ACC 818 — Module 3: Elasticity
Elasticity measures how responsive one variable is to a change in another. Most commonly: how much quantity demanded reacts to a change in price.
Learning Outcomes
- Explain price elasticity of demand and how it’s measured
- Show the relationship between demand elasticity and total expenditure
- Explain price elasticity of supply
Topic 1: Price Elasticity of Demand
Formula: e = (% Change in Quantity Demanded) / (% Change in Price)
The relationship is naturally negative — but we report the absolute value to avoid confusion (“an elasticity of 2,” not “−2”).
| |e| | Type | Effect of price ↑ on Total Revenue | |----|------|-----| | > 1 | Elastic | TR ↓ | | = 1 | Unit elastic | TR unchanged | | < 1 | Inelastic | TR ↑ |
(Reverse for price ↓.)
- Perfectly inelastic demand — vertical curve. Quantity unchanged regardless of price (e.g. essential medication for a small group).
- Perfectly elastic demand — horizontal curve. Any quantity at the going price.
Key driver of elasticity: availability of substitutes. More substitutes → more elastic. Long-run elasticity is generally higher than short-run, because over time consumers find more substitutes.
Topic 2: Price Elasticity of Supply
Same logic, applied to supply. Always positive (supply curves slope upward). Higher number = more flexible/elastic supply.
Topic 3: Income and Cross Elasticity
- Income elasticity = (% ΔQd) / (% ΔIncome).
- Positive → normal good
- Negative → inferior good (e.g. used clothing — demand falls as income rises)
- Cross-price elasticity = (% ΔQx) / (% ΔPy).
- Positive → substitutes (price of Y rises → demand for X rises)
- Negative → complements (price of Y rises → demand for X falls)
Application: Tax Incidence
Who actually pays an excise tax (writes the cheque) vs. who bears the economic burden (real cost in higher prices or lower output) are different. Elasticity determines burden split:
- The less elastic side of the market bears more of the tax burden.
Key Terms
Price Elasticity of Demand · Elastic · Inelastic · Unit Elastic · Income Elasticity · Cross-Price Elasticity · Normal Good · Inferior Good · Substitutes · Complements · Tax Incidence