PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

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 PRICE ELASTICITY OF DEMAND

DEFINITION:

Measures the sensitivity/responsiveness

of the quantity demanded
due to a change in its price.

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

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 DEGREE OF ELASTICITY
Perfectly Inelastic Demand
Price (RM) Inelastic Demand
A condition in which the quantity demanded does
d =0 not change as the price changes.
A large percentage of change in the price of a good
d < 1 will only affect a small percentage of change in the
Elastic Demand
quantity demanded.

A small percentage of change in the

Unitary
price of a good will leadElastic
to larger
percentage of change in quantity
d =  demanded.
Demand
Perfectly Elastic
A condition in which
Demand
percentage changes in price
equals to percentage
A condition in which a small
changes in quantity
percentage of change in
demanded.
price leads to an infinite
d = 1 percentage of change in the
d > 1 quantity demanded.

Quantity Demanded
PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved
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 Proportion
Proportion
Proportion of
Proportionof the
ofthe
of the
the
expenditure
expenditure
expenditureon
expenditure onon
onaaaa Nature
Nature of
of
Existence
Existence
Existence ofof
Existenceof of product
product
product
product goods
goods
substitutes
substitutes
substitutes
substitutes

Frequently
Frequently Income
Income level
level
purchased
purchased
products
products

Time
Time
Complementary
Complementary dimension
dimension
goods
goods Habits
Habits

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 PRICE ELASTICITY OF
DEMAND (cont.)

FORMULA:

d = %  Quantity Demanded
%  Price

d = Q2 – Q 1 x P1

Q1 P 2 – P1

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  IF THE PRICE OF PENS DECREASE FROM
RM2 TO RM1 AND THE QUANTITY DEMAND
FOR PENS INCREASE FROM 40 TO 50
UNITS, CULCULATE THE PRICE ELASTICITY
OF DEMAND

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 RELATIONSHIP TO TOTAL
REVENUE
Total Revenue (TR) = Price (P) x Quantity (Q)

The information on price elasticity of demand will be useful

Price
for the seller to adjust their selling price since it will affect
the total revenue.

RM30
DEMAND IS ELASTIC

Total Revenue
RM20 x 10 = RM200
RM20
If seller increases price to RM30
New Total Revenue
= RM30 x 5 = RM150
 TR =  RM50
D

5 10
Quantity Demanded

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  JOHN IS A COFFEE SHOP OWNER, WHOSE
BUSINESS IS DOING QUITE WELL. HE
PLANS TO INCREASE HIS TOTAL REVENUE,
SHOULD HE INCREASE OR DECREASE THE
PRICE OF A CUP OF COFFEE

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 RELATIONSHIP TO TOTAL
REVENUE (cont.)
Total Revenue (TR) = Price (P) x Quantity (Q)
Price
DEMAND IS INELASTIC

RM2 Total Revenue

RM1 x 15 = RM15
If seller increases price to RM2
RM1
New Total Revenue
= RM2 x 10 = RM20
 TR =  RM5

10 15
Quantity Demanded

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 RELATIONSHIP TO TOTAL
REVENUE (cont.)
Total Revenue (TR) = Price (P) x Quantity (Q)

Price
DEMAND IS UNITARY ELASTIC

RM2
Total Revenue
RM1 x 20 = RM20
If seller increases price to RM2
RM1 New Total Revenue
= RM2 x 10 = RM20
 TR =  0

10 20
Quantity Demanded
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 INCOME ELASTICITY OF
DEMAND

DEFINITION:

Measures the sensitivity/responsiveness

of the quantity demanded
due to a change in income.

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 INCOME ELASTICITY OF
DEMAND (cont.)

FORMULA:

Y = %  Quantity Demanded
%  Income

Y = Q2 – Q 1 x Y1

Q1 Y 2 – Y1

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 RESPONSES OF INCOME
ELASTICITY

Elastic Income
-Type of good: Luxury goods such as antique
furniture and diamonds
Income
y =0
Inelastic Income
-Type of good: Normal goods such as food
and clothing

Negative Income Elasticity

-Type of good: Giffen/ Inferior goods such
as used car and low grade potatoes

0< y < 1 Zero Income Elasticity

-Type of good: Necessity Goods such as rice
and vegetables
y > 1 y< 0
Quantity Demanded
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  IF INCOME INCREASE FROM RM1,000 TO
RM2,000 AND THE QUANTITY DEMAND FOR
THE PRODUCT INCREASE BY 20 TO 30
UNITS, CULCULATE THE INCOME
ELASTICITY OF DEMAND.

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 CROSS ELASTICITY OF
DEMAND

DEFINITION:

Measures the sensitivity/responsiveness

of the quantity demanded of one product
due to a change in the price of a related product.

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  IF THE QUANTITY DEMAND FOR CHICKEN
INCREASE BY 20% WHEN THE PRICE OF
BEEF INCREASE FROM RM0.40 TO RM0.50,
CULCULATE THE CROSS ELASTICITY OF
DEMAND BETWEEN CHICKEN AND BEEF

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 INCOME ELASTICITY OF
DEMAND

FORMULA:

X = %  Quantity Demanded of good X

%  Price of good Y

X = QX2 – QX1 x PY1

QX1 PY2 – PY1

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 SUMMARY

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 RESPONSES OF CROSS
ELASTICITY

Price of Good X Positive Cross Elasticity

x =0 -Good X and Y are substitute goods

Negative Cross Elasticity

-Good X and Y are complementary goods

Zero Cross Elasticity

-Good X and Y have no relationship

x > 0 x < 0

Quantity Demanded
of Good Y
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 PRICE ELASTICITY OF
SUPPLY

DEFINITION:

Measures the sensitivity/responsiveness

of the quantity supplied due to a change
in the price of a product or service.

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 PRICE ELASTICITY OF SUPPLY
(cont.)

FORMULA:

ss = %  Quantity Supplied

%  Price

SS = Q2 – Q 1 x P1

Q1 P2 – P1

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

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 DEGREE OF ELASTICITY
Elastic Supply
A small percentage of change in the price of a good will lead to
larger percentage of change in the quantity supplied.

Inelastic Supply
Price (RM)
ss =0 A large percentage of change in the price of a good
ss = 1 will only affect a small percentage of change of the
quantity supplied.
ss < 1
Unitary Elastic Supply
Percentage change in price equals the percentage
change in the quantity supplied.

Perfectly Elastic Supply

An almost zero percentage of change in price brings
ss =  a very large percentage of change in the quantity
supplied.

Perfectly Inelastic Supply

ss > 1 A percentage of change in price has no effect on
the percentage of change in the quantity supplied.

Quantity Demanded
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 Time
Time Period
Period

Technology
Technology
improvements
improvements
Nature
Nature of
of the
the
market
market

Availability
Availability and
and mobility
mobility of
of Perishability
Perishability
factors
factors ofof production
production

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  IF THE PRICE OF SHOES INCREASE FROM
RM20 TO RM30 AND THE QUANTITY
SUPPLIED INCREASE FROM 40 TO 50
UNITS, CALCULATE THE PRICE ELASTICITY
OF SUPPLY

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PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2013 2– 25
PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved
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