ELASTICITY OF DEMAND AND SUPPLY

4.1 ELASTICITY OF DEMAND

1) PRICE ELASTICITY OF DEMAND
- measures the responsiveness of quantity demanded of a
product to a change in the product’s own price

2) CROSS ELASTICITY OF DEMAND

-the ratio of the percentage change in the quantity demanded
of a good or service to a given percentage change in the price of
a related good.

3) INCOME ELASTICITY OF DEMAND

- the ration of the percentage change in the quantity demanded
of a good or service to a given percentage change in income
Exhibit 1 Price Elasticity of Demand

Arnold Economics, 5e / Ch. 18

Elasticity
©2001 South-Western College
Publishing 3
Exhibit 2 Price Elasticity of Demand

Arnold Economics, 5e / Ch. 18

Elasticity
©2001 South-Western College
Publishing 4
4.1.1 DETERMINANTS OF PRICE
ELASTICITY OF DEMAND
 Availability of substitutes
 Share of budget spent on the product
 Types of the product
 Habits
 Time
Exhibit 3 Elasticities, Price Changes, and Total Revenue

Arnold Economics, 5e / Ch. 18

Elasticity
©2001 South-Western College
Publishing 6
Total expenditure
4

P(£) 2

Consumers’ total expenditure

=
firms’ total revenue
1 =
£2 x 3m = £6m D

0
0 1 2 3 4 5
Q (millions of units per period of time)
Elastic demand between two points

Expenditure falls
as price rises

P(£)
b
5
a
4 D

0 10 20
Q (millions of units per period of time)
Inelastic demand between two points
Expenditure rises
as price rises

c
8

P(£)

a
4

0 15 20
Q (millions of units per period of time)
Totally inelastic demand (PD = 0)
P
D

P2 b

P1 a

O Q1 Q
Infinitely elastic demand (PD = )
P

a b
P1 D

O Q1 Q2
Q
Unit elastic demand (PD = –1)
P

a
20

b
8
D

O 40 100 Q
4.2 PRICE ELASTICITY OF SUPPLY
 The responsiveness of quantity supplied to a change in
the price of a good

 DETERMINANTS OF PRICE ELASTICITY OF

SUPPLY
1) Gestation period
2) Time
3) The change in production cost
Exhibit 6 Price Elasticity of Supply

Arnold Economics, 5e / Ch. 18

Elasticity
©2001 South-Western College
Publishing 14
Exhibit 7 Summary of the Four Elasticity Concepts

Arnold Economics, 5e / Ch. 18

Elasticity
©2001 South-Western College
Publishing 15
4.3 PRICE ELASTICITY AND TAX
INCIDENCE
 Tax incidence is the share of a tax that
is paid by consumers and sellers

 The incidence of taxation

 the producers' share

 the consumers' share

 Incidence of tax: elastic demand
P S + tax

S
P2
CONSUMERS’
SHARE
P1

D
PRODUCERS’
SHARE

P2 - t

O Q2 Q1 Q
 Incidence of tax: inelastic supply
P S + tax

P2
P1 CONSUMERS’ SHARE

PRODUCERS’ SHARE D

P2 - t

O Q2 Q1 Q
 Incidence of tax: elastic supply
P S + tax

P2
S
CONSUMERS’
SHARE
P1
PRODUCERS’
P2 - t SHARE

O Q2 Q1 Q
 Incidence of tax: inelastic demand Incidence of tax: elastic demand
P P S + tax
S + tax

P2
S
S
CONSUMERS’
P2
CONSUMERS’
SHARE SHARE
P1
P1
PRODUCERS’ SHARE PRODUCERS’ D
P2 - t SHARE

P2 - t

D
O Q2 Q1 Q O Q2 Q1 Q
Incidence of tax: inelastic supply Incidence of tax: elastic supply
P P S + tax
S + tax

S P2
S
CONSUMERS’
SHARE
P2
CONSUMERS’ SHARE P1
P1 PRODUCERS’
SHARE
P2 - t
PRODUCERS’ SHARE
D D
P2 - t

O Q2 Q1 Q O Q2 Q1 Q
Effect of subsidies on foodstuffs in which the country is self-
sufficient
P S

S + subsidy

Pg
Subsidy

Pe

Pm

O Qe Q1 Q