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ELASTICITIES:Price Elasticity of Demand, Point Elasticity, Arc Elasticity

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Introduction to Economics ­ECO401
VU
UNIT - 3
Lesson 3.1
ELASTICITIES
Elasticity is a term widely used in economics to denote the "responsiveness of one variable to
changes in another."
Types of Elasticity:
There are four major types of elasticity:
·  Price Elasticity of Demand.
·  Price Elasticity of Supply.
·  Income Elasticity of Demand.
·  Cross-Price Elasticity of Demand.
Price Elasticity of Demand:
Price elasticity of demand is the percentage change in quantity demanded with respect to the
percentage change in price.
Price elasticity of demand can be illustrated by the following formula:
PЄd = Percentage change in Quantity Demanded
Percentage change in Price
Where Є = Epsilon; universal notation for elasticity.
If, for example, a 20% increase in the price of a product causes a 10% fall in the Quantity
demanded, the price elasticity of demand will be:
PЄd = - 10% = - 0.5
20%
Price Elasticity of Supply:
Price elasticity of supply is the percentage change in quantity supplied with respect to the
percentage change in price.
Price elasticity of supply can be illustrated by the following formula:
PЄs = Percentage change in Quantity Supplied
Percentage change in Price
If a 15% rise in the price of a product causes a 15% rise in the quantity supplied, the price
elasticity of supply will be:
PЄs = 15 % = 1
15 %
Income Elasticity of Demand:
Income elasticity of demand is the percentage change in quantity demanded with respect to
the percentage change in income of the consumer.
Income elasticity of demand can be illustrated by the following formula:
YЄd = Percentage change in Quantity Demanded
Percentage change in Income
If a 2% rise in the consumer's incomes causes an 8% rise in product's demand, then the
income elasticity of demand for the product will be:
20
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Introduction to Economics ­ECO401
VU
YЄd = 8% =4
2%
Cross-Price Elasticity of Demand:
Cross price elasticity of demand is the percentage change in quantity demanded of a specific
good, with respect to the percentage change in the price of another related good.
PbЄda = Percentage change in Demand for good a
Percentage change in Price of good b
If, for example, the demand for butter rose by 2% when the price of margarine rose by 8%,
then the cross price elasticity of demand of butter with respect to the price of margarine will be.
PbЄda = 2% = 0.25
8%
If, on the other hand, the price of bread (a compliment) rose, the demand for butter would fall.
If a 4% rise in the price of bread led to a 3% fall in the demand for butter, the cross-price
elasticity of demand for butter with respect to bread would be:
PbЄda = - 3% = - 0.75
4%
Point Elasticity:
Point elasticity is used when the change in price is very small, i.e. the two points between
which elasticity is being measured essentially collapse on each other. Differential calculus is
used to calculate the instantaneous rate of change of quantity with respect to changes in price
(dQ/dP) and then this is multiplied by P/Q, where P and Q are the price and quantity obtaining
at the point of interest. The formula for point elasticity can be illustrated as:
Є=ĆQxP
ĆPQ
Or this formula can also be written as:
Є=dQxP
dPQ
Where d = infinitely small change in price.
Arc Elasticity:
Arc elasticity measures the "average" elasticity between two points on the demand curve. The
formula is simply (change in quantity/change in price)*(average price/average quantity).
As:
Є=ĆQ ÷ ĆP
Q
P
To measure arc elasticity we take average values for Q and P respectively.
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Table of Contents:
  1. INTRODUCTION TO ECONOMICS:Economic Systems
  2. INTRODUCTION TO ECONOMICS (CONTINUED………):Opportunity Cost
  3. DEMAND, SUPPLY AND EQUILIBRIUM:Goods Market and Factors Market
  4. DEMAND, SUPPLY AND EQUILIBRIUM (CONTINUED……..)
  5. DEMAND, SUPPLY AND EQUILIBRIUM (CONTINUED……..):Equilibrium
  6. ELASTICITIES:Price Elasticity of Demand, Point Elasticity, Arc Elasticity
  7. ELASTICITIES (CONTINUED………….):Total revenue and Elasticity
  8. ELASTICITIES (CONTINUED………….):Short Run and Long Run, Incidence of Taxation
  9. BACKGROUND TO DEMAND/CONSUMPTION:CONSUMER BEHAVIOR
  10. BACKGROUND TO DEMAND/CONSUMPTION (CONTINUED…………….)
  11. BACKGROUND TO DEMAND/CONSUMPTION (CONTINUED…………….)The Indifference Curve Approach
  12. BACKGROUND TO DEMAND/CONSUMPTION (CONTINUED…………….):Normal Goods and Giffen Good
  13. BACKGROUND TO SUPPLY/COSTS:PRODUCTIVE THEORY
  14. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):The Scale of Production
  15. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):Isoquant
  16. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):COSTS
  17. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):REVENUES
  18. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):PROFIT MAXIMISATION
  19. MARKET STRUCTURES:PERFECT COMPETITION, Allocative efficiency
  20. MARKET STRUCTURES (CONTINUED………..):MONOPOLY
  21. MARKET STRUCTURES (CONTINUED………..):PRICE DISCRIMINATION
  22. MARKET STRUCTURES (CONTINUED………..):OLIGOPOLY
  23. SELECTED ISSUES IN MICROECONOMICS:WELFARE ECONOMICS
  24. SELECTED ISSUES IN MICROECONOMICS (CONTINUED……………)
  25. INTRODUCTION TO MACROECONOMICS:Price Level and its Effects:
  26. INTRODUCTION TO MACROECONOMICS (CONTINUED………..)
  27. INTRODUCTION TO MACROECONOMICS (CONTINUED………..):The Monetarist School
  28. THE USE OF MACROECONOMIC DATA, AND THE DEFINITION AND ACCOUNTING OF NATIONAL INCOME
  29. THE USE OF MACROECONOMIC DATA, AND THE DEFINITION AND ACCOUNTING OF NATIONAL INCOME (CONTINUED……………..)
  30. MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME
  31. MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME (CONTINUED………..)
  32. MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME (CONTINUED………..):The Accelerator
  33. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS
  34. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….)
  35. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):Causes of Inflation
  36. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):BALANCE OF PAYMENTS
  37. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):GROWTH
  38. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):Land
  39. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):Growth-inflation
  40. FISCAL POLICY AND TAXATION:Budget Deficit, Budget Surplus and Balanced Budget
  41. MONEY, CENTRAL BANKING AND MONETARY POLICY
  42. MONEY, CENTRAL BANKING AND MONETARY POLICY (CONTINUED…….)
  43. JOINT EQUILIBRIUM IN THE MONEY AND GOODS MARKETS: THE IS-LM FRAMEWORK
  44. AN INTRODUCTION TO INTERNATIONAL TRADE AND FINANCE
  45. PROBLEMS OF LOWER INCOME COUNTRIES:Poverty trap theories: