BAEB602

School of Marketing and Entrepreneurship (SoME)FACULTY OF BUSINESS AND MANAGEMENT

PREPARED BY:Nur Suhaili Ramli

CHAPTER 3

MICROECONOMICS

ELASTICITY OF DEMAND AND SUPPLY

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CHAPTER 3: ELASTICITY OF DEMAND AND SUPPLY

Types

There are four types of elasticity: Price elasticity of demand Cross elasticity of demand Income elasticity of demand Price elasticity of supply

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Price elasticity of demand

Can be defined as a measure of the responsiveness of quantity demanded of a good to a change in its price with other determinants remain the same (ceteris paribus).

Formula:

PED = Percentage change in quantity demanded for a good

Percentage change in its price.

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CHAPTER 3: ELASTICITY OF DEMAND AND SUPPLY

Example

Suppose that the 10% increase in the price of petrol causes the amount of petrol demanded to fall by 20%, then PED can be calculated as:

Price Elasticity of Demand = 20% 10%

= 2

An elasticity coefficient of 2 means that, for every one percent change in the priceof petrol, there will be a corresponding change in quantity demanded of petrol by two percent.

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The Values of Price Elasticity of Demand

If the price elasticity of demand coefficient is less than one but greater than

zero, then demand is inelastic.

If the price elasticity of demand coefficient is greater than one but less than

infinity, then demand is elastic.

If the price elasticity of demand coefficient is exactly equal to one, then demand

is unit elastic.

If the price elasticity of demand coefficient is exactly equal to 0, the demand is

said to be perfectly inelastic.

If the price elasticity of demand coefficient is exactly equal to infinity, the

demand is said to be perfectly elastic.

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Cross Elasticity of Demand

Cross Elasticity of Demand (XED) is a measure of the responsiveness of quantity demanded for a good to change in the price of another good with other determinants remain the same.

Formula:

XED = Percentage change in quantity demanded of good A

Percentage change in the price of good B

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Categories of Cross Elasticity of Demand

Cross elasticity of demand can be positive (XED greater than zero) or negative

(XED less than zero).

In the case of substitute goods, such as butter and margarine, the cross

elasticity of demand will be positive (XED greater than zero).

However if two related goods are complementary, such as bread and butter,

the cross elasticity of demand will be negative (XED less than zero).

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Income Elasticity of Demand

The relationship between quantity demanded of a good and income can be

measured using the concept of income elasticity of demand.

Measure the responsiveness of quantity demanded for a good to a change in

income with other determinants remain the same.

YED = Percentage change in quantity demanded

Percentage change in income

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Categories of Income Elasticity of Demand

If the income elasticity is positive (YED>0), it indicates a positive relationship

between quantity demanded for a good and income. Thus we say that the good

is normal good.

However, if the income elasticity is negative (YED<0), it indicates a negative

relationship between quantity demanded for a good and income. Thus, we say

that the good is inferior good. Some examples of negative income elasticity of

demand is bus travel and used car.

If the income elasticity is zero (YED = 0), it indicates that quantity demanded

remain constant as income rises, and we say the good is necessity good.

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Price Elasticity of Supply

Measure the responsiveness of quantity supplied of a good to change in its

price.

Measure by dividing the percentage change in quantity supplied with the

percentage change in its price. That is;

PES = Percentage change in quantity supplied

Percentage change in its price.

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Different Types of Price Elasticity of Supply

There are different types of price elasticity of supply. Supply is:

Inelastic – if there is a less than proportionate response in supply to a change

in price.

Elastic – if there is a more than proportionate response in supply to a change

in price

Unit Elastic – if the percentage change in quantity supplied equals the

percentage change in price.

Perfectly inelastic – if there is no response in supply to a change in price.

Perfectly elastic – if producers are prepared to supply any amount at a given

price.

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CLASS ACTIVITY

Perform a group of 4. Discuss with examples for both Demand and Supply according to the following:

InelasticElasticUnit elasticPerfectly inelasticPerfectly elastic

Additional marks to be given for any additional information (different from other groups)

Submission date: next week