TOPIC 5: Price Elasticity, Income Elasticity, Cross Elasticity, & Elasticity of Supply

Price Elasticity

  • Elastic when the percentage change in price resulted in a larger percentage change in quantity demanded or supplied (responsive)

  • Inelastic when the percentage change in price resulted in a smaller percentage change in quantity demanded or supplied

  • Unit Elastic when the percentage change in price resulted in an equal percentage change in quantity demanded or supplied

  • Perfectly elastic when a small change in price might cause the consumers or producers to be highly responsive

  • Perfectly inelastic means consumers and producers are not responsive at all to any price changes



Elasticity Value (E)

Description

0

Perfectly Inelastic

<1

Inelastic

=1

Unit Elastic

>1

Elastic

∞

Perfectly Elastic


Income Elasticity

  • Income elasticity of Demand is the percentage change in quantity demanded caused by a 1 percent change in income. Y = income  

  • Income-Elastic: positive income elasticity (normal good - luxury)

    • Ey > 1

    • (%) Quantity demanded > (%) Income


  • Income-Inelastic: positive income elasticity (normal good - necessity)

    • 0 < Ey < 1 

    • (%) Quantity demanded < (%) Income

  • Negative Income Elasticity: inferior good

    • Ey < 0

    • When quantity demanded decreases as income increases



Change in Income

Change in Demand

Income Elasticity

Type of Good

Increase

Increase

+

Normal

Increase

Decrease

-

Inferior

Decrease

Increase

-

Inferior

Decrease

Decrease

+

Normal


Cross Elasticity

  • Cross Elasticity of demand shows the percentage change in the quantity demanded of one good when the price of another good changes

  • Substitutes (+) A price increase in one leads to a rise in demand for the other

    • Exy > 0 

  • Complements (-) A price increase in one leads to a decrease in demand for the other

    • Exy < 0

  • Non-related: A change in the price of one does not affect the demand for the other

    • Exy = 0



Change in the price of another good

Change in demand for the first good

Cross elasticity between the goods

Relationship between the goods

Increase

Increase

+

Substitutes

Increase

Decrease

-

Complements

Decrease

Increase

-

Complements

Decrease

Decrease

+

Substitutes


Elasticity of Supply


  • Price elasticity of supply is the measure of the responsiveness of the quantity supplied of a good to changes in price

  • Perfectly Inelastic Supply

    • Es = 0 (absolutely unresponsive)

    • Unique Goods that have no substitutes or alternatives

  • Inelastic Supply: the producers limit their production even if the price increases

    • The percentage change in price is insignificant

    • 0 < Es < 1

    • (%) Quantity demanded < (%) Price

  • Unit Elastic

    • Es = 1

  • Elastic Supply: There is an increase in output produced, even if the cost incurred by the entrepreneur in making the good increases

    • There is a considerable increase in the price of goods being sold

    • Es > 1

    • (%) Quantity demanded > (%) Price

  • Perfectly Elastic Supply

    • Es = ∞



Price Elasticity of Supply

Type of Supply

= ∞

Perfectly Elastic

>1

Elastic

=1

Unit Elastic

<1

Inelastic

= 0

Perfectly Inelastic


Determinants of the Price Elasticity of Supply

  • Length of Time: the shorter the time period, the more inelastic the supply for a product, because it is harder to get additional inputs to increase production. Inversely, a longer time period results in an elastic supply

  • Production Capacity: 

    • A flexible production capacity is more elastic

    • An inflexible production capacity is more inelastic