Price Elasticity

of Demand
Shirley A. Enriquez
 Meaning of Price Elasticity of
Demand
The Price Elasticity Coefficient and
Formula
Factors Affecting Price Elasticity of
Contents Demand
Meaning of Price Elasticity of
Supply
Cross Elasticity of Demand and
income elasticity of demand
 Meaning of Price Elasticity of Demand

It refers to the responsiveness (or

sensitivity) of consumers to a
price change.
 • Elastic - change in price of Goods or services
results to a greater change in quantity
demanded for that good or service. (>1)
• Inelastic - change in price of Goods or services
results to a lesser change in quantity
Types of demanded for that good or service. (<1)
• Unitary - change in price of Goods or services
Elasticity of results to an equal change in quantity
demanded for that good or service. (=1)
Demand • Perfectly Elastic - No change in Price results
to infinite change in QD.
• Perfectly Inelastic – change in Price has no
effect (no change) in QD.
 Percentage change in
ED = quantity demanded of product X
Percentage change in price of product X
Price
Elasticity Change = current minus previous
Coefficient
and Formula
The percentage change in the equation are
calculated by:

• Dividing the change in quantity demanded by the original quantity

demanded and by dividing the change in price by the original price. So we
get the formula:
• Ed = change in quantity demanded of X
original quantity demanded of X / change in price of X
original price of X
100-50 = 50
50-25 = 25 = 50/25 = 2
Using the Mid-point formula in calculating Price
elasticity of demand

• Ed = change in quantity change in price

sum of quantities/2 x100 sum of prices/2 x100
Sample problem #1
If the price of a product changes by P2 (from P7 to P9) and the quantity
demanded changes by 10 units (from 40 to 50 units) then the price
elasticity of demand using the midpoint approach is________.
Solution:
%change of QD = [(50-40)/(50+40)/2] = (10/45)100 = 22.2%
%change of Price = [(9-7)/(9+7)/2] = (2/8)100 = 25%
Ep (Price Elasticity) = [22.2%]/[25%] = 0.89% Inelastic
Sample problem #2
Given: In March 2019 the price of 1 box of face
mask was P250, however in March 2020, its price
increased to P500 per box. With this prices, the
quantity demanded in 2019 was 500 boxes per
day, but in 2020 due to this pandemic since it was
a regulation to wear mask, the quantity demand
increased to 2000 boxes per day. Calculate the
price elasticity of demand.
Solution
%change of QD = [(2000-500)/(2000+500)/2] = (1500/1250)100
=120%
%change of Price = [(250)/(500+250)/2] = (250/375)100 = 66.67 %
Ep (Price Elasticity) = [120%]/[66.67%] = 1.80%
 1 2 3 4
Question 1 Suppose that a store Using the mid-point Make sure that you
decreases the price of approach, calculate include a negative
laundry detergent from
4.5 to 3.8. As a result,
the percentage sign if necessary.
quantity demanded change in price.
increases from 220 to
270.
Solution
%change of QD = [(270-220)/(270+220)/2] = (50/245)100 = 20.4%
%change of Price = [(3.8-4.5)/(3.8+4.5)/2] = (-0.7/4.15)100 = -16.86
%
Ep (Price Elasticity) = [20.4%]/[-16.86 %] = -1.21%
Factors that Determine Demand Elasticity

Substitutability

Proportion of income

Luxuries versus necessities

Time
 If the QS by producers is
Price relatively responsive to
Elasticit price changes, supply is
elastic. If it is relatively
y of incentive to price
changes, supply is
Supply inelastic.
Note:
The degree of price elasticity of supply depends on how easily
and therefore quickly producers can shift resources between
alternative uses. The easier and more rapidly producers can
shift resources between alternative uses, the greater the price
elasticity of supply.
Illustration:
E = %change in QS of X divided by %change in price of product X

Given: Suppose an increase in the price of a good from 4 to 6

increases the quantity supplied from 10 units to 14 units. The
%change in price would be 2/5 or 40%, and the % change in quantity
would e 4/12 or 33 percent.
E = .33/.40 = .83
 Cross elasticity of
Cross demand – measures
Elasticity and how sensitive
consumer purchases
Income of one product (X) are
Elasticity of to a change in the
price of some other
Demand product
Formula for
Cross
Elasticity of
Demand
This cross-elasticity (or cross price
elasticity) concept allows us to
quantify and more fully understand
substitute and complementary
goods. Unlike price elasticity, we
allow the coefficient of cross
elasticity of demand to be either
positive or negative.

.
Positive Exy means the goods or service are
substitute goods. This means that sales of X move
in the same direction as a change in the price of Y.

Negative Exy means that Goods X and Y are

Complementary Goods. This means that an
increase in price of one product decreases the
demand for the other product.

Zero Exy suggests that two products being

considered are unrelated or independent goods.
Explanations:
Substitute Goods. Two
products Apples and banana.
An increase in the price of
apples causes consumers to
buy more bananas resulting to
positive cross elasticity.
Complementary
goods
• Complementary goods. If the price of
one good increases, demand for both
complementary goods will fall. The more
closely linked the goods are, the higher
will be the cross elasticity of demand.
• If they are weak complementary goods
then there will be a low cross elasticity of
demand. For example, if the price of tea
increases it will only have a marginal
impact on reducing demand for tea and
consumption of milk.
• However, if the price of Android Phones
increases, it will negatively affect sales and
therefore reduce demand for Android
Apps.
 Complementary Goods

• Complementary goods are products which are used

together.
• Examples
• DVD player and DVD disks to play in it.
• Tennis balls and tennis rackets.
• Mobile phones and mobile phone credit for making calls.
• iPhone and Apps to use with an iPhone.
• Petrol and car.
How firms make use of complementary goods

• Increase related sales.

Supermarkets will place related food items close to each other. For
example, next to pasta – expensive pasta sauces. The firm hopes to
increase overall sales by suggesting possible related complementary goods.

• Gain loyal consumers to make related sales.

Another strategy a firm can implement is to offer a base product at a
low price, knowing that if consumers buy ‘base product’ they can increase
sales of related (and profitable) add-on items. For example, the owners of
PlayStation have an incentive to cut the price of the PlayStation itself. If
they do, they know they will make increases sales of licensed games, and
this increase in revenue will offset the fall in revenue from a lower price.
 Example 1: cross elasticity and complements

Given: the price of product Y from Php 200 to Php 600. The demand for
Product X have decreased from 2,000 units to 800 units.
Calculate the cross elasticity of demand and explain the meaning of the
computed coefficient.

Solution:
= (600 − 200) ÷ [(600+200) ÷ 2] = 100% Percentage increase in quantity
Sample demanded of product X
= 400 /400X100 = 100%
Computations:
= (800 − 2,000) ÷ [(800+2000) ÷ 2] = -85.71%
= -1200/1,400=-.8571x100 = -85.71%

Cross elasticity of demand = % change in quantity demanded ÷ % change in

price

= -85.71% ÷ 100%
= -0.86
Therefore: products X and Y are complements
Given: the price of product Y from Php 200 to Php 600. The demand for Product X
have decreased from 2,000 units to 800 units.
Calculate the cross elasticity of demand and explain the meaning of the computed
coefficient.

Solution:
= (600 − 200) ÷ [(600+200) ÷ 2] = 100% Percentage increase in quantity demanded of
product X
= 400/800/2= 400/ 400 *100% = 100%

= (800 − 2,000) ÷ [(800+2000) ÷ 2] = -85.71%

Cross elasticity of demand = % change in quantity demanded ÷ % change in price

= -85.71% ÷ 100%
= -0.86
Therefore: products X and Y are complements
 Seat work:
Given:
• The quantity demanded for product A has
increased by 12% in response to a 15% increase
in price of product B. Calculate the cross
elasticity of demand and tell whether the product
pair is (a) apples and oranges, or (b) cars and gas.
Answer to seat work:
• Cross elasticity of demand
= % change in quantity demanded of A ÷ % change in price of B
= 12% ÷ 15%
= 0.8%
The income elasticity of
demand measures the Income
responsiveness of the Elasticity of
demand for a good or
service to a change in
Demand
income.
• Normal Good/Services (Superior) = increase in income results to
increase in the demand of these goods/service; decrease the demand
for inferior goods/service
• Inferior Goods/Service = decrease in income results to increase in
demand for inferior goods; decrease the demand for normal/superior
goods/service
• The income elasticity of demand (YED) measures the responsiveness
of demand for a good to a change in the income of the people
demanding that good, ceteris paribus. It is calculated as the ratio of the
percentage change in demand to the percentage change in income:
• YED=%change in quantity demanded/ % change in real income
Income Elasticity of Demand Formula

Note: Follow the Midpoint method in computing for the income

elasticity of demand.
 For most products, most of the time, the income elasticity of
demand is positive: that is, a rise in income will cause an increase
in the quantity demanded. This pattern is common enough that
these goods are referred to as normal goods. However, for a few
goods, an increase in income means that one might purchase less of
the good; for example, those with a higher income might buy fewer
Positive, hamburgers, because they are buying more steak instead, or those
with a higher income might buy less cheap wine and more imported
Normal, beer. When the income elasticity of demand is negative, the good is
called an inferior good. The concepts of normal and inferior goods
Inferior were introduced in the Supply and Demand module. A higher level
of income for a normal good causes a demand curve to shift to the
Goods right for a normal good, which means that the income elasticity of
demand is positive. How far the demand shifts depends on the
income elasticity of demand. A higher income elasticity means a
larger shift. However, for an inferior good—that is, when the
income elasticity of demand is negative—a higher level of income
would cause the demand curve for that good to shift to the left.
Again, how much it shifts depends on how large the (negative)
income elasticity is.
Example 1

• Country A has experienced exceptional growth in recent years. Its

GDP per capita has increased from around P30,000 to P50,000 in last
5 years. Over the period quantity demanded of personal cars has
increased from 450,000 units per year to 600,000 units. Quantity
demanded of public transport, however, has declined from 10,000
buses to 7,000 buses. Calculate income elasticity of demand and tell
which product is a normal good and which one is inferior.
 Solution
• Percentage increase in income level
= (50,000-30,000) ÷ {(50,000+30,000)/2}
= 50%
• Percentage increase in quantity demanded of cars
= (600,000-450,000) ÷ {(600,000+450,000)/2}
= 28.57%
• Percentage increase in quantity demanded of buses
= (7,000-10,000) ÷ {(7,000+10,000)/2}
= -35.29%
• Income elasticity of demand of cars
= 28.57%/50%
= 0.57
• Income elasticity of demand of buses
= -35.29%/50%
= -0.71
Since cars have positive income elasticity of
demand, they are normal goods (also called
superior goods) while buses have negative income
elasticity of demand which indicates they are
inferior goods.
Seat work:
Given: Your income have increase
from 150,000 to 400,000 in a year.
Your demand for product x have also
increased from 5000 units to 9500
units. Compute for the income
elasticity of demand. Determine
whether the product is normal or
inferior one.
Solution: