Section 2.
2: Price Elasticity, Income
Elasticity and Cross Elasticity of Demand
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Learning Goals
• 2.2.1 definition of price elasticity, income elasticity and cross elasticity of demand (PED,
YED, XED)
• 2.2.2 formulae for and calculation of price elasticity, income elasticity and cross elasticity of
demand
• 2.2.3 significance of relative percentage changes, the size and sign of the coefficient of:
price elasticity of demand, income elasticity of demand, cross elasticity of demand
• 2.2.4 descriptions of elasticity values: perfectly elastic, (highly) elastic, unitary elasticity,
(highly) inelastic, perfectly inelastic
• 2.2.5 variation in price elasticity of demand along the length of a straight-line demand
curve
• 2.2.6 factors affecting: price elasticity of demand, income elasticity of demand, cross
elasticity of demand
• 2.2.7 relationship between price elasticity of demand and total expenditure on a product
• 2.2.8 implications for decision-making of price elasticity, income elasticity and cross
elasticity of demand
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Elasticity
Elasticity shows how sensitive quantity is
to a change in price.
Introduction to Elasticities
Elasticity is an economic concept which refers to the responsiveness among consumers or
producers to a change in a variable which affects either the market demand or the market
supply. There are four types of elasticity that we will study in this unit:
• Price Elasticity of Demand (PED): Measures the responsiveness of consumers of a
particular good to a change in the good’s price.
• 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).
• Income Elasticity of Demand (YED): Measures the responsiveness of consumers of a
particular good to a change in their income.
• Price elasticity of Supply (PES): Measures the responsiveness of producers of a
particular good to a change in the price of that good.
Elasticity is a numerical measure of the responsiveness of Qd or
Qs to one of its determinants.
If price rises by 10% - what happens to demand?
• We know demand will fall,
• By more than 10%?
• By less than 10%?
Elasticity measures the extent to which demand will change
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Price Elasticity of Demand (PED)
Price Elasticity of Demand-
• Measurement of consumers
responsiveness to a change in price.
Who cares?
• Used by firms to help determine prices
and sales
• Used by the government to decide how to
tax
Inelastic Demand
Inelastic Demand
INelastic Demand= Quantity is
INsensitive to a change in price
•If price increases, quantity demanded
will fall a little 20%
•If price decreases, quantity demanded
increases a little
In other words, people will continue to
buy it.
5%
A INELASTIC demand curve is steep! (looks like an “I”)
Examples:
•Gasoline •Medical Care
•Milk •Toilet paper
Elastic Demand
Elastic Demand
Elastic Demand = Quantity is
sensitive to a change in price.
•If price increases, quantity demanded
will fall a lot
•If price decreases, quantity demanded
increases a lot
In other words, the amount people buy is
sensitive to price.
An ELASTIC demand curve is flat!
Examples:
•Soda •Real Estate
•Boats
•Beef
Price Elasticity of Demand
Price elasticity Percentage change in Qd
=
of demand Percentage change in P
• Price elasticity of demand measures how much Qd
responds to a change in P.
Loosely speaking, it measures the price-sensitivity of buyers’
demand
Do price changes impact Qd a lot or a little
Calculating Percentage Changes in Quantity Demanded
Standard method
Demand for soda of computing the
percentage (%) change:
P end value – start value
x 100%
start value
B
$21
A
$20
% change in Qd
Q -.1 million
9.9 10
x 100% = -1%
Q- millions 10 million
Calculating Percentage Changes in Price
Standard method
Demand for soda of computing the
percentage (%) change:
P end value – start value
x 100%
start value
B
$21
A
$20
% change in Price
Q 1
9.9 10
x 100% = 5%
Q- millions 20
Now you can Calculate PED
Demand for soda Price elasticity Percentage change in Qd
of demand =
Percentage change in P
P
B
$21
PED
A
$20
1%
= .2
5%
Q
9.9 10
Q- millions
Price Elasticity of Demand
Price elasticity Percentage change in Qd
=
of demand Percentage change in P
P
Along a D curve, P and Q move
in opposite directions, which P2
would make price elasticity
negative. P1
We will drop the minus sign D
and report all price elasticities Q
as positive numbers. Q2 Q1
Price Elasticity of Demand
Price elasticity Percentage change in Qd
=
of demand Percentage change in P
P
Example:
P rises
Price elasticity P2
by 10%
of demand P1
equals
D
15% Q
= 1.5 Q2 Q1
10%
Q falls
by 15%
Interpreting PED
Price elasticity of demand is used to see how sensitive the demand
for a good is to a price change.
A very high PED suggests that when:
•The price of a good goes up, consumers will buy a great deal less of it
and
•When the price of that good goes down, consumers will buy a great
deal more.
A very low PED implies just the opposite, that
•Changes in price have little influence on demand.
