MANAGERIAL ECONOMICS PROF. D.
TRIPATI RAO
LECTURE 5 – PRICE AND INCOME ELASTICITY
Elasticity of demand
The responsiveness of QD of a commodity/ factors with respect to the change in factors
affecting it measured in percentage terms.
We consider three elasticities of demand in terms of decision making:
Price Elasticity (own)
Income Elasticity
Cross-price Elasticity
Price Elasticity of Demand
The price elasticity of demand is a measure of how sensitive the quantity demanded of it to
its price. Mathematically, it is the percent change in QD due to unit percent change in price.
∈P = % change in QX / % change in PX
∈P = (ΔQX/QX*100)/(ΔPX/PX*100)
∈P = (PX/QX) * (ΔQX/ ΔPX)
PeD (∈) is reciprocal of the slope of DD curve weighted by the ratio of PX to QX.
PeD (∈) will vary along the linear DD curve
Slope and elasticity are not the same!
All points on the DD curve have same slope but different elasticities as shown in the
diagram.
MANAGERIAL ECONOMICS PROF. D. TRIPATI RAO
Inelastic Demand (0< ∈ < 1)
When demand is inelastic, an increase in price of the commodity leads to an increase in total
revenue from the good, i.e., price and total revenue move in same direction.
Elastic Demand (∈ >1)
When demand is elastic, an increase in price of the commodity leads to a decrease in total
revenue from the good, i.e., price and total revenue move in opposite direction.
Point Elasticity
We estimate point elasticity when price and quantity demanded are infinitely small and it is
associated with a particular point on the DD curve.
point elasticity = dQX/dPX * PX/QX
Arc Elasticity
We estimate arc elasticity to measure responsiveness of QD to a discrete change in price, i.e.,
approximation to average price/quantity changes.
∈arc = (Q1 – Q2/ P1 – P2 )* (P1+P2/Q1+Q2)
MANAGERIAL ECONOMICS PROF. D. TRIPATI RAO
Factors affecting Demand Elasticity
Ease of substitution (+)
Proportion of total expenditure (+)
Durability (+)
Possibilities of repair (+)
Used product market (+)
Length of time period (+)
Income Elasticity
The income elasticity of demand is a measure of how sensitive the quantity demanded of it to
the consumer income. Mathematically, it is the percent change in QD due to unit percent
change in consumer income.
Point Income Elasticity
θ = (% ΔQX / % ΔIX) or (dQX/dI * I/QX)
Arc Income Elasticity
θ = (Q1 – Q2 / I1 – I2) * (I1 + I2/Q1 + Q2)
Cross-Price Elasticity
The cross-price elasticity of demand of a good X is a measure of how sensitive the quantity
demanded of it to price of some other good Y. Mathematically, it is the percent change in QD
of X due to unit percent change in price of good Y.
Point Cross-price Elasticity
η = % ΔQX / % ΔPY or dQX/dPY* PY/QX
Arc Cross-price Elasticity
η = (Q1X – Q2X/P1Y – P2Y) * (P1Y + P2Y/Q1X+Q2X)
for substitutes & complementary goods η will be (normally) positive and negative
respectively
Price Elasticity of Supply
It is a measure of responsiveness of quantity supplied of the good QS with respect to the
change in price of the good, in percentage terms.
∈s = % change in Qs / % change in PX
