Economics: Applications of Supply and Demand
Elasticity
Elasticity: Quantifies how responsive supply and demand is to changes in price.
Price Elasticity of Demand (Ped / ED):
 Measures how much the quantity demanded of a good changes when its price
changes.
 The percent change in quantity demanded over the percent change in price.
Ped 
%Qd
%P
Application:
1. A good with elastic demand responds greatly to changes in price.
 Goods with substitutes
tend to have elastic demand. These include luxury

goods such as liquors and designer clothing.
2. A good with inelastic demand responds very little to changes in price.
 Goods that are considered necessities tend to have inelastic demand.
These include food, water, and clothes.
Note: Elasticity can also be dependent on the situation. For example, if both food and shoe prices go up
by 50%, since no substitutes for these exists, demand for these goods will remain inelastic. However, if
there is a shortage of pork in the market – driving prices up – since many substitutes for pork exist,
demand for pork is elastic.
Types of Price Elasticity of Demand:
 Price-elastic demand: Ped > 1
 Unit-elastic demand: Ped = 1
 Price-inelastic demand: Ped < 1
NOTE: The sign (+/-) is insignificant when
referring to Price Elasticity of Demand. When
determining elasticity, drop the sign.
Illustration:
Price
110
90
Quantity Demanded
240
160
140
120
Price
100
80
ED 
60
40
Q
P

(Q1  Q2 )/ 2 (P1  P2 )/ 2
20
0
40
80
120
160
200
Quantity
240
280
320
360

*An example of elastic demand
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Perfectly Inelastic Demand: ED = 0 (Vertical line)
Perfectly Elastic Demand: ED’ = ∞ (Horizontal line)
CAVEAT: Elasticity is NOT equal to slope. In fact, along a straight-line demand curve,
price elasticity varies from zero to infinity. While a (demand curve’s) slope depends
upon the changes in P and Qd, elasticity is dependent on their percent changes. The
above examples, however, are the (only) exceptions to this rule.
Elasticity of a Straight Line:
1. Demand is elastic above the midpoint (ED > 1)
2. Demand is unit elastic at the midpoint (ED = 1)
3. Demand is inelastic below the midpoint (ED < 1)
Total Revenue (TR): P x Qd
 Inelastic demand means a decrease in total revenue when price decreases.
 Elastic demand means an increase in total revenue when price decreases.
 Unit-elastic demand has no change in total revenue when price decreases.
Summary Table:
Value of ED
ED > 1
ED = 1
ED < 1
Description
Elastic
Unit Elastic
Inelastic
Definition
%Qd > %P
%Qd = %P
%Qd < %P
Impact on TR (P )
TR 
TR*
TR 
Price Elasticity of Supply (Pes / ES):
 The responsiveness of the quantity supplied of a good to its market price.
 The percentage change in quantity supplied over the percentage change in price.
Pes 
%Qs
%P
Perfectly Inelastic Supply: ES = 0 (Vertical line)
Perfectly Elastic Supply: ES’ =  (Horizontal line)
NOTE: Elasticity of supply 
is very much like that of demand, save for one exception. Due to the Law of
Downward Sloping Demand (LDSD), there will be a negative response in quantity demanded to changes
in price when a positive response in quantity supplied occurs, and vice versa.
Factors Affecting Supply Elasticity:
1. Ease of increase of production.
2

A ready source of inputs means greater output capacity at minimal
increases in price, creating an elastic supply.
 A very limited source means that even large increases in price can
only bring about small increases in supply, creating an inelastic supply.
2. Time period.
 Immediately after a price hike, it is difficult to increase capital, labor,
and material inputs, causing supply to be inelastic.
 However, as time passes, businesses will have been given time to
increase their inputs, causing supply to become more elastic.
Tax Incidence:
 Incidence: Ultimate economic impact or burden of a tax.
 Producers themselves may shoulder the incidence, or transfer it to consumers.
o Inelastic demand relative to supply: Consumers shoulder the tax.
o Inelastic supply relative to demand: Producers shoulder the tax.
Price Floors:
 The minimum required price, as legislated by the government.
 Ex. Minimum Wage
o
o
o
While this is theoretically good, this can also have a negative impact.
Employers will limit the number of available slots to accommodate the increased amount
in wages.
Employers will also prefer higher-skilled workers (due to better value); thus, demand for
low-skilled workers, being elastic in this case, will decrease – resulting in even more
unemployment.
Price Ceilings:
 The maximum allowed price, as legislated by government.
 Ex. Interest Rate Caps
Scarcity Revisited:
 Scarcity: There is a finite amount of supply of goods, while peoples’ wants and
needs are infinite.
 Normally, price acts as the (efficient) rationing factor for the scarce supply.
 Sometimes, however, government may decide to step in and interfere. This
method, however, is usually inefficient.
Substitution:
 Replacing a highly priced good with a similar one of a lower price.
 Ex. Coffee prices soar, making people opt to buy tea and cola instead.
Income Elasticity of Demand (Yed):
 Percent change in quantity demanded over percent change in income.
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Yed 

%Qd
%Y
Measures the income effect.
o Income effect: Wherein a price increase, given a fixed income, is like a
decrease in your income, and vice versa.
o Is related to the substitution effect.
*(Higher
prices makes a person feel that he or she has a “lower” income, prompting
him or her to buy less expensive versions of his or her usual purchases –
substitutes)
Substitutes and Complements:
 Substitutes: If, given 2 goods A and B, an increase in the price of good A will
increase demand for good B.
 Complements: If, given 2 goods A and B, an increase in the price of good A will
decrease demand for good B.
Applications on Commodities:
1. Situation A:
o The commodity has a high price
o There are ready substitutes available
o The demand for the product is very price-elastic
o Strong income and substitution effect
2. Situation B:
o The commodity has a relatively low price
o Not easily replaced
o Needed in small amounts (usually as a complement)
o The demand for the product is price-inelastic
o Weak income and substitution effect
Reference:
Economics: 15th Edition by Samuelson and Nordhaus
1. Chapter 4: Applications of Supply and Demand, pp. 57 – 69
2. Chapter 5: Demand and Consumer Behavior, pp. 78 – 81
Additional Reading:
Be sure to consult Sir Job’s powerpoint especially regarding other topics not
included here (i.e. Consumer and Producer Surplus, Cross-price Elasticity, etc.)!
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