity supplied of it, and so the value of PES is greater than zero and less than one. (Bottom right)
Unit elastic supply: The value of PES is equal to one- If a product has unit elastic supply, then a change in the price of the product leads to a proportionate change in the quantity supplied of it and so the value of PES is equal to one. (Bottom left graph)
Perfectly elastic supply: is when the price stays the same while the quantity supplied increases, for infinity. (Top middle graph)
Perfectly inelastic supply: is when the quantity supplied stays the same, while the price keeps increasing, for infinity. (Top right graph)
AO2 – Explain the determinants of PES, including time, mobility of factors of production, unused capacity and ability to store stocks.
The determinants of PES are again factors that affect the elasticity of the supply of a product.
Time: The amount of time over which PES is measured will affect its value. In general terms the longer the time period considered the more elastic the supply will be.
Ability to store stocks: If a firm is able to store high levels of stock of their product, then they will be able to react to price increases with swift supply increases and so the PES for the product will be relatively elastic.
Unused capacity: If a firm has a lot of unused capacity then it will be able to increase output easily without great cost increases. It is therefore unlikely that the firm will increase supply. PES will be relatively inelastic.

Applications of price elasticity of supply
Mobility of factors of production:
If factors of production are easily moved from one productive use to another then PES will be relatively elastic.
AO2 – Explain why the PES for primary commodities is relatively low and the PES for manufactured products is relatively high.
* Commodities tend to have inelastic supply, as a change in price cannot lead to a proportionally large increase in quantity supplied.
* Consumers of Commodities tend to be manufacturing industries which process the raw material into finished products.
*The supply of manufactured goods tends to be more elastic as it is easier to increase or decrease quantity supplied in response to a change in price.