Elasticities - IB Economics

price elasticities of demand and
supply, income and cross elasticities
of demand, and using elasticity to
forecast the impact of taxes on prices
3/21/2020
CPS GLOBAL SCHOOL - IB ECONOMICS- MONICA
UNIT 1.2
ELASTICITIES

3/21/2020
CPS GLOBAL SCHOOL - IB ECONOMICS-
MONICA
 Price elasticity
of demand(PED)
% change in quantity demanded
% change in price
= Q2/Q
P2/P
=
Q2P
P2Q
Price
Quantity demanded
P2
Q2
0

3/21/2020
MONICA
 PED -> % change in QD resulting from 1%
change in price
 PED is always negative (Inverse relationship b/w
P & QD)
Interpretations:
1. [PED] = 0, No change in QD irrespective of
Price
PERFECTLY INELASTIC Demand

3/21/2020
MONICA
2. [PED] is 0<1 INELASTIC Demand
Change in QD< Change in P
Consumer -> Unresponsive to P changes
Few substitutes, Few consumers do not increase or
decrease QD wrto P
3. [PED] = 1 UNIT ELASTIC Demand
Change in QD = Change in P
4. [PED]> 1 ELASTIC Demand
Consumers relatively responsive to P changes
Change in QD> Change in P
5. [PED] = ∞, Perfectly ELASTIC Demand
Any change in P will lead to infinite change in QD

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MONICA
P decreases -> Everyone will buy
P increases -> No one buys
Theoretical situation

RELATIVE ELASTICITY AND
SLOPE OF THE DEMAND CURVE
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MONICA
D3 -> Perfectly inelastic (Cigarettes), D4 - > Perfectly elastic
(Movie tickets)
D5 - > Relatively Elastic at Higher Prices and relatively
Inelastic at lower prices (Chocolate ice creams)

Determinants of PED: SPLAT
MONICA
 S-> No of substitutes
Increase in substitutes-> More Elastic, consumers->switch.
 P-> Propotion of Consumers’s income , the price of a
Good represents.
Cheap Goods-> Less P {eg: Salt}, consumers -> Less
responsive
 L-> Luxury/ Neccesity
Luxury-> elastic-> can live without
Necessity-> inelastic -> We need it. Eg: Electricity, gas
 A-> Addictiveness of a good
Alcohol, cigarettes, tobacco, drugs -> Inelastic. Becomes a
necessity
 T-> Amount of TIME following a price change. Time to
notice a price change.
Short term -> Inelastic,
Long term -> Elastic/ More Responsive

Total Revenue (TR)
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MONICA
 TR = Business Income from the sale of products
 TR = P * Q
Inelastic
E
L
A
S
T
I
c

How does a change in “P” affect
business revenues?.
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MONICA
 At high Prices, Fall in price -> Increase TR
 As price falls, TR eventually maximizes but will
decrease at lower prices.
TOTAL REVENUE AND PED:
Price Total Revenue PED Elastic/Inelasti
c
Increases Increases <1 Inelastic
Increases Decreases >1 Elastic
Decreases Increases > 1 Elastic
Decreases Decreases <1 Inelastic

Cross price elasticity of Demand
(XED)
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MONICA
 Responsiveness of consumers of a particular
good to a change in the price of a related good.
 Consumer’s POV
Goods-> Substitutes, Complements.
FORMULA:
XED = Percentage change in QD of Good A
Percentage change in Price of Good B

XED For complements
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MONICA
 The price of one good has an inverse relationship
with QD of complementary good
 Eg: Oil and new cars(Cars-> Gasoline -> Oil)
 P(Oil) Increases -> P(Gasoline) Increases - >
Demand(new cars) Decreases
 XED = Percentage change in QD of new cars
Percentage change in P of Oil
 XED is always Negative (Inverse relationship b/w
QD and price for a complementary good)

XED for Substitutes
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MONICA
 The price of one good has an direct relationship
with QD of complementary good
 Eg: Oil and Public Transport. Need not carry Oil
for Public Transport
 P(Oil) Increases - > Ppl will demand Public
Transport (PT) -> Demand (PT) Increases
 XED will be Positive

3/21/2020
MONICA
XED Elasticity Inference
>1 Cross-price Elastic A particular change
in P will lead to a
larger percentage
change in the QD of
the
complementary/suppl
ementary good
<1 Cross-price Inelastic A particular change
in P will lead to a
lesser percentage
change in QD of the
complementary/suppl
ementary good

Determinants of XED:
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MONICA
 Substitutability: More easily substitutable, higher
the XED co-eff
 Dependence: How strongly consumers of one
good depend on the related good

Income Elasticity of Demand
(YED)
3/21/2020
MONICA
 Responsiveness of a consumer’s demand for a
particular good to a change in income
 Increase in Income -> Decrease in Consumption
of a good Inferior Goods - fast food, generic
brand groceries, second-hand clothes, public
transport
 Increase in Income -> Increase in consumption of
a good
Normal Goods – restaurant meals, taxi rides, air
travel
YED = % change in QD for a good
% change in consumer’s income = %

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MONICA
 YED = QD2 – QD1
QD1
Y2-Y1
Y1
Y1, QD1 -> Original Income & Original Qty
Demanded
Y2, QD2 -> New Income & New Qty Demanded
following income change
 Y dir prop to QD-> YED is +ve-> NORMAL Good
 Y inversely prop to QD -> YED is –ve ->
INFERIOR Good
 YED-> effects of change in NI on D for a
Particular G/S in a nation as a whole.

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MONICA
YED Elasticity Interpretation Type of Good
>1 Elastic Percentage
change in
Income will lead
to a greater
percentage
change in QD
NORMAL
<1 Inelastic Percentage
change in
Income will lead
to a lesser
percentage
change in QD
INFERIOR

Applications of YED:
3/21/2020
MONICA
 For the Firm:
Determine pdn nos based on Income Inc/Dec
Inc Inferior Goods O/P-> Recession
Inc Normal Goods O/P -> Economy is proper
 For the Govt:
YED for G&S produced by nation’s economy
Tax revenue-> largest source -> Income Tax set
Inc/Dec IT-> Inc/Dec Disposable Income-> Inc/Dec
Demand for G&S in a nation
Tax Inc -> Disposable Goods Dec -> Dec in Normal
Goods & Inc in Inferior Goods
Tax Policy – Structured using these details

Elasticities - IB Economics

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