What this lesson teaches
I can use price elasticities of demand and supply to judge how large those changes will be.
Syllabus 8843, 2.1.2(g). Demand and Supply Analysis and its Applications: These outcomes can be affected by price elasticities of demand and supply
Make a guess
Two shops each lose 50 sales a week after a 10% price rise. One used to sell 100 a week, the other 5,000. Are their customers equally responsive?
- Yes. Both lost exactly the same number of sales each week.
- Yes. Both faced the same 10% price rise.
- No. The small shop lost 50%, the large shop only 1%.
Show the answer
No. The small shop lost 50%, the large shop only 1%.
Elasticity compares percentage changes. Losing 50 of 100 is a huge response; losing 50 of 5,000 is tiny.
Elasticity measures how strongly quantity responds to a change in price, income or another good's price.
Knowing that quantity falls when price rises is not enough. Firms and governments need to know by how much. Elasticity measures that.
It compares percentage changes, not raw numbers. A fall of 20 units is huge for a small shop and tiny for a supermarket; percentages make them comparable.
There are four elasticities in the syllabus. Price elasticity of demand (PED) and price elasticity of supply (PES) are for H1 and H2. Income elasticity (YED) and cross elasticity (XED) are H2 only.
On a diagram, a steeper demand curve through the same point usually means a smaller response to price: demand is more inelastic.
- Elasticity
- How strongly quantity responds to a change in another variable.
- Why percentages
- They make responses comparable across markets.
Worked example: Two shops lose 20 sales
Both shops raise their price by 10%. Shop A's weekly sales fall from 100 to 80. Shop B's fall from 1,000 to 980.
- Both lose 20 sales, but that means very different things.
- Shop A: 20 / 100 = a 20% fall. Quantity changes by more than the price: elastic.
- Shop B: 20 / 1,000 = a 2% fall. Quantity changes by less than the price: inelastic.
- Percentages show that shop A's customers are far more responsive.
Watch out for this
Both shops lost 20 sales, so their customers are equally responsive.
Elasticity uses percentage changes. 20 out of 100 is a much bigger response than 20 out of 1,000.
Check your understanding
Why does elasticity use percentage changes instead of the number of units?
- So that responses can be compared across markets of different sizes and units.
- Percentages give larger numbers, so small responses are easier to see.
- Official statistics are reported in percentages, so elasticity follows the same form.
Show the answer
So that responses can be compared across markets of different sizes and units.
Right. Percentages remove the effect of units and market size.