Elasticity of Demand & Supply

ELASTICITY of DEMAND
&SUPPLY
Price Elasticity of Demand
 Argument on weather a company should increase or
decrease the market price for its goods.
 From the law of demand and supply, setting a low

price will increase demand, but increase cost;
While high price will reduce demand but increase
revenue.
 But this argument cannot be backed only by the law

of demand and supply, the firm needs to know the
price elasticity of demand for the produce.
2
1) Price elasticity of demand
 Price Elasticity of Demand also known as elasticity of
demand:
Is a measure used to show the responsiveness of the quantity
demanded of a good to a change in its price, ceteris paribus.
• That is it gives the percentage change in quantity demanded

in response to a one percent change in price.
 Elasticity can also be defined as the ratio of the percentage

change in demand to the percentage change in price of a
particular commodity. E(p)=dQ/Q/dP/P
3
……..
Elasticity
• The price elasticity of demand

• It is defined as:
% change in quantity demanded
% change in price
Types of price elasticity of demand

(a) Elastic demand
Measures the responsiveness of changes in quantity demanded
as a result of change in price (Figure1). Demand is said to be
elastic if it changes a lot when there is a small price changes
4
Figure 1
5
(b) Inelastic demand
Inelastic demand is when the buyer's demand does

not change as much as the price changes. When price
increases by 20% and demand decreases by only 1%,
demand is said to be inelastic. This situation typically
occurs with everyday household products and services
6
Figure 2
7
Note that:
The minus sign (-ve)

• When the price rises, the quantity demanded decreases
along the demand curve. Price and quantity always
change in opposite directions.
• So to compare the percentage change in the price and

the percentage change in the quantity demanded, we
ignore the minus sign and use the absolute values.
8
Factors Influencing the Elasticity of Demand
The elastic or inelastic nature of the demand for a commodity is
determined by the following factors.
(1) Degree of necessity: Other things being equal, the demand for
necessities is inelastic or less elastic than that for comforts and
luxuries. The reason is simple. The necessities must be bought
whatever be the price because no one can live without them. The
demand for a necessity without a substitute is less elastic than
the demand for a necessity with a substitute. For example, the
demand for salt is less elastic than that for paddy.
(2) Proportion of consumer’s income spent on the commodity: The
demand for a commodity on which the consumer spends only a
small proportion of his income is less elastic. For instance, even if
the price of salt or match-box rises by 100 per cent, the demand
for them may not decline substantially.
9
3. Existence of substitutes: The demand for a commodity is more
elastic, if it has a number of good substitutes. A small rise in the
price of such a commodity will induce the consumers to go for its
substitutes, assuming that their prices do not rise.
4) Several uses of the commodity: The demand for a commodity

is said to be more elastic, if it can be put to a variety of uses. A fall
in the price of electricity will result in the substantial increase in
its demand.
5) Time: The elasticity of demand varies with the length of time.

In general, demand is more elastic for longer period of time. For
instance, if the price of kerosene rises, it may be difficult to
substitute it with cooking gas within a very short time. But if
sufficient time is given, people will make adjustments and use
firewood or cooking gas instead of kerosene. 10
Measurement of Elasticity of Demand:.
Price elasticity of demand can be measured by three
methods, they are:
(1) Total Expenditure or Outlay Method
(2) Measuring Elasticity at a Point
(3) Arc Method
Assignment to students:
Read more about each of the method mentioned above and how
calculations are done through each of the method
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Uses of Elasticity of Demand
(1) The business firms take into account the elasticity of
demand when they take decisions regarding pricing
of goods.
(2) The elasticity of demand concept is used by the

government in economic policy regarding regulation
of prices of farm products.
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2) Income elasticity of Demand
It may be defined as the ratio of proportionate change in the
quantity demanded of commodity to a given proportionate
change in income of the consumer.
• Income elasticity is positive for normal goods but

• Negative for inferior goods
Income Elasticity, Ei = Percentage Change in Quantity Demanded
Percentage Change In Income
13
Mathematically
Ei = ΔQ x 100 divide by ΔY x 100
Q Y
= ΔQ x Y
Q ΔY
= ΔQ x Y
ΔY Q
Where, Q = Quantity demanded; Y-income
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If, for instance, consumer’s income rises from Tsh. 1000 to Tsh.
1200, his purchase of the good X (say, rice) increases from 25 kgs
per month to 28 kgs, then his income elasticity of demand for rice is:
Ei= 3 X 1000
200 25
= 0.60
From this, we conclude that, the quantity demanded of rice rises by

(0.60 x 100) per cent, if the income of the consumer rises by one per
cent. Income elasticity of demand can be divided into following five
sub-heads:
15
Types of Income Elasticity of Demand
1) Zero income elasticity:
A given increase in the consumer’s money income does not result in
any increase in the quantity demanded of a commodity (Ei=0).
2) Negative income elasticity:

A given increase in the consumer’s money income is followed by an
actual fall in the quantity demanded of a commodity. This happens
in the case of economically inferior goods (Ei < 0).
3) Unitary income elasticity:

A given proportionate rise in the consumer’s money income is
accompanied by an equally proportionate rise in the quantity
demanded of a commodity and vice versa (Ei=1).
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4) Income elasticity of demand greater than unity:
For a given proportionate rise in the consumer’s money
income, there is a greater proportionate rise in the
quantity demanded of a commodity. Ei is greater than
unity. This is in case of luxuries.
5) Income elasticity of demand less than unity:

For a given proportionate rise in the consumer’s money
income, there is a smaller proportionate rise in the
quantity demanded of a commodity. The income elasticity
of demand is less than 1
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ELASTICITY of SUPPLY
Price Elasticity of Supply
 The law of supply states that there is a direct
relationship between the quantity supplied and price
of a commodity. To point out, this is a very qualitative
statement.
 However, markets for different commodities differ in

ways we can’t even imagine. Interestingly, the
concept of elasticity of supply handles all this with
ease.
Elasticity of supply
 Price Elasticity of supply also known as elasticity of supply
Is a measure used to show the responsiveness of the quantity
supplied of a good to a change in its price, ceteris paribus.
• That is it gives the percentage change in quantity supplied in

response to a one percent change in price.
 Elasticity can also be defined as the ratio of the percentage

change in supply to the percentage change in price of a
particular commodity.
 A measure of the way suppliers respond to a change in price.

• A supplier’s responsiveness to a price change
Elasticity of supply ……..
• The price elasticity of supply
• It is defined as:
% change in quantity supplied
% change in price
• Is the percentage change in quantity supplied associated
with a percentage change in price.
• Es = % ΔQs / % Δ P
Types of price elasticity of supply

(1) Unit elastic supply
The percentage change in the quantity supplied equals the
percentage change in price. Happened when the percent increase in
price increases the quantity supplied by the exact amount. (see figure 1)
Figure 1
Elastic supply Vs Inelastic supply
(2) Elastic supply

• The percentage change in the quantity supplied exceeds
(high) the percentage change in price (small).
• (1 < PES < ∞), The Quantity Supplied changes by a larger
percentage than the percentage change in price. (not so much
with steeper slope as the latter)
(3) Inelastic supply

• The percentage change in the quantity supplied is less than
(small) the percentage change in price (high).
• (0 < PES < 1), Quantity Supplied changes by a lower
percentage than a percentage change in price (steeper slope)
• For illustration see figure 2
Figure 2
Calculating Price Elasticity of Supply
To calculate the price elasticity of supply, use the
following formula:
• Price Elasticity of Supply (PES) =

Percentage Change in Quantity Supply divided by the
Percentage Change in Price
That is
PES example
• Given the following data for the supply and demand of
Nyamachoma in kilograms, calculate the price elasticity of
supply when the price changes from $9.00 to $10.00.
After calculation, the PES= 3.6

The price elasticity of supply when the price increases from $9 to $10 is 3.6. So for
nyamachoma, the price is elastic and thus supply is very sensitive to price changes.
The end of AEA 101 teaching sessions

Elasticity of Demand & Supply

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ELASTICITY of DEMAND

 From the law of demand and supply, setting a low

 But this argument cannot be backed only by the law

• That is it gives the percentage change in quantity demanded

 Elasticity can also be defined as the ratio of the percentage

• The price elasticity of demand

Types of price elasticity of demand

Inelastic demand is when the buyer's demand does

The minus sign (-ve)

• So to compare the percentage change in the price and

4) Several uses of the commodity: The demand for a commodity

5) Time: The elasticity of demand varies with the length of time.

(2) The elasticity of demand concept is used by the

• Income elasticity is positive for normal goods but

From this, we conclude that, the quantity demanded of rice rises by

2) Negative income elasticity:

3) Unitary income elasticity:

5) Income elasticity of demand less than unity:

 However, markets for different commodities differ in

• That is it gives the percentage change in quantity supplied in

 Elasticity can also be defined as the ratio of the percentage

 A measure of the way suppliers respond to a change in price.

Types of price elasticity of supply

(2) Elastic supply

(3) Inelastic supply

• Price Elasticity of Supply (PES) =

After calculation, the PES= 3.6

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