MABINI COLLEGES, INC.
Daet, Camarines Norte
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
1st Sem., S.Y.2020-2021
BACC1 – BASIC MICROECONOMICS
MODULE 3
Title: Elasticities and Its Applications
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Module Overview:
The relationship between price and quantity, as introduced in the previous modules, can be
either directly proportional (supply) or inversely proportional (demand). Under ceteris paribus
assumption, when price increases, it is expected that quantity demanded will decrease and quantity
supplied will increase; and vice versa.
However, we know that demand and supply are not static in a competitive market. Both respond
to changes in price and other factors. As a result, we can observe some shifts in the demand and supply
curves as reactions to the changes in these various determinants. The degree to which the curves react to
these changes is referred to as elasticity.
In this module, a very practical approach is introduced to better understand the different
concepts and users of elasticity.
Learning Outcomes
After completing this module, students must have:
Know the basic concepts about elasticity, properly identify its types and be able to differentiate
all; and
Explain the importance of elasticity, its types, concepts, and uses, and its significance to pricing
decisions.
LECTURE NOTES
READ THIS…
We all know that demand and supply are not fixed; these two respond to changes, it reacts in
various determinants (it may shift to the right or it may shift to the left)
….. the degree to which either the demand or supply curve reacts to changes is referred to ELASTICITY
1
Price Elasticity of Demand and Pricing Decisions
Price elasticity of demand
– the degree of responsiveness of quantity demanded to a change in price
– how important does the price play in buyer’s decision to buy?
o Is price really important? Or it doesn’t matter.
If it is important, maybe a small increase in price will make you decide not to buy
that product and look for a substitute.
Also, maybe a small decrease in price will make you decide to buy more of that
product
But if the price is not really important, you don’t care what it cost, you will buy it
instantly
EXAMPLE: if fuel increases its price does it change people’s decision to buy or not
to buy fuel? Of course not; whether fuel’s price increase or decrease, consumer
will still buy it. (price is irrelevant…… it is inelastic; you’re willing to pay for it just
to keep buying this product)
If price is relevant…. It is elastic; a small increase in price might cause you
to look for an alternative, substitute or stop buying it.
– Elastic vs Inelastic
o It is elastic if (luxury, many substitutes, lots of time to compare, large % in income or
budget)
o It is inelastic if (necessity, few substitutes, little time to compare, small % in income or
budget)
– Computations
o PEd refers to the measurement of two quantities or two points on the demand curve and
how sensitive it is in the change of price.
o Formula:
PEd = % change in Qd / % change in P
Graph
P
10 a
8 b
Q
16 24 … compute the change in quantity
… 8 /16 = 50% or 8 / 24 = 33%
… we have to compute the change in quantity by using the
mid-point formula (change in quantity / average quantity)
= 8 / (16+24/2) = 0.4 ; change in quantity
= 2 / (10+8/2) = 0.22 ; change in price
PEd = 0.4 / 0.22 = 1.8
Interpretations:
2
o > 1 (elastic) Qd responds strongly to price changes
o < 1 (inelastic) Qd does not respond strongly to price changes
o = 1 (unitary)
The answer PEd is always negative; but your final answer will change to an absolute value [ ],
then it will be positive.
Total Revenue in Pricing Decisions
Formula: TR = P x Q
o TR – total revenue
o P – Price
o Q – Quantity
Things to remember
o If it’s Elastic; As price decrease; total revenue increase and vice versa
o If it’s Inelastic; As price decrease, total revenue decrease and vice versa
o If it’s Unitary; whether price increase or decrease; total revenue will not change
Income elasticity of demand
o the degree of responsiveness of quantity demanded to a change in income
o Formula:
o YEd = % change in Qd / % change in Y
o Interpretations:
o > 1 & > 0 (luxury & normal goods)
o < 1 & < 0 (necessity & inferior goods)
Cross elasticity of demand
The degree of responsiveness of a percentage change in quantity of a good with a percentage
change in the price of other goods
Formula:
o XEd = % change in Qd for X / % change in P of Y
Interpretations:
o = 0 (product x & y are not related)
o > 0 (x & y are substitutes)
o < 0 (x & y are complements)
Price elasticity of Supply
the degree of responsiveness of quantity supplied to a change in price
o It is elastic;
if producers can increase production to take advantage of rising price even
without an increase in the cost of production
change in price is significant
goods that can be safely stored (non-perishable items)
if the availability of infrastructure facilities is available for expansion to
accommodate the increase of production
o It is inelastic;
if producers are hindered to produce more can’t take advantage of rising prices
(example: palay; a month ago, palay’s price reach to Php19/kl …..)
3
Change in price is insignificant
Goods that are perishable
If it takes time to increase the infrastructure facilities to accommodate expansion
o Example: supply of pizza is more elastic than supply of doctors; because pizzeria can easily
create new pizza when there’s an order… but for you to increase supply doctors when
needed is not possible, you need to spend years in medical school, tedious trainings to
produce doctors
Formula:
o PEs = % change in Qs / % change in P
Interpretations:
o > 1 (elastic)
o < 1 (inelastic)
o = 1 (unitary)
Reference:
Manapat, C. and Pedrosa, F. (2014). Economics, Taxation and Agrarian Reform
Quezon City, C & E Publishing Inc
