ELASTICITYIt measures the degree of

responsiveness of quantity demanded due to a change in a specific factor that

affects demand.

Price elasticity of demand• It measures the extent to which demand for a

product changes due to a change in its price. Price inelasticCustomers are not responsive to changes in price

Price elastic Customers are highly responsive to changes in

price.

Essential

Price elastic or inelastic?

Price elastic or inelastic?

Inelastic Elastic

Elastic/Inelastic Inelastic

> 1 (ignoring the minus sign)

<1 (ignoring the minus sign)

<1 (ignoring the minus sign)

Unitary price elasticityChange in price leads to a proportional change in

the quantity demandedExample:we increase the price of ice cream from USD1 to

USD1.05. Because of increased price we used to sell 200 ice creams a day, now we sell 190 ice-creams a day....

= 1 (ignoring the minus sign)

Implications and uses of price elasticity of demand

• Decide on pricing policy. Ex: Price inelastic demand = It’s likely to raise price

• Luxury products= High PED. They tend to suffer the most during recession (Elastic)

• Helps government to determine the optimum level of taxes (Price inelastic products). Ex: Petrol and cigarettes.

• Exporters will generally benefit from lower exchange rate. Assuming PED for exports is Price elastic

Factors affecting price elasticity of demand

• Substitution: number and availability of substitutes, PED (Elastic), people can buy to another place because there are a lot of competitors.

• Income: incomes, less sensitive to changes in price (Inelastic)

• Durability: More durable a product is, Price elasticity of demand (Elastic). Customers may try

their possessions last a little longer if price of durable products is on the rise.

• Time: Ex: Parents with children in private education are unlikely to withdraw their offspring from school. This could be disruptive to their learning. (Inelastic)

• Fashion, addictions, habits and tastes:

• Necessity

Income elasticity of demand

• It measures the degree of responsiveness of demand for a product following a change in the income level.

Nappies Water

Giffen goods – A special case of Inferior goods.

Advertising elasticity of demand

• It measures the degree of responsiveness of demand for a product following a change in the advertising expenditure for that product.

Billboards

Cross-price elasticity of demand

Complements

A fall in the price of computers, perhaps due to advances in production technologies, has led an expansion in their demand. This then leads to an increase in the demand for computer software

products

Substitutes

A fall in the supply of strawberries, perhaps due to a poor harvest, has caused an increase in its price and reduced the quantity demanded. The higher price in strawberries has subsequently caused an increase in the demand for bananas

• Higher value of CED, more customers see the products as being close substitutes.