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Elasticity . . .
• … allows us to analyze supply and demand with greater
precision.
• … is a measure of how much buyers and sellers respond
to changes in market conditions

THE ELASTICITY OF
DEMAND
• The price elasticity of demand is a measure of
how much the quantity demanded of a good
responds to a change in the price of that good.
• When we talk about elasticity, that
responsiveness is always measured in
percentage terms.
• Specifically, the price elasticity of demand is
the percentage change in quantity demanded
due to a percentage change in the price.

Computing the Price Elasticity
of Demand
• The price elasticity of demand is computed as
the percentage change in the quantity
demanded divided by the percentage change in
price.
Price elasticity of demand =
Percentage change in quantity demanded
Percentage change in price

• Example: If the price of an ice cream cone
increases from $6.00 to $5.00 and the amount
you buy falls from 7 to 11 cones, then your
elasticity of demand would be calculated as:

Computing the Price
Elasticity of Demand
• Example: If the price of an ice cream cone increases
from $2.00 to $2.20 and the amount you buy falls
from 10 to 8 cones, then your elasticity of demand
would be calculated as:
( )
( . . )
.
10 8
10
100
2 20 2 00
2 00
100
20%
10%
2




 
Price elasticity of demand =
Percentage change in quantity demanded
Percentage change in price
8 10
-20
-2

The Variety of Demand
Curves
• Inelastic Demand
o Quantity demanded does not respond strongly to
price changes.
o Price elasticity of demand is less than one.
• Elastic Demand
o Quantity demanded responds strongly to changes
in price.
o Price elasticity of demand is greater than one.

The Variety of Demand
Curves
• Perfectly Inelastic
o Quantity demanded does not respond to price
changes.
• Perfectly Elastic
o Quantity demanded changes infinitely with any
change in price.
• Unit Elastic
o Quantity demanded changes by the same percentage
as the price.

Elasticity Values
0 Perfectly inelastic
1 Inelastic
1 Unit elastic
1 Elastic
Perfectly elastic









 

Figure 1 The Price Elasticity
of Demand
(a) Perfectly Inelastic Demand: Elasticity Equals 0
$5
4
Quantity
Demand
100
0
1. An
increase
in price . . .
2. . . . leaves the quantity demanded unchanged.
Price

of Demand
(b) Inelastic Demand: Elasticity Is Less Than 1
Quantity
0
$5
90
Demand
1. A 22%
increase
in price . . .
Price
2. . . . leads to an 11% decrease in quantity demanded.
4
100

of Demand
2. . . . leads to a 22% decrease in quantity demanded.
(c) Unit Elastic Demand: Elasticity Equals 1
Quantity
4
100
0
Price
$5
80
1. A 22%
increase
in price . . .
Demand

of Demand
(d) Elastic Demand: Elasticity Is Greater Than 1
Demand
Quantity
4
100
0
Price
$5
50
1. A 22%
increase
in price . . .
2. . . . leads to a 67% decrease in quantity demanded.

of Demand
(e) Perfectly Elastic Demand: Elasticity Equals Infinity
Quantity
0
Price
$4 Demand
2. At exactly $4,
consumers will
buy any quantity.
1. At any price
above $4, quantity
demanded is zero.
3. At a price below $4,
quantity demanded is infinite.

The Price Elasticity of Demand
• The sign of price elasticity of demand is
always negative, indicating the inverse
relationship

Other Demand Elasticities
• Cross-price elasticity of demand
o A measure of how much the quantity demanded of one
good responds to a change in the price of another good,
computed as the percentage change in quantity
demanded of the first good divided by the percentage
change in the price of the second good
2
good
of
price
in
%change
1
good
of
demanded
quantity
in
%change
demand
of
elasticity
price
-
Cross 

Cross Price Elasticity of
Demand
• Definition: responsiveness of quantity demand of a
good to changes in price of other goods.
• Formula:
• Sign: + for substitutes,
- for complements
%
%
dx
xy
y
Q
e
P




Calculate the cross elasticity of demand for
the two goods oranges and bananas if you
know that an increase in the price of
bananas by 20% led to an increase in the
quantity demanded of oranges by 10%?
Example

• Calculate the cross elasticity of demand
for the two goods, tea and sugar, if you
know that a 10% increase in the price of
sugar led to a 15% decrease in the
quantity demanded of tea?
Example

• Income Elasticity of Demand
o Income elasticity of demand measures how
much the quantity demanded of a good
responds to a change in consumers’ income.
o It is computed as the percentage change in
the quantity demanded divided by the
percentage change in income.

Other Demand
Elasticities
• Computing Income Elasticity
Income elasticity of demand =
Percentage change
in quantity demanded
Percentage change
in income
Remember, all elasticities are measured
by dividing one percentage change by
another

Income Elasticity of
Demand
• Definition: responsiveness of quantity demanded of a
good to changes in income
• Formula:
• Sign: + for normal goods
- for inferior goods
%
%
dx
xI
Q
I





• Income Elasticity
o Types of Goods
• Normal Goods
• Inferior Goods
o Higher income raises the quantity demanded for normal goods but lowers the
quantity demanded for inferior goods.

• If IED > 0 the good is normal
• If IED < 0 the good is bad or inferior
• If IED > 1 the good is a luxury item
• If IED < 1 the good is necessary
income elasticity of demand

• If income increases from 5,000 pounds to
10,000 pounds, the quantity demanded for
a good increases from 10 units to 20 units
(with the price constant). Calculate the
Example

• If income increases from 5,000 pounds to
10,000 pounds, the quantity demanded for
a good increases from 10 units to 15 units
(with the price constant). Calculate the
Example

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