Assignment # 1

Submitted To:
Miss Memona Altaf
Name:
Laiba Waheed
Roll no:
18531509-026
Course title:
Introduction to Economics
Course code:
ECO-101
BS-III (Mathematics)
Section: A
Price Elasticity of Supply:
Price Elasticity of Supply is defined as the
responsiveness of quantity supplied when the price of the good changes.
 It is the ratio of the percentage change in quantity supplied to the
percentage change in price.
 The Price Elasticity of Supply is always positive because the Law of Supply
says that quantity supplied increases with an increase in price.

Price Elasticity of Supply Formula:

To calculate the price elasticity of supply, use the following formula:
Price Elasticity of Supply (PES) = % change in Qs
% change in p
= ((New Quantity Supplied – Old Quantity Supplied)/ (Old Quantity Supplied)) /
((New Price – Old Price)/ (Old Price))

Example:
Given the following data for the supply and demand of movie tickets,
calculate the price elasticity of supply when the price changes from $9.00 to
$10.00.
Price Quantity Demanded Quantity Supply
$7 100 25
$8 90 45
$9 75 75
$10 55 105
$11 30 125
Sol:
So we have:
Price (Old) = $9
Price (New) = $10
Quantity Supplied (Old) = 75
Quantity Supplied (New) = 105
The formula used to calculate the percentage change in quantity supplied is:
[Quantity Supplied (New) –Quantity Supplied (Old)] /Quantity Supplied (Old))
[105 – 75] / 75 = (30/75) = 0.4
So we note that % Change in Quantity Supplied = 0.4
The formula used to calculate the percentage change in price is:
[Price (New) – Price (Old)] /Price (Old))
By putting the values, we get:
[10 – 9] / 9 = (1/9) = 0.1111
PES = (% Change in Quantity Supplied)/ (% Change in Price)
PEoD = (0.4)/ (0.1111) = 3.6
We get the price elasticity of supply when the price increases from $9 to $10 is
3.6. So for movie tickets, the price is elastic and thus supply is very sensitive to
price changes.
Types of Price Elasticity of Supply:
These are the following five types of Price Elasticity of Supply.

1. Relatively Elastic Supply:

(1 < PES < ∞), The Quantity Supplied
changes by a larger percentage than the percentage change in price.

Price (P) S

Quantity (Q)

2. Relatively Inelastic Supply:

(0 < PES < 1), Quantity Supplied
changes by a Lower percentage than a percentage change in price.

Price (P) S

Quantity (Q)

Unit Elastic Supply:

(PES = 1), Quantity Supplied changes by the
Same percentage as the change in price
 Price (P) S

Quantity (Q)

3. Perfectly Elastic Supply:

(PES = ∞), Suppliers will be willing and
able to supply any amount at a given price but none at a different price.

Price
S

Quantity
Perfectly Inelastic Supply:
(PES = 0), The Quantity Supplied
doesn’t change as the price changes
Price (P)
S

Quantity (Q)

Income Elasticity of Demand:

Income Elasticity of Demand (YED) is
defined as the responsiveness of demand when a consumer’s income changes. It
is defined as the ratio of the change in quantity demanded over the change in
income.
 YED can be positive or negative. This depends on the type of good. A
normal good has a positive sign, while an inferior good has a negative sign.

Income Elasticity of Demand Formula:

The formula for calculating the Income Elasticity of Demand is defined as the ratio
of the change in quantity demand over the change in income.
Income Elasticity of Demand = % change in Qd
% change in Y
YED = (New Quantity Demand – Old Quantity Demand)/ (Old Quantity Demand) /
(New Income – Old Income)/ (Old Income)
Types of Income Elasticity of Demand
We can categorize income elasticity of demand into 5 different categories
depending on the value.
 Normal goods have a positive income elasticity of demand so as
consumers’ income increase, there is an increase in quantity demand.
 Necessities have an income elasticity of demand of between 0 and +1. For
example, a staple like rice or bread could be considered a necessity.
 Inferior goods have a negative income elasticity of demand meaning that
demand falls as income rises.
1. Income Elasticity of Demand for a Normal Good:
A normal good has an Income Elasticity of Demand > 0.
This means the demand for a normal good will increase as the consumer’s
income increase

Dy
Income

Quantity

2. Income Elasticity of Demand for an Inferior Good:

An inferior good has an Income Elasticity of Demand < 0. This means the
demand for an inferior good will decrease as the consumer’s income
decreases

Dy

Income
Dy

Quantity
3. Income Elasticity of Demand for a Luxury Good:
Luxury goods usually have Income Elasticity of Demand > 1, which means
they are income elastic. This implies that consumer demand is more
responsiveness to a change in income. For example, diamonds are a luxury
good that is income elastic.
4. Relatively Inelastic Income Elasticity of Demand:
0 < Income Elasticity of Demand < 1 are goods that are relatively inelastic.
This means that consumer demand rises less proportionately in response
to an increase in income.
5. Income Elasticity of Demand is 0:
Income Elasticity of Demand = 0 means that the demand for the good isn’t
affected by a change in income.

Income

Dy

Quantity
Example:
A shop that sells widgets. They estimate that when the average real income
of its customers falls from $60,000 to $40,000, the demand for its widgets
falls from 5,000 to 4,000 units sold, with all other things remaining the
same.
Sol:
Using the income elasticity of demand formula:
YED = (New Quantity Demand – Old Quantity Demand)/ (Old Quantity
Demand) / (New Income – Old Income)/ (Old Income)
= (4,000 – 5,000)/ (5,000) / (40,000-60,000)/ (60,000)
= ~0.67
This produces an elasticity of 0.67, which indicates customers are not
particularly sensitive to changes in their income when it comes to buying
these widgets. The demand does not fall significantly with a fall in come.

Applications of Elasticity of Demand and Supply:

The price elasticity of demand not only enables an organization to analyze
economic problems, but also helps in solving managerial problems.
 Pricing Decisions:
Refer to one of the major role of price elasticity of demand. The price
elasticity of demand helps an organization to determine the price of
its products in various circumstances.
I. Monopoly Pricing:
It is the fact that under monopolistic market conditions, the price of
products is determined only on the basis of price elasticity of
demand. In monopolistic market conditions, if is the demand elastic,
the price is set very low for per unit of product. This results in high
demand for the product due to low price. On the other hand, if the
demand is inelastic, the price is set very high. The high price of a
product with demand remaining the constant helps in generating the
large revenue for an organization.

II. Price Discrimination:

In this situation when different prices are charged from different
consumers. For example, A monopolist charges more prices from
consumers whose demand for products is inelastic. This implies high
prices are charged from consumers whose demand does not change
with change in the price of products. On the other hand, a
monopolist charges less prices from consumers whose demand is
elastic.
III. Formulation of Government Policies:
It is an important significance of the concept of price elasticity of
demand. The government takes into consideration the price
elasticity of demand while planning taxes. For example, tax on
products having elastic demand generate less revenue for the
 government as the taxes increase the price of products, which
results in decrease in demand.

 In Agriculture for cultivation of crops:

It is important for public managers as well as the agriculture
business to decide what kind of crops shall help their revenue. A
hybrid seed may produce a surplus to decrease the demand as well
as the price of the product. If everyone goes for it, the government
would have to change its agriculture policies accordingly to maintain
healthy competition.
 Wage Bargaining by Trade Unions:
The bargaining power of the trade unions in raising the wages of a
group of labor in a particular industry also depends, among other
things, on the elasticity of demand for their services to the
employer. A trade union usually succeeds in raising wages when the
demand for the services of labor to the employer is inelastic:
because, in such a case the employer cannot easily dispense with
their services. On the other hand, it may not succeed when demand
for labor is elastic.
 Importance in Taxation:
This is also useful tool in taxation. A finance minister is to consider
the elasticity of demand of the different commodities for the
purpose of taxation. If he pushes commodity tax rates up too much
the consequent increase in price may make the total tax yield even
lower than before. On the other hand, a small tax reduction may
result in an increase in the tax yield. Firstly, the total expenditure by
the consumers will determine the size of the tax yield. And, the total
expenditure is the measure of elasticity of demand. So, before
imposing a tax or raising the existing rate of a tax, the government
will have to consider the elasticity of demand of the commodity
concerned. It can get more revenue from the taxes imposed on
commodities with inelastic demand (like sugar, clothes, kerosene oil,
etc.) than what is possible from the taxation of those with elastic
demand (like refrigerators, motor cars, steel furniture’s, etc.).
 Importance in Determining the Incidence of Taxation:
The concept of the elasticity of demand, along with that of supply, is
used to determine the shifting and incidence of a tax. When a tax is
imposed on a commodity of inelastic demand, the seller can
generally transfer the burden of the tax upon the consumers by
raising the price, and so the incidence of tax falls upon the buyers.
But, in the case of a tax on a commodity with elastic demand, such a
shifting of tax is not an easy task. Similarly, in the case of import and
export duties on commodities the inelasticity of demand can be used
to determine the incidence of such duties.
 Price Determination of Joint-cost Products:
In the case of the joint-cost products (e.g., cotton fiber and cotton
seeds) where the cost of each cannot be separately determined, the
criterion of demand elasticity is applied in determining their
individual prices.
 Economic Policy:
The knowledge of elasticity is also valuable in the formation of
economic policies. A country suffering from balance of payments
problems may try to tackle the imbalance by devaluing its currency.
But, whether devaluation will be successful or not crucially depends
upon other countries, i.e., the rest of the world’s demand for the
devaluing country’s products. If the demand for its products is
inelastic there will be no increase in volume sold after devalu-ation,
and consequently export earnings will fail due to lower unit price of
its product (sales remaining constant).